Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**(MarkOne)**

** **

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended April 3, 2010**

** **

**or**

** **

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**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 incorporation or organization |       | (I.R.S. Employer  Identification No.) |

 

**51 Discovery, Suite 150**

**Irvine, CA 92618**

 (Address ofprincipal executive offices) (Zip Code)

 

**(949) 435-0025**

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

** **

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   Yes x No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (section232.405 of this chapter) during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).   Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting 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) |   |                             |

 

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

 

Thenumber of shares outstanding of each of the registrant’s classes of commonstock as of the latest practicable date:

 

Common Stock, par value $0.001 per share

25,266,327 shares outstanding at April 30, 2010

 

 

 

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**Table of Contents**

** **

**NETLIST, INC. ANDSUBSIDIARIES**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE MONTHSENDED APRIL 3, 2010**

** **

**TABLE OF CONTENTS**

 
| ** **    | ** **                                                                                                                            | ** ** | **Page** |
|---------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I.  | FINANCIAL INFORMATION                                                                                                                 |       | 3        |
| Item 1.       | Financial Statements                                                                                                                  |       | 3        |
|          | Condensed  Consolidated Balance Sheets at April 3, 2010 (unaudited) and January 2,  2010 (audited)                          |       | 3        |
|          | Unaudited  Condensed Consolidated Statements of Operations for the Three Months Ended April 3,  2010 and April 4, 2009 |       | 4        |
|          | Unaudited  Condensed Consolidated Statements of Cash Flows for the Three Months Ended April 3,  2010 and April 4, 2009      |       | 5        |
|          | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                       |       | 6        |
| Item  2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                           |       | 20       |
| Item  3.      | Quantitative  and Qualitative Disclosures About Market Risk                                                                           |       | 31       |
| Item 4.       | Controls  and Procedures                                                                                                              |       | 31       |
| Item  4T.     | Controls  and Procedures                                                                                                              |       | 31       |
|          |                                                                                                                                  |       |     |
| PART II. | OTHER  INFORMATION                                                                                                                    |       | 31       |
| Item 1.       | Legal  Proceedings                                                                                                                    |       | 31       |
| Item 1A.      | Risk Factors                                                                                                                          |       | 31       |
| Item  2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                          |       | 31       |
| Item  3.      | Defaults  Upon Senior Securities                                                                                                      |       | 32       |
| Item 4.       | Removed  and Reserved                                                                                                                 |       | 32       |
| Item 5.       | Other  Information                                                                                                                    |       | 32       |
| Item 6.       | Exhibits                                                                                                                              |       | 32       |

 

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**Table of Contents**

** **

**PART I. FINANCIALINFORMATION**

 

**Item1. Financial Statements**

** **

**NETLIST, INC.AND SUBSIDIARIES**

**CondensedConsolidated Balance Sheets**

**(inthousands, except par value)**

** **
| ** **                                                                                                                 | ** ** | **(unaudited)**   | ** ** | **(audited)**       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                                                                                 | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
| ** **                                                                                                                 | ** ** | **2010**          | ** ** | **2010**            | ** ** |
| ** **                                                                                                                 | ** ** | ** **        | ** ** | ** **          | ** ** |
| **ASSETS**                                                                                                                 | ** ** | ** **        | ** ** | ** **          | ** ** |
| Current  assets:                                                                                                           |       |              |       |                |       |
| Cash  and cash equivalents                                                                                                 |       | $                 | 19,237     |                | $          | 9,942 |   |
| Investments  in marketable securities                                                                                      |       | 6,268             |       | 3,949               |       |
| Accounts  receivable, net                                                                                                  |       | 5,365             |       | 4,273               |       |
| Inventories                                                                                                                |       | 3,929             |       | 2,232               |       |
| Income  taxes receivable                                                                                                   |       | 649               |       | —              |       |
| Prepaid  expenses and other current assets                                                                                 |       | 880               |       | 854                 |       |
| Total  current assets                                                                                                      |       | 36,328            |       | 21,250              |       |
|                                                                                                                       |       |              |       |                |       |
| Property  and equipment, net                                                                                               |       | 4,409             |       | 4,779               |       |
| Long-term  investments in marketable securities                                                                            |       | 906               |       | 941                 |       |
| Other  assets                                                                                                              |       | 218               |       | 221                 |       |
| Total  assets                                                                                                              |       | $                 | 41,861     |                | $          | 27,191 |   |
|                                                                                                                       |       |              |       |                |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                              |       |              |       |                |       |
| Current  liabilities:                                                                                                      |       |              |       |                |       |
| Accounts  payable                                                                                                          |       | $                 | 5,388      |                | $          | 4,057 |   |
| Accrued  payroll and related liabilities                                                                                   |       | 1,758             |       | 2,332               |       |
| Accrued  expenses and other current liabilities                                                                            |       | 478               |       | 605                 |       |
| Accrued  engineering charges                                                                                               |       | 1,032             |       | 661                 |       |
| Current  portion of long-term debt                                                                                         |       | 101               |       | 108                 |       |
| Current  portion of deferred gain on sale and leaseback transaction                                                        |       | 79                |       | 108                 |       |
| Total  current liabilities                                                                                                 |       | 8,836             |       | 7,871               |       |
| Long-term  debt, net of current portion                                                                                    |       | 24                |       | 51                  |       |
| Total  liabilities                                                                                                         |       | 8,860             |       | 7,922               |       |
| Commitments  and contingencies                                                                                             |       |              |       |                |       |
| Stockholders’  equity:                                                                                                |       |              |       |                |       |
| Common  stock, $0.001 par value - 90,000 shares authorized; 24,780 (2010) and 20,111 (2009)  shares issued and outstanding |       | 25                |       | 20                  |       |
| Additional  paid-in capital                                                                                                |       | 88,059            |       | 71,332              |       |
| Accumulated  deficit                                                                                                       |       | (54,991           | )          | (52,026             | )          |
| Accumulated  other comprehensive loss                                                                                      |       | (92               | )          | (57                 | )          |
| Total  stockholders’ equity                                                                                           |       | 33,001            |       | 19,269              |       |
| Total  liabilities and stockholders’ equity                                                                           |       | $                 | 41,861     |                | $          | 27,191 |   |

** **

Seeaccompanying notes.

 

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**NETLIST, INC. AND SUBSIDIARIES**

**UnauditedCondensed Consolidated Statements of Operations**

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

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                        | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                        | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net  sales                                        |       | $                      | 7,890      |   | $ | 2,162 |   |
| Cost  of sales(1)                                 |       | 6,072                  |       | 2,699 |   |
| Gross  profit (loss)                              |       | 1,818                  |       | (537 | ) |
| Operating  expenses:                              |       |                   |       |   |   |
| Research  and development(1)                      |       | 3,008                  |       | 1,614 |   |
| Selling,  general and administrative(1)           |       | 2,570                  |       | 1,935 |   |
| Total  operating expenses                         |       | 5,578                  |       | 3,549 |   |
| Operating  loss                                   |       | (3,760                 | )          | (4,086 | ) |
| Other  income:                                    |       |                   |       |   |   |
| Interest  income, net                             |       | 1                      |       | 82 |   |
| Other  income, net                                |       | 67                     |       | 175 |   |
| Total  other income, net                          |       | 68                     |       | 257 |   |
| Loss  before (benefit) provision for income taxes |       | (3,692                 | )          | (3,829 | ) |
| (Benefit)  provision for income taxes             |       | (727                   | )          | 18 |   |
| Net  loss                                         |       | $                      | (2,965     | ) | $ | (3,847 | ) |
| Net  loss per common share:                       |       |                   |       |   |   |
| Basic                                             |       | $                      | (0.14      | ) | $ | (0.19 | ) |
| Diluted                                           |       | $                      | (0.14      | ) | $ | (0.19 | ) |
| Weighted-average  common shares outstanding:      |       |                   |       |   |   |
| Basic  and diluted                                |       | 20,688                 |       | 19,855 |   |

 

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| (1)   Amounts include stock-based compensation expense as follows: |   |   |   |   |   |
|-------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                                    |   |   |   |   |   |
| Cost  of sales                                                          |   | $      | 10     |   | $      | 29 |   |
| Research  and development                                               |   | 46     |   | 58     |   |
| Selling,  general and administrative                                    |   | 326    |   | 220    |   |
|                                                                         |        |        |        |        |        |  |  |

 

See accompanying notes.

 

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** **

**NETLIST, INC.AND SUBSIDIARIES**

**UnauditedCondensed Consolidated Statements of Cash Flows**

**(inthousands)**

 
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                   | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                                                   | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                                                   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Cash  flows from operating activities:                                       | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net  loss                                                                    |       | $                      | (2,965     | ) | $ | (3,847 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                   |       |   |   |
| Depreciation  and amortization                                               |       | 578                    |       | 581 |   |
| Amortization  of deferred gain on sale and leaseback transaction             |       | (29                    | )          | (30 | ) |
| Gain  on disposal of assets                                                  |       | —                 |       | (168 | ) |
| Stock-based  compensation                                                    |       | 382                    |       | 307 |   |
| Changes  in operating assets and liabilities:                                |       |                   |       |   |   |
| Accounts  receivable                                                         |       | (1,092                 | )          | 1,022 |   |
| Inventories                                                                  |       | (1,697                 | )          | 507 |   |
| Income  taxes receivable                                                     |       | (649                   | )          | 1,233 |   |
| Prepaid  expenses and other current assets                                   |       | (26                    | )          | (25 | ) |
| Other  assets                                                                |       | 3                      |       | 9 |   |
| Accounts  payable                                                            |       | 1,331                  |       | (466 | ) |
| Accrued  payroll and related expenses                                        |       | (574                   | )          | (75 | ) |
| Accrued  expenses and other current liabilities                              |       | (127                   | )          | 37 |   |
| Accrued  engineering charges                                                 |       | 371                    |       | — |   |
| Net  cash used in operating activities                                       |       | (4,494                 | )          | (915 | ) |
| Cash  flows from investing activities:                                       |       |                   |       |   |   |
| Acquisition  of property and equipment                                       |       | (208                   | )          | (22 | ) |
| Proceeds  from sales of equipment                                            |       | —                 |       | 276 |   |
| Purchase  of investments in marketable securities                            |       | (2,379                 | )          | (10,297 | ) |
| Proceeds  from maturities and sales of investments in marketable securities  |       | 60                     |       | 4,430 |   |
| Net  cash used in investing activities                                       |       | (2,527                 | )          | (5,613 | ) |
| Cash  flows from financing activities:                                       |       |                   |       |   |   |
| Borrowings  on line of credit                                                |       | 1,000                  |       | 4,916 |   |
| Payments  on line of credit                                                  |       | (1,000                 | )          | (4,916 | ) |
| Proceeds  from public offering, net                                          |       | 16,260                 |       | — |   |
| Proceeds  from exercise of stock options and warrants                        |       | 90                     |       | — |   |
| Payments  on debt                                                            |       | (34                    | )          | (123 | ) |
| Net  cash provided by (used in) financing activities                         |       | 16,316                 |       | (123 | ) |
| Increase  (decrease) in cash and cash equivalents                            |       | 9,295                  |       | (6,651 | ) |
| Cash  and cash equivalents at beginning of period                            |       | 9,942                  |       | 15,214 |   |
| Cash  and cash equivalents at end of period                                  |       | $                      | 19,237     |   | $ | 8,563 |   |
|                                                                         |       |                   |       |   |   |
| Supplemental  disclosure of non-cash investing activities:                   |       |                   |       |   |   |
| Unrealized  losses from investments in marketable securities                 |       | $                      | 35         |   | $ | — |   |

 

See accompanying notes.

 

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**NETLIST, INC.AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**April 3,2010**

** **

**Note 1—Descriptionof Business**

** **

Netlist, Inc. (the “Company” or “Netlist”) designs, manufacturesand sells high-performance, logic-based memory subsystems for the server,storage and communications equipment markets. The Company’s memory subsystemsconsist of combinations of dynamic random access memory integrated circuits,NAND flash memory, application —specific integrated circuits (“ASICs”) andother components assembled on printed circuit boards.  The Company primarily markets and sells itsproducts to leading original equipment manufacturer (“OEM”) customers. Netlist’ssolutions are targeted at applications where memory plays a key role in meetingsystem performance requirements.

 

**Note 2—Summary ofSignificant Accounting Policies**

** **

*Basis of Presentation*

* *

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 unauditedcondensed consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements and notes thereto forthe year ended January 2, 2010, included in the Company’s Annual Report onForm 10-K filed with the SEC on February 19, 2010.

 

The condensedconsolidated financial statements included herein as of April 3, 2010 areunaudited; however, they contain all normal recurring accruals and adjustmentsthat, in the opinion of the Company’s management, are necessary to present fairlythe consolidated financial position of the Company and its wholly ownedsubsidiaries as of April 3, 2010, the consolidated results of itsoperations for the three months ended April 3, 2010 and April 4,2009, and the consolidated cash flows for the three months ended April 3,2010 and April 4, 2009.  The resultsof operations for the three months ended April 3, 2010 are not necessarilyindicative of the results to be expected for the full year or any futureinterim periods.

 

*Reclassifications*

 

Certain amounts inthe 2009 financial statements have been reclassified to conform with thecurrent year presentation.

 

*Principlesof Consolidation*

 

The consolidated financial statements include theaccounts of Netlist, Inc. and its wholly owned subsidiaries. Allintercompany balances and transactions have been eliminated in consolidation.

 

*Fiscal Year*

* *

The Companyoperates under a 52/53-week fiscal year ending on the Saturday closest to December 31.  For fiscal 2010, the Company’s fiscal year isscheduled to end on January 1, 2011 and will consist of 52 weeks. Each ofthe Company’s first three quarters in a fiscal year is comprised of 13 weeks.

 

*Use of Estimates*

* *

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the U.S. requires management to make estimates andassumptions that affect the reported amounts of the assets and liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements, and the reported amounts of net sales and expenses duringthe reporting period. By their nature, these estimates and assumptions aresubject to an inherent degree of uncertainty. Significant estimates made by management include, among others,provisions for uncollectible receivables and sales returns, warrantyliabilities, valuation of inventories, fair value of financial instruments,impairment of long-lived assets, stock-based compensation expense andrealization of deferred tax assets. The Company bases its estimates on historicalexperience, knowledge of current conditions and our beliefs of what could occurin the future considering available information.  The Company reviews its estimates on anon-going basis.. The actual results experienced by the Company may differmaterially and adversely from its estimates. To the extent there are materialdifferences between the estimates and the actual results, future results ofoperations will be affected.

 

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* *

*Revenue Recognition*

 

TheCompany’s revenues primarily consist of product sales of high-performancememory subsystems to OEMs. Revenues also include sales of excessinventories to distributors and other users of memory integrated circuits (“ICs”)totaling approximately $0.1 million and $0.1 million, for the three monthsended April 3, 2010 and April 4, 2009, respectively.

 

TheCompany recognizes revenues in accordance with the Financial AccountingStandards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic605.  Accordingly, 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.

 

TheCompany generally uses customer purchase orders and/or contracts as evidence ofan arrangement. Delivery occurs when goods are shipped for customers with FOBShipping Point terms and upon receipt for customers with FOB Destination terms,at which time title and risk of loss transfer to the customer. Shippingdocuments are used to verify delivery and customer acceptance. The Companyassesses whether the sales price is fixed or determinable based on the paymentterms associated with the transaction and whether the sales price is subject torefund. Customers are generally allowed limited rights of return for up to30 days, except for sales of excess inventories, which contain noright-of-return privileges. Estimated returns are provided for at the time ofsale based on historical experience or specific identification of an eventnecessitating a reserve. The Company offers a standard product warranty to itscustomers and has no other post-shipment obligations. The Company assessescollectibility based on the creditworthiness of the customer as determined bycredit checks and evaluations, as well as the customer’s payment history.

 

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

 

*Cash and Cash Equivalents*

* *

Cashand cash equivalents consist of cash and short-term investments with originalmaturities of three months or less, other than short-term investments insecurities that lack an active market.

 

*Investments in MarketableSecurities*

* *

TheCompany accounts for its investments in marketable securities in accordancewith ASC Topic 320.  The Companydetermines the appropriate classification of its investments at the time ofpurchase and reevaluates such designation at each balance sheet date. TheCompany’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, net in the unaudited condensed consolidated statements ofoperations.

 

The Company generally invests its excess cash in domestic bank-issuedcertificates of deposit which carry federal deposit insurance, money marketfunds and in highly liquid debt instruments of U.S. municipalities,corporations and the U.S. government and its agencies. All highly liquidinvestments with stated maturities of three months or less from the date ofpurchase are classified as cash equivalents; all investments with statedmaturities of greater than three months are classified as investments inmarketable securities.

 

*Fair Value of FinancialInstruments*

* *

TheCompany’s financial instruments consist principally of cash and cashequivalents, investments in marketable securities, accounts receivable,accounts payable, accrued expenses and debt instruments.  Other than for certain investments in auctionrate securities (see Note 4), the fair value of the Company’s cash equivalentsand investments in marketable securities, other than commercial paper orshort-term corporate bonds,  isdetermined based on quoted prices in active markets for identical assets orLevel 1 inputs.  Because of their short-termnature, commercial paper and short-term corporate bonds are not frequentlytraded.  Although there are observablequotes for these securities, the markets are not considered active.  Accordingly, the fair values of theseinvestments are based on Level 2 inputs. The Company recognizes transfers between Levels 1 through 3 of the fairvalue hierarchy at the beginning of the reporting period.  The Company believes that the carrying valuesof all other financial instruments approximate their current fair values due totheir nature and respective durations.

 

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*Allowancefor Doubtful Accounts*

 

The Company evaluates the collectibility of accounts receivable basedon a combination of factors. In cases where the Company is aware ofcircumstances that may impair a specific customer’s ability to meet itsfinancial obligations subsequent to the original sale, the Company will recordan allowance against amounts due, and thereby reduce the net recognizedreceivable to the amount the Company reasonably believes will be collected. Forall other customers, the Company records allowances for doubtful accounts basedprimarily on the length of time the receivables are past due based on the termsof the originating transaction, the current business environment and itshistorical experience.  Uncollectibleaccounts are charged against the allowance for doubtful accounts when all costeffective commercial means of collection have been exhausted.

 

*Concentrationof Credit Risk*

 

Financial instruments that potentially subject the Company tosignificant concentrations of credit risk consist principally of cash and cashequivalents, investments in marketable securities, and accounts receivable.

 

The Company invests its cash equivalents primarilyin money market funds.  Cash equivalentsare maintained with high quality institutions, the composition and maturitiesof which are regularly monitored by management. The Company had $0.7 million ofFederal Deposit Insurance Corporation insured cash and cash equivalents at April 3,2010.  Investments in marketablesecurities are generally in high-credit quality debt instruments with an activeresale market. Such investments are made only in instruments issued or enhancedby high-quality institutions.  TheCompany has not incurred any credit risk losses related to these investments.

 

The Company’s trade accounts receivable are primarily derived fromsales to OEMs in the computer industry. The Company performs creditevaluations of its customers’ financial condition and limits the amount ofcredit extended when deemed necessary, but generally requires no collateral.The Company believes that the concentration of credit risk in its tradereceivables is moderated by its credit evaluation process, relatively shortcollection terms, the high level of credit worthiness of its customers (seeNote 3), and foreign credit insurance. Reserves are maintained for potentialcredit losses, and such losses historically have not been significant and havebeen within management’s expectations.

 

*Inventories*

* *

Inventoriesare valued at the lower of actual cost to purchase or manufacture the inventoryor net realizable value of the inventory. Cost is determined on an average costbasis which approximates actual cost on a first-in, first-out basis andincludes raw materials, labor and manufacturing overhead.  At each balance sheet date, the Companyevaluates its ending inventory quantities on hand and on order and records aprovision for excess quantities and obsolescence. Among other factors, theCompany considers historical demand and forecasted demand in relation to theinventory on hand, competitiveness of product offerings, market conditions andproduct life cycles when determining obsolescence and net realizable value ofraw material inventory. Provisions are made to reduce excess or obsoleteinventories to their estimated net realizable values. Once established,write-downs are considered permanent adjustments to the cost basis of theexcess or obsolete inventories.

 

*Propertyand Equipment*

 

Property and equipment are recorded at cost anddepreciated on a straight-line basis over their estimated useful lives, whichgenerally range from three to seven years. Leasehold improvements are recordedat cost and amortized on a straight-line basis over the shorter of theirestimated useful lives or the remaining lease term.

 

*Impairment of Long-Lived Assets*

 

The Company evaluates the recoverability of the carrying value oflong-lived assets held and used in its operations for impairment on at least anannual basis or whenever events or changes in circumstances indicate that theirnet book value may not be recoverable. When such factors and circumstances exist, the Company compares theprojected undiscounted future net cash flows associated with the related assetor group of assets over their estimated useful lives against their respectivecarrying amount.  These projected futurecash flows may vary significantly over time as a result of increasedcompetition, changes in technology, fluctuations in demand, consolidation ofour customers and reductions in average selling prices.  If the carrying value is determined not to berecoverable from future operating cash flows, the asset is deemed impaired andan impairment loss is recognized to the extent the carrying value exceeds theestimated fair value of the asset.  Thefair value of the asset or asset group is based on market value when available,or when unavailable, on discounted expected cash flows.

 

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*Warranties*

 

TheCompany offers warranties generally ranging from one to three years, dependingon the product and negotiated terms of the purchase agreements withcustomers.  Such warranties require theCompany to repair or replace defective product returned to the Company duringthe warranty period at no cost to the customer. Warranties are not offered onsales of excess inventory.  The Companyrecords an estimate for warranty-related costs at the time of sale based on itshistorical and estimated product return rates and expected repair orreplacement costs (see Note 3). Such costs have historically been consistentbetween periods and within management’s expectations and the provisionsestablished.

 

*Stock-Based Compensation*

* *

The Company accounts for equity issuances tonon-employees in accordance with ASC Topic 505. All transactions in which goods or services are the consideration receivedfor the issuance of equity instruments are accounted for based on the fairvalue of the consideration received or the fair value of the equity instrumentissued, whichever is more reliably measurable. The measurement date used todetermine the fair value of the equity instrument issued is the earlier of thedate on which the third-party performance is complete or the date on which itis probable that performance will occur.

 

In accordance with ASC Topic 718, employee anddirector stock-based compensation expense recognized during the period is basedon the value of the portion of stock-based payment awards that is ultimatelyexpected to vest during the period. Given that stock-based compensation expense recognized in theconsolidated statements of operations is based on awards ultimately expected tovest, it has been reduced for estimated forfeitures. ASC Topic 718 requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. TheCompany’s estimated average forfeiture rates are based on historical forfeitureexperience and estimated future forfeitures.

 

The fair value of common stock option awards toemployees and directors is calculated using the Black-Scholes option pricingmodel. The Black-Scholes model requires subjective assumptions regarding futurestock price volatility and expected time to exercise, along with assumptionsabout the risk-free interest rate and expected dividends, which affect the estimatedfair values of the Company’s common stock option awards.  The expected term of options granted iscalculated as the average of the weighted vesting period and the contractualexpiration date of the option.  Thiscalculation is based on the safe harbor method permitted by the SEC ininstances where the vesting and exercise terms of options granted meet certainconditions and where limited historical exercise data is available.  Prior to fiscal 2009, the expected volatilitywas based on the historical volatilities of the common stock of comparablepublicly traded companies based on management’s belief that the Company hadlimited historical data regarding the volatility of its stock price on which tobase a meaningful estimate of expected volatility. Beginning in fiscal 2009,the expected volatility is based on the historical volatility of the Company’scommon stock.  The risk-free rateselected to value any particular grant is based on the U.S. Treasury rate thatcorresponds to the expected term of the grant effective as of the date of thegrant. The expected dividend assumption is based on the Company’s history andmanagement’s expectation regarding dividend payouts.   Compensation expense for awards with gradedvesting schedules is recognized on a straight-line basis over the requisiteservice period for the last separately vesting portion of the award.

 

*Income Taxes*

* *

Under ASC Topic 270, theCompany is required to adjust its effective tax rate each quarter to beconsistent with the estimated annual effective tax rate. The Company is alsorequired to record the tax impact of certain discrete items, unusual orinfrequently occurring, including changes in judgment about valuationallowances and effects of changes in tax laws or rates, in the interim period inwhich they occur. In addition, jurisdictions with a projected loss for the yearor a year-to-date loss where no tax benefit can be recognized are excluded fromthe estimated annual effective tax rate. The impact of such an exclusion couldresult in a higher or lower effective tax rate during a particular quarter,based upon the mix and timing of actual earnings versus annual projections.

 

Deferred tax assets and liabilities are recognizedto reflect the estimated future tax effects, calculated at currently effectivetax rates, of future deductible or taxable amounts attributable to events thathave been recognized on a cumulative basis in the consolidated financialstatements.  A valuation allowancerelated to a net deferred tax asset is recorded when it is more likely than notthat some portion of the deferred tax asset will not be realized.

 

ASC Topic 740 prescribes a recognition threshold andmeasurement requirement for the financial statement recognition of a taxposition that has been taken or is expected to be taken on a tax return andalso provides guidance on de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. Under ASCTopic 740 the Company may only recognize or continue to recognize tax positionsthat meet a “more likely than not” threshold.

 

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*Researchand Development Expenses*

 

Research and development expenditures are expensed in the periodincurred.

 

*Collaborative Arrangement*

 

TheCompany has entered into a collaborative arrangement with a partner in order todevelop products using certain of the Company’s proprietary technology.  Under the arrangement, the developmentpartner was granted a non-exclusive license to specified intellectual propertyfor exclusive use in the development and production of ASIC chipsets for theCompany.  Both the Company and the developmentpartner provided and continue to provide engineering project managementresources at their own expense.  Thedevelopment partner is entitled to non-recurring engineering fees based uponthe achievement of development milestones, and to a minimum portion of theCompany’s purchasing allocations for the component.  Expenses incurred and paid to the developmentpartner are included in research and development expense in the accompanyingconsolidated statements of operations.

 

*Comprehensive Loss*

 

ASC Topic 220 establishes standards for reporting and displayingcomprehensive income and its components in the condensed consolidated financialstatements. Accumulated other comprehensive loss includes unrealized gains orlosses on investments.

 

*Risks and Uncertainties*

* *

The Company’s operations in the PRC are subject to various political,geographical and economic risks and uncertainties inherent to conductingbusiness in China. These include, but are not limited to, (i) potentialchanges in economic conditions in the region, (ii) managing a local workforcethat may subject the Company to uncertainties or certain regulatory policies, (iii) changesin other policies of the Chinese governmental and regulatory agencies, and (iv) changesin the laws and policies of the U.S. government regarding the conduct ofbusiness in foreign countries, generally, or in China, in particular.  Additionally, the Chinese government controlsthe procedures by which its local currency, the Chinese Renminbi (“RMB”), isconverted into other currencies and by which dividends may be declared orcapital distributed for the purpose of repatriation of earnings andinvestments.  If restrictions in theconversion of RMB or in the repatriation of earnings and investments throughdividend and capital distribution restrictions are instituted, the Company’soperations and operating results may be negatively impacted.  Restricted net assets of our subsidiary inthe PRC totaled $2.8 million and $2.7 million at April 3, 2010 and January 2,2010, respectively.

 

*Foreign CurrencyRe-measurement*

* *

The functionalcurrency of the Company’s foreign subsidiary is the U.S. dollar. Local currencyfinancial statements are re-measured into U.S. dollars at the exchange rate ineffect as of the balance sheet date for monetary assets and liabilities and thehistorical exchange rate for nonmonetary assets and liabilities. Expenses arere-measured using the average exchange rate for the period, except itemsrelated to nonmonetary assets and liabilities, which are re-measured usinghistorical exchange rates. All re-measurement gains and losses are included indetermining net loss.

 

*Net LossPer Share*

 

Basic net loss per share is calculated by dividing net loss by theweighted-average common shares outstanding during the period. Diluted net lossper share is calculated by dividing the net loss by the weighted-average sharesand dilutive potential common shares outstanding during the period. Dilutivepotential shares consist of dilutive shares issuable upon the exercise ofoutstanding stock options and warrants computed using the treasury stockmethod.  In periods of losses, basic anddiluted loss per share are the same, as the effect of stock options andwarrants on loss per share is anti-dilutive.

 

*New AccountingPronouncements*

* *

In September 2009,the FASB issued Accounting Standards Update (“ASU”) 2009-13, *Multiple-Deliverable Revenue Arrangements* (“ASU 2009-13”),which amends the revenue guidance under ASC Topic 605, which describes theaccounting for multiple element arrangements. ASU 2009-13 addresses how to determine whether an arrangement involvingmultiple deliverables contains more than one unit of accounting and howarrangement consideration shall be measured and allocated to the separate unitsof accounting in the arrangement.  ASU2009-13 is effective on a prospective basis for the Company’s fiscal year 2011,with earlier adoption permitted.  TheCompany is currently evaluating the adoption of ASU 2009-13 and the impact thatASU 2009-13 will have on its condensed consolidated financial statements.

 

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In September 2009,the FASB issued ASU 2009-14, *Certain RevenueArrangements That Include Software Elements* (“ASU 2009-14”), whichexcludes tangible products containing software components and non-softwarecomponents that function together to deliver the product’s essentialfunctionality from the scope of ASC Topic 985, which describes the accountingfor software revenue recognition.  ASU2009-14 is effective on a prospective basis for the Company’s fiscal year 2011,with earlier adoption permitted.  TheCompany is currently evaluating the impact that ASU 2009-14 will have on itscondensed consolidated financial statements.

 

In January 2010, theFASB issued ASU 2010-6, *Fair Value Measurementsand Disclosures: Improving Disclosures About Fair Value Measurement*(“ASU2010-6”), which affects the disclosures made about recurring and non-recurringfair value measurements.  The Companyadopted the expanded disclosure requirements in the quarter ended April 3,2010.

 

**Note3—Supplemental Financial Information**

** **

*Inventories*

 

Inventoriesconsist of the following (in thousands):

 
| ** **       | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|------------------|------------|-------------------|------------|---------------------|------------|
| ** **       | ** ** | **2010**          | ** ** | **2010**            | ** ** |
|             |       |              |       |                |       |
| Raw  materials   |       | $                 | 2,244      |                | $          | 997 |   |
| Work  in process |       | 457               |       | 342                 |       |
| Finished  goods  |       | 1,228             |       | 893                 |       |
|             |       | $                 | 3,929      |                | $          | 2,232 |   |

 

*WarrantyLiability*

 

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

 
| ** **                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                     | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                           | ** ** | ** **             |       |   |   |
| Beginning  balance             |       | $                      | 240        |   | $ | 277 |   |
| Charged  to costs and expenses |       | 40                     |       | 29 |   |
| Usage                          |       | (32                    | )          | (29 | ) |
| Ending  balance                |       | $                      | 248        |   | $ | 277 |   |

 

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

 

*FacilityRelocation Costs*

 

The followingtable summarizes the activity related to the Company’s accrual for facilityrelocation costs during the three months ended April 3, 2010 and April 4,2009 (in thousands):

 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                              | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                    | ** ** | ** **             |       |   |   |
| Beginning  balance                      |       | $                      | 84         |   | $ | 80 |   |
| Reversal  of accrual/reduction of costs |       | (28                    | )          | — |   |
| Net  payments                           |       | (8                     | )          | (1 | ) |
| Ending  balance                         |       | $                      | 48         |   | $ | 79 |   |

 

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In February 2010,a sublessor of a portion of the Company’s headquarters facility vacated thespace that it had subleased.  The Companydetermined that the space could be used in its operations.  As a result, the Company reversed $28,000 ofits accrual for facility relocation costs. The resulting expense reduction is included as a component of selling,general and administrative expenses in the accompanying condensed consolidatedstatement of operations for the three months ended April 3, 2010.

 

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

 

*Comprehensive Loss*

* *

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

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                       | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                                       | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                             |       |                   |       |   |   |
| Net  loss                                                        |       | $                      | (2,965     | ) | $ | (3,847 | ) |
| Other  comprehensive loss:                                       |       |                   |       |   |   |
| Change  in net unrealized gain (loss) on investments, net of tax |       | (35                    | )          | 32 |   |
| Total  comprehensive loss                                        |       | $                      | (3,000     | ) | $ | (3,815 | ) |

 

Accumulated othercomprehensive loss reflected on the condensed consolidated balance sheets at April 3,2010 and January 2, 2010, represents accumulated net unrealized losses oninvestments 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** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                                      | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Numerator:  Net loss                                            |       | $                      | (2,965     | ) | $ | (3,847 | ) |
| Denominator:  Weighted-average common shares outstanding, basic |       | 20,688                 |       | 19,855 |   |
| Net  loss per share, basic and diluted                          |       | $                      | (0.14      | ) | $ | (0.19 | ) |

 

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** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Common  share equivalents |       | 2,270                  |       | 121 |   |

 

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.

 

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* *

*MajorCustomers*

 

Net sales to someof our OEM customers include memory modules that are qualified by us directlywith the OEM customer and sold to electronic manufacturing services providers(“EMSs”), for incorporation into products manufactured exclusively for the OEMcustomer or in some instances, to facilitate credit and logistics. These netsales to EMSs have historically fluctuated period to period as a portion of thetotal net sales to the OEM customers. Net sales to Hon Hai Precision Industry Co. Ltd., an EMS operating underthe trade name Foxconn that purchases memory modules from us for incorporationinto products manufactured exclusively for Dell, represented approximately 89%and 67% of net sales to Dell for the three months ended April 3, 2010 and April 4,2009, respectively.  Arrow Electronics,Inc. (“Arrow”) is an EMS for DRS Electronics, Inc. (“DRS Electronics”).  Substantially all of our products sold toArrow are incorporated into components manufactured for DRS Electronics.  Similarly, Flextronics International Ltd.(“Flextronics”) distributes substantially all of the products purchased from usto F5 Networks, Inc (“F5 Networks”). The following table sets forth salesto customers comprising 10% or more of the Company’s net sales for the periodspresented:

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                | ** ** | **2010**               | ** ** | **2009** | ** ** |
| **Customer:**                             |       |                   | ** ** | ** ** | ** ** |
| Foxconn (Dell Computer)                   |       | 37                     | %          | 33 | % |
| Flextronics  (F5 Networks)                |       | 31                     | %          | * | % |
| Arrow  Electronics Inc. (DRS Electronics) |       | 16                     | %          | 21 | % |

 

----

*  less than 10% of net sales

 

The Company’saccounts receivable are concentrated with three customers at April 3, 2010representing approximately 41%, 39% and 15% of aggregate gross receivables. Asignificant reduction in sales to, or the inability to collect receivablesfrom, a significant customer could have a material adverse impact on theCompany.

 

*Cash FlowInformation*

 

The followingtable sets forth cash paid (received) for income taxes and interest for theperiods presented (in thousands):

 
| ** **                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                     | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                           |       |                        |       |   |   |
| Income  taxes refunds received |       | $                      | —     |   | $ | (23 | ) |
| Interest  paid                 |       | $                      | 21         |   | $ | 11 |   |

 

**Note4—Fair Value Measurements**

** **

The followingtable details the fair value measurements within the fair value hierarchy ofthe Company’s investments in marketable securities (in thousands):

 
| ** **                                   | ** ** | ** **        | ** ** | **Fair Value Measurements at April 3, 2010 Using** | ** ** |
|----------------------------------------------|------------|-------------------|------------|---------------------------------------------------------|------------|
| ** **                                   | ** ** | ** **        | ** ** | **Quoted Prices in**                                    | ** ** | **Significant Other** | ** ** | **Significant** | ** ** |
| ** **                                   | ** ** | **Fair Value at** | ** ** | **Active Markets for**                                  | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                                   | ** ** | **April 3,** | ** ** | **Identical Assets**                                    | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| ** **                                   | ** ** | **2010**          | ** ** | **(Level 1)**                                           | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| ** **                                   |       |              |       |                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Available  for sale debt securities:         | ** ** | ** **        |       |                                                    |       |   | ** ** | ** ** | ** ** |
| Obligations  of the United States government |       | $                 | 998        |                                                    | $          | 998 |   | $ | — |   | $ | — |   |
| Federal  agency notes and bonds              |       | 501               |       | 501                                                     |       | — |   | — |   |
| Commercial  paper                            |       | 2,098             |       | —                                                  |       | 2,098 |   | — |   |
| Corporate  notes and bonds                   |       | 2,671             |       | —                                                  |       | 2,671 |   | — |   |
| Auction  and variable floating rate notes    |       | 906               |       | —                                                  |       | — |   | 906 |   |
| Total                                        |       | $                 | 7,174      |                                                    | $          | 1,499 |   | $ | 4,769 |   | $ | 906 |   |

 

As of January 3,2010, the Company reclassified its investments in commercial paper andcorporate notes and bonds, with a fair value of $2,891,000, from assetsmeasured at fair value using Level 1 inputs to assets measured at fair value usingLevel 2 inputs.  The transfer resultedfrom solely from management’s reassessment of the level of activity in thesecondary 

 

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market for theseinvestments, which historically has been low due to the short-term nature ofthe instruments.  Management does notbelieve that the reassessment in any way reflects a change in the actualliquidity or credit quality of these investments.  The reassessment was precipitated by a changein custodial institutions in connection with the Company’s new revolving creditagreement (see Note 6).

 

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):

 
| ** **                                                        | ** ** | **Three Months  Ended** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                        | ** ** | **April 3,**       | ** ** |
| ** **                                                        | ** ** | **2010**                | ** ** |
| ** **                                                        | ** ** | ** **              | ** ** |
| Beginning  balance                                                |       | $                       | 941        |   |
| Unrealized  loss included in accumulated other comprehensive loss |       | (35                     | )          |
| Ending  balance                                                   |       | $                       | 906        |   |

 

**Note5—Investments in Marketable Securities**

** **

Investments in marketable securities consist of the following at April 3,2010 (in thousands):

 
| ** **                                   | ** ** | **April 3, 2010** | ** ** |
|----------------------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | ** **             | ** ** | **Net** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Amortized**          | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**               | ** ** | **Gain (Loss)** | ** ** | **Value** | ** ** |
|                                         |       |                   |       |   |   |   |   |
| Obligations of the  United States government |       | $                      | 997        |   | $ | 1 |   | $ | 998 |   |
| Federal agency notes  and bonds              |       | 502                    |       | (1 | ) | 501 |   |
| Commercial paper                             |       | 2,098                  |       | — |   | 2,098 |   |
| Corporate notes and  bonds                   |       | 2,667                  |       | 4 |   | 2,671 |   |
| Auction and variable  floating rate notes    |       | 1,002                  |       | (96 | ) | 906 |   |
|                                         |       | $                      | 7,266      |   | $ | (92 | ) | $ | 7,174 |   |

 

Realized gains and losses on the sale of investments in marketablesecurities are determined using the specific identification method.  Net realized gains recorded during the threemonths ended April 3, 2010 were not significant.

 

Thefollowing table provides the breakdown of investments in marketable securitieswith unrealized losses at April 3, 2010 (in thousands):

 
| ** **                                | ** ** | **April 3, 2010**         | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **Continuous Unrealized Loss** | ** ** |
| ** **                                | ** ** | **Less than 12 months**        | ** ** | **12 months or greater** | ** ** |
| ** **                                | ** ** | **Fair**                       | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                                | ** ** | **Value**                      | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
|                                      |       |                           |       |   |   |   |   |   |   |
| Federal  agency notes and bonds           |       | $                              | 501        |   | $ | (1 | ) | $ | — |   | $ | — |   |
| Corporate  notes and bonds                |       | 844                            |       | (1 | ) | — |   | — |   |
| Auction  and variable floating rate notes |       | —                         |       | — |   | 906 |   | (96 | ) |
|                                      |       | $                              | 1,345      |   | $ | (2 | ) | $ | 906 |   | $ | (96 | ) |

 

As of April 3, 2010, the Company held four investments that werein an unrealized loss position.

 

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*AuctionRate Securities*

 

Disruptions in thecredit market continue to adversely affect the liquidity and overall market forauction rate securities. As of April 3, 2010 and January 2, 2010, theCompany held two investments in auction rate securities with a total purchasecost of $1.0 million. These two investments represent (i) a Baa1 rated,fully insured debt obligation of a municipality and (ii) an A3 rated debtobligation backed by pools of student loans guaranteed by the U.S. Departmentof Education. Given the insufficient observable market inputs and relatedinformation available, the Company has classified its investments in auctionrate securities within Level 3 of the fair value hierarchy (see Note 4).

 

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 April 3,2010. The Company has concluded that the estimated gross unrealized losses onthese investments, which totaled approximately $96,000 at April 3, 2010,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 relatively high credit quality andinterest is paid as due and (iii) the Company has the intent and abilityto hold these investments 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 $1,000 and $1,000 asof April 3, 2010 and January 2, 2010, respectively, and are generallydue to the ongoing uncertainties in the credit and financial markets, as wellas changes in interest rates. The fair value of these investments wasdetermined based on Level 1 and Level 2 inputs, consisting of quoted pricesfrom actual market transactions for identical investments. The Company hasdetermined that the unrealized losses on these investments as of April 3,2010 are temporary in nature. Factors considered in determining whetherimpairments are other than temporary include (i) the length of time andextent to which fair value has been less than the amortized cost basis, (ii) thefinancial condition and near-term prospects of the investee and (iii) theCompany’s intent and ability to hold an investment for a period of timesufficient to allow for any anticipated recovery in market value.

 

The Company maintains an investment portfolio of various holdings,types and maturities. The Company invests in instruments that meet high qualitycredit standards, as specified in its investment policy guidelines. Theseguidelines generally limit the amount of credit exposure to any one issue,issuer or type of instrument. The fair value of the Company’s investments inmarketable securities could change significantly in the future and the Companymay be required to record other-than-temporary impairment charges or additionalunrealized losses in future periods.

 

The following table presents the amortized cost and fair value of theCompany’s investments in marketable securities classified as available-for-saleat April 3, 2010 by contractual maturity (in thousands):

 
| ** **               | ** ** | **April 3, 2010** | ** **  |
|--------------------------|------------|------------------------|-------------|
| ** **               | ** ** | **Amortized**          | ** **  | **Fair** | ** ** |
| ** **               | ** ** | **Cost**               | ** **  | **Value** | ** ** |
|                     |       |                   |        |   |   |
| **Maturity**             | ** ** | ** **             | ** **  | ** ** | ** ** |
| Less  than one year      |       | $                      | 6,264       |   | $ | 6,268 |   |
| One  to two years        |       | —                 |        | — |   |
| Greater  than two years* |       | 1,002                  |        | 906 |   |
|                     |       | $                      |  7,266 |   | $ | 7,174 |   |

 

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*               Comprised of auction rate securitieswhich generally have reset dates of 90 days or less but final contractualmaturity dates in excess of 15 years.

 

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**Note6—Credit Agreement**

** **

On October 31,2009, the Company entered into a revolving credit agreement with a financialinstitution.  Under the original terms of the credit agreement, theCompany could borrow up to the lesser of (i) 80% of eligible accountsreceivable, minus $1.0 million, or (ii) $5.0 million.  The revolvingcredit agreement was amended on March 24, 2010 to allow for increasedaccounts receivable eligibility and to remove the $1.0 million reduction fromthe calculated accounts receivable borrowing base.  The credit agreement contains an overallsublimit of $2.5 million to collateralize the Company’s contingent obligationsunder letters of credit, foreign exchange contracts and cash managementservices.  Amounts outstanding under the overall sublimit reduce theamount available pursuant to the credit agreement.  At April 3, 2010, a letter of credit inthe amount of $0.5 million was outstanding. The letter of credit expires on September 30, 2010.

 

Interest ispayable monthly at either (i) prime plus 1.25%, as long as the Company maintains$8.5 million in revolving credit availability plus unrestricted cash on depositwith the financial institution, or (ii) prime plus 2.25%.  Theminimum monthly interest due is $3,750 minus the aggregate amount of anyinterest earned by the bank. The credit agreement matures on October 30,2010, at which time all advances and interest are due and payable.

 

The Company’s previous credit facility, which consisted of a revolvingline of credit and a non-revolving equipment line, expired on August 31,2009 and all borrowings were repaid to the bank.  Interest on the credit facility was payablemonthly at the greatest of (i) the sum of the prime rate plus 3%, (ii) LIBORplus 6% or (iii) 8%.

 

The following table presents details of interestexpense related to borrowings on revolving credit lines, along with certainother applicable information (in thousands):

 
| ** **        | ** ** | **Three Months Ended** | ** ** |
|-------------------|------------|------------------------|------------|
| ** **        | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **        | ** ** | **2010**               | ** ** | **2009** | ** ** |
|              |       |                   |       |   |   |
| Interest  expense |       | $                      | 11         |   | $ | 3 |   |
|                   |            |                        |            |  |  |  |  |

 
| ** **                                                 | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | **2010**          | ** ** | **2010**            | ** ** |
| Outstanding  borrowings on the revolving line of credit    |       | $                 | —     |                | $          | — |   |
| Borrowing  availability under the revolving line of credit |       | $                 | 3,344      |                | $          | — |   |

 

Obligationsunder this revolving credit agreement are secured by a first priority lien onthe Company’s tangible and intangible assets. In connection with the revolving credit agreement, the Company enteredinto an Intercompany Subordination Agreement, which provided that one of theCompany’s subsidiaries, Netlist Technology Texas, LP, is an additional obligoron the revolving credit agreement.

 

The revolvingcredit agreement subjects the Company to certain affirmative and negativecovenants, including financial covenants with respect to the Company’sliquidity and profitability and restrictions on the payment of dividends. As of April 3, 2010, the Company was in compliance with its financialcovenants.

 

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**Note 7—Long-TermDebt**

** **

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

 
| ** **                        | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|-----------------------------------|------------|-------------------|------------|---------------------|------------|
| ** **                        | ** ** | **2010**          | ** ** | **2010**            | ** ** |
|                              | ** ** | ** **        |       |                |       |
| Obligations  under capital leases |       | $                 | 125        |                | $          | 159 |   |
| Less  current portion             |       | (101              | )          | (108                | )          |
|                              |       | $                 | 24         |                | $          | 51 |   |

 

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

 
| ** **        | ** ** | **Three Months Ended** | ** ** |
|-------------------|------------|------------------------|------------|
| ** **        | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **        | ** ** | **2010**               | ** ** | **2009** | ** ** |
|              |       |                   |       |   |   |
| Interest  expense |       | $                      | 3          |   | $ | 11 |   |
|                   |            |                        |            |  |  |  |  |

 

**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** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                            | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                            |       |                   |       |   |   |
| (Benefit)  provision for income taxes |       | $                      | (727       | ) | $ | 18 |   |
| Effective  tax rate                   |       | 19.7                   | %          | (0.50 | )% |
|                                       |            |                        |            |  |  |  |  |

 

The Company is required toadjust its effective tax rate each quarter to be consistent with the estimatedannual effective tax rate.  The Companyis also required to record the tax impact of certain discrete items, unusual orinfrequently occurring, including changes in judgment about valuationallowances and effects of changes in tax laws or rates, in the interim periodin which they occur.  During the quarterended April 3, 2010, the Company carried back approximately $1.7 millionof gross net operating losses under the Worker, Homeownership, and Business Actand recorded a tax benefit and income tax receivable of approximately $0.7million.  In addition, jurisdictions witha projected loss for the year or a year-to-date loss where no tax benefit canbe recognized are excluded from the estimated annual effective tax rate.  The impact of such an exclusion could resultin a higher or lower effective tax rate during a particular quarter, based uponthe mix and timing of actual earnings versus annual projections.

 

The Company evaluateswhether a valuation allowance should be established against its deferred taxassets based on the consideration of all available evidence using a “morelikely than not” standard.  Due to uncertainty of future utilization,the Company has provided a full valuation allowance as of April 3, 2010and January 2, 2010.  Accordingly,no benefit has been recognized for net deferred tax assets, including netoperating losses that cannot be realized currently via carryback to periods oftaxable income.

 

The Company hadunrecognized tax benefits at April 3, 2010 and January 2, 2010 ofapproximately $0.1 million that, if recognized, would affect the Company’sannual effective tax rate.

 

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**Note9—Commitments and Contingencies**

** **

*Litigation*

 

*Federal Securities Class Action*

 

Beginning in May 2007, the Company, certain ofits officers and directors, and the Company’s underwriters were named asdefendants in four purported class action shareholder complaints, two of whichwere filed in the U.S. District Court for the Southern District of New York,and two of which were filed in the U.S. District Court for the Central Districtof California. These purported class action lawsuits were filed on behalf ofpersons and entities who purchased or otherwise acquired the Company’s commonstock pursuant or traceable to the Company’s November 30, 2006 initialpublic offering (the “IPO”). The lawsuits were consolidated into a singleaction—Belodoff v. Netlist, Inc., Lead Case No. SACV07-677 DOC(MLGx)—which is currently pending in the Central District of California. LeadPlaintiff filed the Consolidated Complaint in November 2007. Defendantsfiled their motions to dismiss the Consolidated Complaint in January 2008.The motions to dismiss were taken under submission in April 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 (“Amended Complaint”) in July 2008.The defendants filed motions to dismiss the Amended Complaint in January 2009,and on April 17, 2009, the court granted defendants’ motions to dismiss.However, plaintiffs were again granted the right to amend their complaint.Plaintiffs’ filed their Second Amended Consolidated Class Action Complaint(“Second Amended Complaint”) in May 2009. Generally, the Second AmendedComplaint, like the preceding complaints, alleged that the RegistrationStatement filed by the Company in connection with the IPO contained untruestatements of material fact or omissions of material fact in violation ofSections 11 and 15 of Securities Act of 1933. Defendants filed motions todismiss the Second Amended Complaint in June 2009. The motions to dismisswere taken under submission in August 2009 and on September 1, 2009,the Court granted the defendants’ motions. However, plaintiffs again weregranted the right to amend their complaint.

 

In December 2008,  the parties reached a tentative agreement inprinciple to settle the class action. In February 2010, the partiesexecuted a Stipulation and Agreement of Settlement documenting the essentialterms of the proposed settlement, informed the court of their proposedsettlement, and drafted a joint motion to submit to the court for preliminaryapproval of the proposed settlement. Under the settlement agreement presentedto the court for approval, plaintiffs and the class will dismiss all claims,with prejudice, in exchange for a cash payment of $2.6 million. TheCompany’s directors’ and officers’ liability insurers will pay the settlementamount in accordance with the Company’s insurance policies.

 

On April 19, 2010, the court issued an orderpreliminarily approving the settlement. A final settlement approval hearing is scheduled to be held on September 30,2010. Despite the proposed agreement to settle this action, the Companybelieves that the allegations lack merit and, if necessary, intends tovigorously defend all claims asserted. The Company makes no assurances at thistime that the court will grant final approval of the proposed settlement termsor that the matter ultimately will be settled.

 

*PatentClaims*

 

In May 2008, the Company initiated discussions with Google, Inc.regarding the Company’s claims that Google has infringed on a US patentassigned to the Company relating generally to “rank multiplication” in memorymodules. On August 29, 2008, Google filed a declaratory judgment lawsuitagainst the Company in United States District Court for the Northern Districtof California, seeking a declaration that Google did not infringe on theCompany’s patent, and that the Company’s patent is invalid. Google is not seekingany monetary damages. On November 18, 2008, the Company filed acounterclaim for infringement of the patent by Google. Claim constructionproceedings were held on November 14, 2009, and the Company prevailed onevery disputed claim construction issue. Trial is currently set for November 2010.

 

OnDecember 4, 2009, the Company filed a patent infringement suit againstGoogle in the United States District Court for the Northern District ofCalifornia, seeking damages and injunctive relief based on Google’s infringementof a recently issued patent related to the Company’s patent-in-suit in the August 29,2008 declaratory judgment action filed by Google. On February 11, 2010,Google answered the Company’s complaint and has asserted counterclaims againstthe Company seeking a declaration that the patent is invalid and not infringed,and claiming that the Company committed fraud, negligent misrepresentation andcontractual breaches in connection with the setting of standards covered by thepatent. The counterclaim seeks unspecified compensatory damages.  On April 30, 2010, the parties attendeda court ordered settlement conference but the dispute remains unresolved. TheCompany intends to vigorously pursue its infringement claims against Google andto vigorously defend against Google’s claims.

 

On March 17, 2009, the Company filed a complaint for patentinfringement against MetaRAM, Inc. for its infringement of one of theCompany’s patents. On March 26, 2009, MetaRAM filed a complaint againstthe Company for patent infringement. Both actions were settled on December 21,2009. Pursuant to the Settlement Agreement, MetaRAM agreed to no longer sellthe accused product at issue in the case filed by the Company, and the partiesexecuted conditional licenses to one another for the respective patents-in-suitin the two actions.

 

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On September 22, 2009, the Company filed a patent infringementlawsuit against Inphi Corporation in the United States District Court for theCentral District of California. The suit alleges that Inphi is contributorilyinfringing and actively inducing the infringement of a US patent assigned tothe Company which is directed to memory modules with load isolation and memorydomain translation capabilities. The Company is seeking damages and injunctiverelief based on Inphi’s use of its patented technology. On December 22,2009, Netlist filed an Amended Complaint asserting claims of patentinfringement based on two additional patents concerning load isolation andmemory domain translation technologies. Inphi has denied infringement and hasasserted that the patents-in-suit are invalid. On April 20, 2010, Inphi fileda request for reexamination of all three patents in suit with the United StatesPatent and Trademark Office (“PTO”). Shortly thereafter, on April 30, 2010, the PTO rejected Inphi’sinitial request. On May 7, 2010, Inphi re-filed its request for reexaminationof all three patents.  The Companyintends to vigorously pursue its infringement claims and to vigorously defendagainst any further claims of invalidity in the PTO as well as the Court.

 

On November 30, 2009, Inphi Corporation filed a patent infringementlawsuit against the Company in the United States District Court for the CentralDistrict of California alleging infringement of two patents related to memorymodule output buffers. The Company recently answered Inphi’s Complaint andintends to vigorously defend against Inphi’s claims of infringement.

 

On March 24,2010, Ring Technologies Enterprises filed a patent infringement lawsuit in theUnited States District Court for the Eastern District of Texas against DellComputer and its suppliers.  The suitalleges that the Company and forty-two (42) other defendants infringed on itspatent no. 6,879,526.  The Company ispreparing an answer to Ring Technologies’ complaint and intends to vigorouslydefend against Ring Technologies’ claims of infringement.

 

*TradeSecret Claim*

 

On November 18, 2008, the Company filed a claim for trade secretmisappropriation against Texas Instruments (“TI”) in Santa Clara CountySuperior Court, based on TI’s disclosure of confidential Company materials tothe JEDEC standard-setting body.  On May 7,2010, the parties entered into a settlement agreement. The court dismissed thecase with prejudice.

 

*OtherContingent Obligations*

 

During its normal course of business, the Company has made certainindemnities, commitments and guarantees under which it may be required to makepayments in relation to certain transactions. These include (i) intellectualproperty indemnities to the Company’s customers and licensees in connectionwith the use, sales and/or license of Company products; (ii) indemnitiesto vendors and service providers pertaining to claims based on the Company’snegligence or willful misconduct; (iii) indemnities involving the accuracyof representations and warranties in certain contracts; (iv) indemnitiesto directors and officers of the Company to the maximum extent permitted underthe laws of the State of Delaware; and (v) certain real estate leases,under which the Company may be required to indemnify property owners forenvironmental and other liabilities, and other claims arising from the Company’suse of the applicable premises. The duration of these indemnities, commitmentsand guarantees varies and, in certain cases, may be indefinite. The majority ofthese indemnities, commitments and guarantees do not provide for any limitationof the maximum potential for future payments the Company could be obligated tomake. Historically, the Company has not been obligated to make significantpayments for these obligations, and no liabilities have been recorded for theseindemnities, commitments and guarantees in the accompanying condensedconsolidated balance sheets.

 

**Note10—Stockholders’ Equity**

** **

*Common Stock*

* *

*On March 24,2010, the Company sold 4,594,250 shares of common stock in a registered publicoffering.  The shares were sold to thepublic at a price of $3.85 per share. The Company received net proceeds of $16.3 million, after underwritingdiscounts and commissions, and estimated expenses payable by the Company.*

* *

*Common Stock Options*

* *

A summary of theCompany’s common stock option activity as of and for the three months ended April 3,2010 is presented below (shares in thousands):

 
| ** **                                   | ** ** | ** **    | ** ** | **Weighted-** | ** ** |
|----------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                   | ** ** | ** **    | ** ** | **Average**   | ** ** |
| ** **                                   | ** ** | **Number of** | ** ** | **Exercise**  | ** ** |
| ** **                                   | ** ** | **Shares**    | ** ** | **Price**     | ** ** |
| Options  outstanding at January 2, 2010 |       | 4,298         |       | $             | 2.41       |   |
| Options  granted                             |       | 235           |       | 4.44          |       |
| Options  exercised                           |       | (56           | )          | 1.19          |       |
| Options  cancelled                           |       | —        |       | —        |       |
| Options  outstanding at April 3, 2010   |       | 4,477         |       | $             | 2.54       |   |

 

The intrinsicvalue of options exercised in the three months ended April 3, 2010 was$0.2 million.

 

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The followingtable presents details of the assumptions used to calculate theweighted-average grant date fair value of common stock options granted by theCompany:

 
| ** **                                        | ** ** | **Three  Months  Ended** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|
| ** **                                        | ** ** | **April 3,**        | ** ** |
| ** **                                        | ** ** | **2010**                 | ** ** |
| Expected  term (in years)                         |       | 5.5                      |       |
| Expected  volatility                              |       | 148                      | %          |
| Risk-free  interest rate                          |       | 2.61                     | %          |
| Expected  dividends                               |       | —                   |       |
| Weighted-average  grant date fair value per share |       | $                        | 4.10       |   |
|                                                   |            |                          |            |  |

 

*TheCompany did not issue options in the period ended April 4, 2009.*

* *

*At April 3,2010, the amount of unearned stock-based compensation currently estimated to beexpensed from fiscal 2010 through fiscal 2014 related to unvested common stockoptions is approximately $1.9 million, net of estimated forfeitures. Theweighted-average period over which the unearned stock-based compensation isexpected to be recognized is approximately 2.6 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.*

* *

*Warrants*

* *

A summary ofactivity with respect to outstanding warrants to purchase shares of the Company’scommon stock as of and for the three months ended April 3, 2010 ispresented below (shares in thousands):

 
| ** **                                                  | ** ** | ** **    | ** ** | **Weighted-** | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                  | ** ** | ** **    | ** ** | **Average**   | ** ** |
| ** **                                                  | ** ** | **Number of** | ** ** | **Exercise**  | ** ** |
| ** **                                                  | ** ** | **Shares**    | ** ** | **Price**     | ** ** |
| Warrants  outstanding at January 2, 2010               |       | 18            |       | $             | 1.25       |   |
| Warrants  exercised                                         |       | (18           | )          | 1.25          |       |
| Warrants  outstanding and exercisable at April 3, 2010 |       | —        |       | $             | —     |   |

 

**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 April 3,2010 and January 2, 2010, approximately $2.7 million and $3.0 million,respectively, of the Company’s net long-lived assets were located in the PRC.

 

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

** **

**CautionaryStatement**

** **

*Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our Unaudited CondensedConsolidated Financial Statements and the related notes thereto contained in Part I,Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Qis not a complete description of our business or the risks associated with aninvestment in our common stock. We urge you to carefully review and considerthe various disclosures made by us in this Report and in our other reportsfiled with the Securities and Exchange Commission, or SEC, including our AnnualReport on Form 10-K for the fiscal year ended January 2, 2010 andsubsequent reports on Form 8-K, which discuss our business in greaterdetail.*

 

*Thesection entitled “Risk Factors” set forth in Part I, Item 1A of our AnnualReport on Form 10-K for the fiscal year ended January 2, 2010 filedwith the Securities and Exchange Commission on February 19, 2010, andsimilar discussions in our other SEC filings, describe some of the importantrisk factors that may affect our business, results of operations and financialcondition. You should carefully consider those risks, in addition to the otherinformation in this Report and in our other filings with the SEC, beforedeciding to purchase, hold or sell our common stock.*

 

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*ThisReport contains forward-looking statements that involve risks, uncertainties,estimates and assumptions. These statements are not guarantees of futureperformance and are subject to certain risks, uncertainties and assumptionsthat are difficult to predict. Therefore, our actual results could differmaterially and adversely from those expressed in any forward-looking statementsas a result of various factors, including but not limited to those identifiedunder the heading “Risk Factors” set forth in Part II, Item 1A of thisReport and in our Annual Report on Form 10-K for the year ended January 2,2010.  Except as required by law, weundertake no obligation to revise or update publicly any forward-lookingstatements for any reason.*

 

**Overview**

** **

We design, manufacture and sell high-performance, logic-based memorysubsystems for the server, storage and communications equipment markets. Ourmemory subsystems consist of combinations of dynamic random access memoryintegrated circuits (“DRAM ICs” or “DRAM”), NAND flash memory (“NAND”),application-specific integrated circuits (“ASICs”) and other componentsassembled on printed circuit boards (“PCBs”). We primarily market and sell our products to leading original equipmentmanufacturer (“OEM”) customers.  Oursolutions are targeted at applications where memory plays a key role in meetingsystem performance requirements.

 

In November 2009, we introduced HyperCloudTMDDR3 memory technology.  HyperCloudTMutilizes an ASIC chipset that incorporates Netlist patented rank multiplicationtechnology that increases memory capacity and load reduction functionality thatincreases memory bandwidth.  We expectthat this achievement will make possible improved levels of performance formemory intensive datacenter applications and workloads, including searchengines, social networks/communications, media internet portals,virtualization, and high performance scientific and defense-relatedcomputing.  HyperCloudTM memory is beingevaluated by several of our OEM customers for use in their serverproducts.  HyperCloudTM is interoperablewith Joint Electronics Devices Engineering Council (“JEDEC”) standard DDR3memory modules.  As of April 3,2010, we have not shipped any production quantities of HyperCloudTM.

 

In February 2010, we announced generalavailability of NetVaultTM, anon-volatile cache memory subsystem targeting Redundant Array of IndependentDisks, (“RAID”) storage applications. NetVaultTM provides server and storage OEMs a solutionfor enhanced datacenter fault recovery. Unlike traditional battery-poweredfault tolerant cache schemes which rely solely on batteries to power the cache,NetVaultTM utilizes a combination of DRAM for highthroughput performance and flash for extended data retention.

 

Our HyperCloudTM products can be installed in servers without the needfor a bios change.  As such, their designand anticipated sales launch is not dependent on the design plans or productcycle of our OEM customers. Alternatively, when developing custom modules for an equipment productlaunch, we engage with our OEM customers from the earliest stages of newproduct definition, providing us unique insight into their full range of systemarchitecture and performance requirements. This close collaboration has alsoallowed us to develop a significant level of systems expertise. We leverage aportfolio of proprietary technologies and design techniques, includingefficient planar design, alternative packaging techniques and customsemiconductor logic, to deliver memory subsystems with high speed, capacity andsignal integrity, small form factor, attractive thermal characteristics and lowcost 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, Inc. (“Dell”),Flextronics International Ltd. (“Flextronics”) and Arrow Electronics, Inc.(“Arrow”) represented approximately 37%, 31% and 16%, respectively, of our netsales for the three months ended April 3, 2010.  Dell and Arrow represented approximately 33%and 21%, respectively, of our net sales for the three months ended April 4,2009. Net sales to some of our OEM customers include memory modules that arequalified by us directly with the OEM customer and sold to electronicmanufacturing services providers (“EMSs”), for incorporation into productsmanufactured exclusively for the OEM customer or in some instances, tofacilitate credit and logistics. These net sales to EMSs have historicallyfluctuated period to period as a portion of the total net sales to the OEMcustomers.  Net sales to Hon HaiPrecision Industry Co. Ltd., an EMS operating under the trade name Foxconn thatpurchases memory modules from us for incorporation into products manufacturedexclusively for Dell, represented approximately 89% and 67% of net sales toDell for the three months ended April 3, 2010 and April 4, 2009,respectively.  Arrow is an EMS for DRSElectronics, Inc. (“DRS Electronics”). Substantially all of our products sold to Arrow are incorporated intocomponents manufactured for DRS Electronics. Similarly, Flextronics distributes substantially all of the productspurchased from us to F5 Networks, Inc.

 

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**Key BusinessMetrics**

 

The followingdescribes certain line items in our consolidated statements of operations thatare important to management’s assessment of our financial performance:

 

*Net Sales.*  Net sales consist primarily of sales of ourhigh performance memory subsystems, net of a provision for estimated returnsunder our right of return policies, which generally range up to 30 days.We generally do not have long-term sales agreements with our customers.Although OEM customers typically provide us with non-binding forecasts offuture product demand over specific periods of time, they generally placeorders with us approximately two weeks in advance of scheduled delivery.Selling prices are typically negotiated monthly, based on competitive marketconditions and the current price of DRAM ICs and NAND. Purchase ordersgenerally have no cancellation or rescheduling penalty provisions. We oftenship our products to our customers’ international manufacturing sites. All ofour sales to date, however, are denominated in United States (“U.S.”) dollars.We also sell excess component inventory of DRAM ICs and NAND to distributorsand other users of memory ICs.  Ascompared to previous years, component inventory sales remain a relatively smallpercentage 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 ourproducts constitute a significant portion of our cost of sales, and thus ourcost of sales will fluctuate based on the current price of DRAM ICs and NAND.We attempt to pass through such DRAM IC and NAND flash memory cost fluctuationsto our customers by renegotiating pricing prior to the placement of theirpurchase orders.  However, the salesprices of our memory subsystems can also fluctuate due to competitivesituations unrelated to the pricing of DRAM ICs and NAND, which affects grossmargins. The gross margin on our sales of excess component DRAM IC and NANDinventory is much lower than the gross margin on our sales of our memorysubsystems.  As a result, a decrease inexcess DRAM IC and NAND inventory sales as a percentage of our overall salescould result in an improved overall gross margin. We assess the valuation ofour inventories on a monthly basis and record a provision to cost of sales asnecessary to reduce inventories to the lower of cost or net realizable value.

 

*Research and Development.*  Research and development expense consistsprimarily of employee and independent contractor compensation and relatedcosts, non-recurring engineering fees, patent filing and protection legal fees,computer-aided design software licenses, reference design development costs,depreciation or rental of evaluation equipment, stock-based compensation, andoccupancy and other allocated overhead costs. Also included in research anddevelopment expense are the costs of material and overhead related to theproduction of engineering samples of new products under development or productsused solely in the research and development process. Our customers typically donot separately compensate us for design and engineering work involved indeveloping application-specific products for incorporation into their products.  All research and development costs areexpensed as incurred. We anticipate that research and development expenditureswill increase in future periods as we seek to expand new product opportunities,increase our activities related to new and emerging markets and continue todevelop additional proprietary technologies.

 

*Selling, General and Administrative.*  Selling, general and administrative expensesconsist primarily of employee salaries and related costs, stock-basedcompensation, independent sales representative commissions, professionalservices, promotional and other selling and marketing expenses, and occupancyand other allocated overhead costs. A significant portion of our selling effortis directed at building relationships with OEMs and other customers andworking through the product approval and qualification process with them.Therefore, the cost of material and overhead related to products manufacturedfor qualification is included in selling expenses. As we continue to serviceexisting and establish new customers, we anticipate that our sales andmarketing expenses will increase. For fiscal 2010, we are subject toattestation services requirements with respect to our internal control overfinancial reporting, the result of which will increase legal and accountingexpenses in future periods.

 

*Provision (Benefit) forIncome Taxes.*  We are required to adjust our effective taxrate each quarter to be consistent with the estimated annual effective taxrate.  We are also required to record thetax impact of certain discrete items, unusual or infrequently occurring,including changes in judgment about valuation allowances and effects of changesin tax laws or rates, in the interim period in which they occur.  In addition, jurisdictions with a projectedloss for the year or a year-to-date loss where no tax benefit can be recognizedare excluded from the estimated annual effective tax rate.  The impact of such an exclusion could resultin a higher or lower effective tax rate during a particular quarter, based uponthe mix and timing of actual earnings versus annual projections.

 

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We evaluate whether avaluation allowance should be established against our deferred tax assets basedon the consideration of all available evidence using a “more likely than not”standard.  As of April 3, 2010 and January 2, 2010, wehave provided a full valuation allowance and no benefit has been recognized fornet operating losses and other deferred tax assets due to uncertainty of futureutilization.

 

**CriticalAccounting Policies**

** **

The preparation of our consolidated financial statements in conformitywith accounting principles generally accepted in the U.S. requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of net sales andexpenses during the reporting period. By their nature, these estimates andassumptions are subject to an inherent degree of uncertainty. We base ourestimates on our historical experience, knowledge of current conditions and ourbeliefs of what could occur in the future considering available information. Wereview our estimates on an on-going basis. Actual results may differ from theseestimates, which may result in material adverse effects on our operatingresults and financial position. We believe the following critical accountingpolicies involve our more significant assumptions and estimates used in thepreparation of our consolidated financial statements:

 

*Revenue Recognition.*  We recognize revenues in accordance with theFinancial Accounting Standards Board (“FASB”) Accounting Standards Codification(“ASC”) Topic 605. Accordingly, we recognize revenues when there is persuasiveevidence that an arrangement, product delivery and acceptance have occurred,the sales price is fixed or determinable, and collectibility of the resultingreceivable is reasonably assured.

 

We generally use customer purchase orders and/or contracts as evidenceof an arrangement. Delivery occurs when goods are shipped for customers withFOB Shipping Point terms and upon receipt for customers with FOB Destinationterms, at which time title and risk of loss transfer to the customer. Shippingdocuments are used to verify delivery and customer acceptance. We assesswhether the sales price is fixed or determinable based on the payment termsassociated with the transaction and whether the sales price is subject torefund.  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. We offer a standard productwarranty to our customers and have no other post-shipment obligations. Whilethese sales returns have historically been within our expectations and theprovisions established, we cannot guarantee that we will continue to experiencesimilar sales return rates in the future. Any significant increase in productreturn rates could have a material adverse effect on our operating results forthe period or periods in which such returns materialize.  We assess collectibility based on thecreditworthiness of the customer as determined by credit checks andevaluations, as well as the customer’s payment history.

 

All amounts billed to customers related to shipping and handling areclassified as net sales, while all costs incurred by us for shipping andhandling are classified as cost of sales.

 

*Fair Value of Financial Instruments.*  Our financial instruments consist principallyof cash and cash equivalents, investments in marketable securities, accountsreceivable, accounts payable, accrued expenses and debt instruments.  Other than for certain investments in auctionrate securities, the fair value of our cash equivalents and investments inmarketable securities, other than commercial paper or short-term corporatebonds,  is determined based on quotedprices in active markets for identical assets or Level 1 inputs.  Because of their short-term nature,commercial paper and short-term corporate bonds are not frequently traded.  Although there are observable quotes forthese securities, the markets are not considered active.  Accordingly, the fair values of theseinvestments are based on Level 2 inputs. We recognize transfers between Levels 1 through 3 of the fair valuehierarchy at the beginning of the reporting period.  We believe that the carrying values of allother financial instruments approximate their current fair values due to theirnature and respective durations.

 

*Allowance for Doubtful Accounts.*  We perform credit evaluations of ourcustomers’ financial condition and limit the amount of credit extended to ourcustomers as deemed necessary, but generally require no collateral.  We evaluate the collectibility of accountsreceivable based on a combination of factors. In cases where we are aware ofcircumstances that may impair a specific customer’s ability to meet itsfinancial obligations subsequent to the original sale, we will record anallowance against amounts due, and thereby reduce the net recognized receivableto the amount that we reasonably believe will be collected. For all othercustomers, we record allowances for doubtful accounts based primarily on thelength of time the receivables are past due based on the terms of theoriginating transaction, the current business environment and our historicalexperience.  Uncollectible accounts arecharged against the allowance for doubtful accounts when all cost effective commercialmeans of collection have been exhausted. Generally, our credit losses have been within our expectations and theprovisions established. However, we cannot guarantee that we will continue toexperience credit loss rates similar to those we have experienced in the past.

 

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Our accounts receivable are highly concentrated among a small number ofcustomers, and a significant change in the liquidity or financial position ofone of these customers could have a material adverse effect on thecollectability of our accounts receivable, our liquidity and our futureoperating results.

 

*Inventories.*  We value our inventories at the lower of theactual cost to purchase or manufacture the inventory or the net realizablevalue 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.  At each balance sheet date, weevaluate ending inventory quantities on hand and record a provision for excessquantities and obsolescence.  Among otherfactors, we consider historical demand and forecasted demand in relation to theinventory on hand, competitiveness of product offerings, market conditions andproduct life cycles when determining obsolescence and net realizable value. Inaddition, we consider changes in the market value of DRAM ICs and NAND indetermining the net realizable value of our raw material inventory. Onceestablished, any write downs are considered permanent adjustments to the costbasis of our excess or obsolete inventories.

 

A significant decrease in demand for our products could result in anincrease in the amount of excess inventory quantities on hand. In addition, ourestimates of future product demand may prove to be inaccurate, in which case wemay have understated or overstated the provision required for excess andobsolete inventory.  In the future, ifour inventories are determined to be overvalued, we would be required torecognize additional expense in our cost of sales at the time of suchdetermination. Likewise, if our inventories are determined to be undervalued,we may have over-reported our costs of sales in previous periods and would berequired to recognize additional gross profit at the time such inventories aresold. In addition, should the market value of DRAM ICs or NAND decreasesignificantly, we may be required to lower our selling prices to reflect thelower current cost of our raw materials. If such price decreases reduce the net realizable value of ourinventories to less than our cost, we would be required to recognize additionalexpense in our cost of sales in the same period. Although we make everyreasonable effort to ensure the accuracy of our forecasts of future productdemand, any significant unanticipated changes in demand, technologicaldevelopments or the market value of DRAM ICs or NAND could have a materialeffect on the value of our inventories and our reported operating results.

 

*Impairment of Long-Lived Assets.*  We evaluate the recoverability of thecarrying value of long-lived assets held and used in our operations forimpairment on at least an annual basis or whenever events or changes in circumstancesindicate that their net book value may not be recoverable.  When such factors and circumstances exist, wecompare the projected undiscounted future net cash flows associated with therelated asset or group of assets over their estimated useful lives againsttheir respective carrying amount.  Theseprojected future cash flows may vary significantly over time as a result ofincreased competition, changes in technology, fluctuations in demand,consolidation of our customers and reductions in average selling prices.  If the carrying value is determined not to berecoverable from future operating cash flows, the asset is deemed impaired andan impairment loss is recognized to the extent the carrying value exceeds theestimated fair value of the asset.  Thefair value of the asset or asset group is based on market value when available,or when unavailable, on discounted expected cash flows.

 

*Warranty Reserve.*  We offer product warranties generally rangingfrom one to three years, depending on the product and negotiated terms ofpurchase agreements with our customers. Such warranties require us to repair orreplace defective product returned to us during the warranty period at no costto the customer.  Warranties are notoffered on sales of excess inventory.  Our estimates for warranty-related costs arerecorded at the time of sale based on historical and estimated future productreturn rates and expected repair or replacement costs. While such costs havehistorically been consistent between periods and within our expectations andthe provisions established, unexpected changes in failure rates could have amaterial adverse impact on us, requiring additional warranty reserves, andadversely affecting our gross profit and gross margins.

 

*Stock-Based Compensation.*  We account for equity issuances tonon-employees in accordance with ASC Topic 505. All transactions in which goods or services are the considerationreceived for the issuance of equity instruments are accounted for based on thefair value of the consideration received or the fair value of the equityinstrument issued, whichever is more reliably measurable. The measurement dateused to determine the fair value of the equity instrument issued is the earlierof the date on which the third-party performance is complete or the date onwhich it is probable that performance will occur.

 

In accordance with ASC Topic 718, 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.  Given thatstock-based compensation expense recognized in the consolidated statements ofoperations is based on awards ultimately expected to vest, it has been reducedfor estimated forfeitures. ASC Topic 718 requires forfeitures to be estimatedat the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Our estimated average forfeiture ratesare based on historical forfeiture experience and estimated future forfeitures.

 

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The fair value of common stock option awards to employees and directorsis calculated using the Black-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, all of which affect the estimated fair values of our common stockoption awards. The expected term of options granted is calculated as theaverage of the weighted vesting period and the contractual expiration date ofthe option.  This calculation is based onthe safe harbor method permitted by the SEC in instances where the vesting andexercise terms of options granted meet certain conditions and where limitedhistorical exercise data is available. Prior to fiscal 2009, the expected volatility was based on thehistorical volatilities of the common stock of comparable publicly tradedcompanies based on our belief that we had limited historical data regarding thevolatility of our stock price on which to base a meaningful estimate ofexpected volatility. Beginning in fiscal 2009, the expected volatility is basedon the historical volatility of our common stock.  The risk-free rate selected to value anyparticular grant is based on the U.S. Treasury rate that corresponds to theexpected term of the grant effective as of the date of the grant. The expecteddividends assumption is based on our history and our expectations regardingdividend payouts. We evaluate the assumptions used to value our common stockoption awards on a quarterly basis. If factors change and we employ differentassumptions, stock- based compensation expense may differ significantly fromwhat we have recorded in prior periods. Compensation expense for awards with graded vesting schedules is recognizedon a straight-line basis over the requisite service period for the lastseparately vesting portion of the award.

 

If there are any modifications or cancellations of the underlyingvested or unvested stock-based awards, we may be required to accelerate,increase or cancel any remaining unearned stock-based compensation expense, orrecord additional expense for vested stock-based awards.  Future stock-based compensation expense andunearned stock- based compensation may increase to the extent that we grantadditional common stock options or other stock-based awards.

 

*Income Taxes.*  Under ASC Topic 270, 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.

 

Deferred tax assets and liabilities are recognizedto reflect the estimated future tax effects, calculated at currently effectivetax rates, of future deductible or taxable amounts attributable to events thathave been recognized on a cumulative basis in the consolidated financialstatements.  A valuation allowancerelated to a net deferred tax asset is recorded when it is more likely than notthat some portion of the deferred tax asset will not be realized.

 

ASC Topic 740 prescribes a recognition threshold andmeasurement requirement for the financial statement recognition of a taxposition that has been taken or is expected to be taken on a tax return andalso provides guidance on de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. Under ASCTopic 740 we may only recognize or continue to recognize tax positions thatmeet a “more likely than not” threshold.

 

The application of tax laws and regulations is subject to legal andfactual interpretation, judgment and uncertainty. Tax laws and regulationsthemselves are subject to change as a result of changes in fiscal policy,changes in legislation, the evolution of regulations and court rulings. Therefore,the actual liability for U.S. or foreign taxes may be materially different fromour estimates, which could result in the need to record additional taxliabilities or potentially reverse previously recorded tax liabilities.

 

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**Results ofOperations**

** **

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

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                        | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                        | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net  sales                                        |       | 100                    | %          | 100 | % |
| Cost  of sales                                    |       | 77                     |       | 125 |   |
| Gross  profit (loss)                              |       | 23                     |       | (25 | ) |
| Operating  expenses:                              |       |                   |       |   |   |
| Research  and development                         |       | 38                     |       | 75 |   |
| Selling,  general and administrative              |       | 33                     |       | 90 |   |
| Total  operating expenses                         |       | 71                     |       | 164 |   |
| Operating  loss                                   |       | (48                    | )          | (189 | ) |
| Other  income:                                    |       |                   |       |   |   |
| Interest  income, net                             |       | —                 |       | 4 |   |
| Other  income, net                                |       | 1                      |       | 8 |   |
| Total  other income, net                          |       | 1                      |       | 12 |   |
|                                              |       |                   |       |   |   |
| Loss  before (benefit) provision for income taxes |       | (47                    | )          | (177 | ) |
| (Benefit)  provision for income taxes             |       | (9                     | )          | 1 |   |
| Net  loss                                         |       | (38                    | )%         | (178 | )% |

 

***Three Months Ended April 3,2010 Compared to Three Months Ended April 4, 2009***

*** ***

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

 

*The following table presents net sales, cost of sales andgross profit for the three months ended April 3, 2010 and April 4,2009 (in thousands, except percentages):*

* *
| ** **           | ** ** | **Three Months Ended** | ** ** | ** **        | ** ** | ** ** | ** ** |
|----------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **           | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **           | ** ** | **2010**               | ** ** | **2009**          | ** ** | **Change** | ** ** | **Change** | ** ** |
|                 |       |                   |       |              |       |       |       |   |   |
| Net  sales           |       | $                      | 7,890      |              | $          | 2,162      |       | $ | 5,728 |   | 265 | % |
| Cost  of sales       |       | 6,072                  |       | 2,699             |       | 3,373      |       | 125 | % |
| Gross  profit (loss) |       | $                      | 1,818      |              | $          | (537       | )          | $ | 2,355 |   | 439 | % |
| Gross  margin        |       | 23                     | %          | (25               | )%         | 48         | %          |   |   |

 

*Net Sales.*** The overall increase in our net sales wasprimarily driven by (i) an increase of $2.1 million in sales of memorymodules used in RAID controller subsystems, including sales of NetVaultTM, (ii) anincrease of $1.9 million in sales of memory modules utilized in serverapplications, and (iii) an increase of $1.2 million in sales of memorymodules designed for industrial applications. Net sales of RAID, data center optimization and industrial applicationsincreased as a result of the selection of our memory modules for inclusion innew product platforms.  Net sales in allproduct categories have benefited from a resurgence in technology investment,as general economic conditions have improved. Should economic conditions erode, these expectations may not berealized.

 

Sales of our componentinventory to distributors and other users of memory ICs representedapproximately 1.2% and 2.8% of net sales for the three months ended April 3,2010 and April 4, 2009, respectively. Component inventory sales havedecreased as a percentage of net sales as a result of our ability to use thesame components across a wider range of memory subsystems.

 

*Gross Profit (Loss) andGross Margin.*** Gross profit(loss) for the three months ended April 3, 2010 as compared to the threemonths ended April 4, 2009 increased due to the 265% increase in net salesbetween the two periods. The increase in gross margin for the three monthsended April 3, 2010 as compared to the three months ended April 4,2009 is mostly due to the improved ability to absorb manufacturing costs causedby the increase in units manufactured and sold during the recent quarter.  The cost savings generated from the improvementin capacity utilization were partially offset by increased DRAM prices.

 

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***Researchand Development****.*

 

The following tablepresents research and development expenses for the three months ended April 3,2010 and April 4, 2009 (in thousands, except percentages):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                | ** ** | **2010**               | ** ** | **2009**          | ** ** | **Change** | ** ** | **Change** | ** ** |
|                      |       |                   |       |              |       |       |       |   |   |
| Research  and development |       | $                      | 3,008      |              | $          | 1,614      |       | $ | 1,394 |   | 86 | % |
|                           |            |                        |            |                   |            |            |            |  |  |  |  |  |

 

The increase in researchand development expense in the three months ended April 3, 2010 ascompared to the three months ended  April 4,2009 resulted primarily from increases of (i) $0.7 million in engineeringexpenses as a result of an increase in non-recurring engineering charges andboth internal engineering headcount and outside contractors engaged in new product development activities in thefirst quarter of 2010, (ii) $0.6 million in legal and professional fees aswe continue to increase patent filing and protection activities related to newand emerging markets and (iii) $0.1 million in expenses related to productqualification builds and testing.

 

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

 

The following tablepresents selling, general and administrative expenses for the three monthsended April 3, 2010 and April 4, 2009 (in thousands, exceptpercentages):

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | ** **        | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                           | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **2010**               | ** ** | **2009**          | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                 |       |                   |       |              |       |       |       |   |   |
| Selling,  general and administrative |       | $                      | 2,570      |              | $          | 1,935      |       | $ | 635 |   | 33 | % |
|                                      |            |                        |            |                   |            |            |            |  |  |  |  |  |

 

The increase in selling,general and administrative expense in the three months ended April 3, 2010as compared to the three months ended April 4, 2009 resulted primarilyfrom increases of (i) $0.3 million in personnel-related expenses primarilyattributable to hiring personnel to support the development of  markets for HyperCloudTM and NetVaultTM, (ii) $0.2million in product samples and travel costs as a result of activities relatedto the OEM qualification process for HyperCloudTM and NetVaultTM, and (iii) $0.1million in commission expenses due to an increase in sales revenue.

 

***Other Income.***

 

The following table presents other income for the three months ended April 3,2010 and April 4, 2009 (in thousands, except percentages):

 
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **        | ** ** | ** ** | ** ** |
|--------------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **               | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **               | ** ** | **2010**               | ** ** | **2009**          | ** ** | **Change** | ** ** | **Change** | ** ** |
|                     |       |                   |       |              |       |       |       |   |   |
| Interest  income, net    |       | $                      | 1          |              | $          | 82         |       | $ | (81 | ) | (99 | )% |
| Other  income, net       |       | 67                     |       | 175               |       | (108       | )          | (62 | )% |
| Total  other income, net |       | $                      | 68         |              | $          | 257        |       | $ | (189 | ) | (74 | )% |

 

Net interest income forthe three months ended April 3, 2010 was comprised of nominal interestincome, offset by nominal interest expense. Net interest income for the three months ended April 4, 2009 wascomprised of interest income of approximately $0.1 million, offset by interestexpense of approximately $0.03 million. The decrease in interest income in the three months ended April 3,2010 as compared to the three months ended April 4, 2009 was due to acombination of our lower average cash and investment balances and the decreasein the yield earned on those balances due to lower interest rates.  The decrease in interest expense during 2010as compared to 2009 resulted primarily from our lower average outstandingbalances on our line of credit and debt balances during the current year.

 

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Other income, net, forthe three months ended April 3, 2010 is primarily comprised of cashproceeds from the early termination of a sublease of our headquartersfacility.  Other income, net, for thethree months ended April 4, 2009 is primarily comprised of gains from thesale of equipment held for sale.

 

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

 

The following tablepresents the (benefit) provision for income taxes for the three months ended April 3,2010 and April 4, 2009 (in thousands, except percentages):

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                            | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **2010**               | ** ** | **2009**          | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                  |       |                   |       |              |       |       |       |   |   |
| (Benefit)  provision for income taxes |       | $                      | (727       | )                 | $          | 18         |       | $ | (745 | ) | (4,139 | )% |
|                                       |            |                        |            |                   |            |            |            |  |  |  |  |  |

 

Onan interim basis, we estimate what our effective tax rate will be in eachjurisdiction for the full fiscal year and record a quarterly income tax(benefit) provision in accordance with the anticipated blended annual rate. Weare also required to record the tax impact of certain discrete items, unusualor infrequently occurring, including changes in judgment about valuationallowances and effects of changes in tax laws or rates, in the interim periodin which they occur.  During the quarter ended April 3,2010, we carried back approximately $1.7 million of gross net operating lossesunder the Worker, Homeownership, and Business Act and recorded a tax benefitand income tax receivable of approximately $0.7 million.  In addition, jurisdictions with a projectedloss for the year or a year-to-date loss where no tax benefit can be recognizedare excluded from the estimated annual effective tax rate.  The impact of such an exclusion could resultin a higher or lower effective tax rate during a particular quarter, based uponthe mix and timing of actual earnings versus annual projections.

 

We evaluate whether avaluation allowance should be established against our deferred tax assets basedon the consideration of all available evidence using a “more likely than not”standard.  Due to uncertainty of future utilization, we haveprovided a full valuation allowance as of April 3, 2010 and January 2,2010.  Accordingly, no benefit has beenrecognized for net deferred tax assets, including net operating losses thatcannot be realized currently via carryback to periods of taxable income.

 

Our income tax benefit of$0.7 million for the quarter ended April 3, 2010 is the result of aspecial carryback of operating losses that was made available throughlegislative changes.  We recorded aprovision for income taxes for the quarter ended April 4, 2009 due tostate minimum taxes.

 

**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 and from the sale and leaseback ofour domestic manufacturing facility.

 

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

 

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

 
| ** **                           | ** ** | **April 3,** | ** **   | **January 2,** | ** ** |
|--------------------------------------|------------|-------------------|--------------|---------------------|------------|
| ** **                           | ** ** | **2010**          | ** **   | **2010**            | ** ** |
| Working  Capital                     |       | $                 | 27,492       |                | $          | 13,379 |   |
|                                 |       |              |         |                |       |
| Cash  and cash equivalents(1)        |       | $                 | 19,237       |                | $          | 9,942 |   |
| Short-term  marketable securities(1) |       | 6,268             |         | 3,949               |       |
| Long-term  marketable securities     |       | 906               |         | 941                 |       |
|                                 |       | $                 |  26,411 |                | $          | 14,832 |   |

 

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*(1) Included in working capital*

 

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*Our working capital increased in the three months ended April 3,2010 primarily as a result of our increase in cash, cash equivalents andshort-term marketable securities resulting from our public offering of ourshares of common stock.  Additionally, weexperienced increases in certain operating assets, offset by increases incertain operating liabilities resulting from our increase in sales andproduction ramp up for HyperCloudTM and NetVaultTM.*

 

***CashProvided and Used in the Three Months Ended April 3, 2010 and April 4,2009***

 

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

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **April 3,**      | ** ** | **April 4,** | ** ** |
| ** **                                            | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                  |       |                   |       |   |   |
| **Net cash provided by (used in):**                   |       |                   |       |   |   |
| Operating  activities                                 |       | $                      | (4,494     | ) | $ | (915 | ) |
| Investing  activities                                 |       | (2,527                 | )          | (5,613 | ) |
| Financing  activities                                 |       | 16,316                 |       | (123 | ) |
| Net  increase (decrease) in cash and cash equivalents |       | $                      | 9,295      |   | $ | (6,651 | ) |

 

*Operating Activities.* Net cash used by operating activitiesfor the three months ended April 3, 2010 was primarily a result of (i) netloss of approximately $3.0 million and (ii) cash provided by changes inoperating assets and liabilities of approximately $2.4 million, partiallyoffset by approximately $0.9 million in net non-cash operating expenses,primarily consisting of depreciation and amortization and stock-basedcompensation expense.  Net cash used byoperating activities for the three months ended April 4, 2009 wasprimarily a result of a net loss of approximately $3.8 million, partiallyoffset by (i) approximately $2.2 million in net cash provided by changesin operating assets and liabilities, and (ii) approximately $0.7 millionin net non-cash operating expenses, primarily comprising depreciation andamortization, stock-based compensation and gain on disposal of assets.

 

Accounts receivableincreased approximately $1.0 million during the three months ended April 3,2010 primarily as a result of the increase in our net sales during the period.During the same period, we were successful in collecting cash from sales to ourcustomers substantially in accordance with our standard payment terms withthose customers.  Inventories increasedapproximately $1.7 million during the three months ended April 3, 2010 aswe prepare for production of our HyperCloudTM and NetVaultTM products.

 

*Investing Activities.* Net cash used in investing activitiesfor the three months ended April 3, 2010 was primarily the result of purchasesof $2.4 million of investments in marketable securities, offset by sales of$0.06 million.  Additionally, we acquired$0.2 million in property and equipment. Net cash used in investing activities for the three months ended April 4,2009 was primarily a result of purchases of additional investments inmarketable securities of approximately $10.3 million, partially offset by (i) proceedsreceived from maturities and sales of certain investments in marketablesecurities of approximately $4.4 million and (ii) proceeds from the saleof equipment.

 

*Financing Activities.* Net cash provided by financingactivities for the three months ended April 3, 2010 was a result of thenet proceeds of $16.3 million from the sale of 4,594,250 shares of our commonstock in a registered public offering. Net cash used in financing activities for the three months ended April 4,2009 was a result of repayment of approximately $0.1 million on our long termdebt.

 

***Capital Resources***

*** ***

On October 31,2009, we entered into a revolving credit agreement with a financialinstitution.  Under the original terms of the credit agreement, we couldborrow up to the lesser of (i) 80% of eligible accounts receivable, minus$1.0 million, or (ii) $5.0 million.  The revolving credit agreementwas amended on March 24, 2010 to allow for increased accounts receivableeligibility and to remove the $1.0 million reduction from the calculatedaccounts receivable borrowing base.  Thecredit agreement contains an overall sublimit of $2.5 million to collateralizeour contingent obligations under letters of credit, foreign exchange contractsand cash management services.  Amounts outstanding under the overallsublimit reduce the 

 

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amount available pursuantto the credit agreement.  Interest ispayable monthly at either (i) prime plus 1.25%, as long as we maintain$8.5 million in revolving credit availability plus unrestricted cash on depositwith the financial institution, or (ii) prime plus 2.25%.  The credit agreement matures on October 30,2010, at which time all advances and interest are due and payable.

 

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

 
| ** **                                                 | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | **2010**          | ** ** | **2010**            | ** ** |
| Outstanding  borrowings on the revolving line of credit    |       | $                 | —     |                | $          | — |   |
| Borrowing  availability under the revolving line of credit |       | $                 | 3,344      |                | $          | — |   |

 

Obligations underour revolving credit agreement are secured by a first priority lien on ourtangible and intangible assets.  Inconnection with the revolving credit agreement, we entered into an IntercompanySubordination Agreement, which provided that Netlist Technology Texas, LP, oneof our subsidiaries, is an additional obligor on the revolving creditagreement.

 

While we arecurrently in compliance with all financial covenants and expect to maintaincompliance for the foreseeable future, we have in the past been in violation ofone or more covenants of other credit agreements. We cannot assure you that wewill not violate one or more covenants in the future. If we were to be inviolation of covenants under our credit agreement, our lender could choose toaccelerate payment on all outstanding loan balances. There can be no assurancethat we would be able to quickly obtain equivalent or suitable replacementfinancing in this event. If we were not able to secure alternative sources offunding, such acceleration would have a material adverse impact on ourfinancial condition.

 

We have in thepast utilized equipment leasing arrangements to finance certain capitalexpenditures.  Equipment leases willcontinue to be a financing alternative that we may pursue in the future.

 

We believe ourexisting cash balances, borrowing availability under our bank credit facility,and the cash expected to be generated from operations, will be sufficient tomeet our anticipated cash needs for at least the next 12 months. 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 funds may not be available on terms acceptable to us,or at all.

 

*NewAccounting Pronouncements*

 

In September 2009,the FASB issued Accounting Standards Update (“ASU”) 2009-13, *Multiple-Deliverable Revenue Arrangements* (“ASU 2009-13”),which amends the revenue guidance under ASC Topic 605, which describes theaccounting for multiple element arrangements. ASU 2009-13 addresses how to determine whether an arrangement involvingmultiple deliverables contains more than one unit of accounting and howarrangement consideration shall be measured and allocated to the separate unitsof accounting in the arrangement.  ASU2009-13 is effective on a prospective basis for the Company’s fiscal year 2011,with earlier adoption permitted.  We arecurrently evaluating the adoption of ASU 2009-13 and the impact that ASU2009-13 will have on our condensed consolidated financial statements.

 

In September 2009,the FASB issued ASU 2009-14, *Certain RevenueArrangements That Include Software Elements* (“ASU 2009-14”), whichexcludes tangible products containing software components and non-softwarecomponents that function together to deliver the product’s essential functionalityfrom the scope of ASC Topic 985, which describes the accounting for softwarerevenue recognition.  ASU 2009-14 iseffective on a prospective basis for our fiscal year 2011, with earlieradoption permitted.  We are currentlyevaluating the impact that ASU 2009-14 will have on its condensed consolidatedfinancial statements.

 

In January 2010, theFASB issued ASU 2010-6, *Fair Value Measurementsand Disclosures: Improving Disclosures About Fair Value Measurement*(“ASU2010-6”), which affects the disclosures made about recurring and non-recurringfair value measurements.  We adopted theexpanded disclosure requirements in the quarter ended April 3, 2010.

 

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*** ***

***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 Qualitative Disclosures About MarketRisk

** **

***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 an evaluation, under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, (“Exchange Act”)) as ofthe end of our fiscal quarter ended April 3, 2010.  Based upon that evaluation, our principalexecutive officer and principal financial officer concluded that our disclosurecontrols and procedures are effective to provide reasonable assurance thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act (i) is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and (ii) isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer as appropriate to allowtimely decisions regarding required disclosure.

 

*(b) Change ininternal controls over financial reporting.* During the fiscal quarter that ended April 3,2010, there were no changes in our internal controls over financial reporting(as defined in Rules 13a-15(f) and 15d-15(f) under the ExchangeAct) that have materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

***Inherent Limitations on InternalControl***

 

Acontrol system, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met. Further, the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, have been detected. These inherent limitationsinclude the realities that judgments in decision making can be faulty, and thatbreakdowns can occur because of simple errors. Additionally, controls can becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the control. The design of any systemof controls is also based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Because ofthe inherent limitations in a cost-effective control system, misstatements dueto error or fraud may occur and not be detected.

 

**PART II. OTHER INFORMATION**

 

**Item 1.**                          Legal Proceedings

** **

The informationset forth in the sections entitled Federal Securities Class Action, PatentClaims and Trade Secret Claim under Note 9 of Notes to Unaudited CondensedConsolidated Financial Statements, included in Part I, Item I of thisReport, 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. Please refer to the Risk Factors setforth in Part I, Item 1A of our Annual Report on Form 10-K for thefiscal year ended January 2, 2010 filed with the Securities and ExchangeCommission on February 19, 2010.***

*** ***

**Item 2.**                          Unregistered Sales of Equity Securities and Use ofProceeds

** **

None.

 

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**Item 3.**                          Defaults Upon Senior Securities

** **

None.

 

**Item 4.**                          Removed and Reserved

** **

None.

 

**Item 5.**                          Other Information

** **

None.

 

**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)     |       | Amendment to Loan Documents entered into as of March 24, 2010,  by and between Silicon Valley Bank and Netlist, Inc., a Delaware  Corporation.                                                                                              |
|        |       |                                                                                                                                                                                                                                                  |
| 10.2(2)     |       | Form of Restricted Stock Award issued pursuant to the 2006  Equity Incentive Plan of Netlist, Inc.                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                  |
| 10.3(2)*    |       | Design and  Production Agreement relating to Register ASIC (the “Production Register  Agreement”), dated July 31, 2008, by and between Netlist, Inc. and  Toshiba America Electronic Components, Inc. (“Toshiba”). |
|        |       |                                                                                                                                                                                                                                                  |
| 10.4(2)*    |       | Amendment #1 to  the Production Register Agreement, dated May 22, 2009, by and between  Netlist, Inc. and Toshiba.                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                  |
| 10.5(2)*    |       | Amendment #1 to the  Production Register Agreement, dated January 28, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                  |
| 10.6(2)*    |       | Amendment #2 to the  Production Register Agreement, dated March 10, 2010, by and between Netlist, Inc.  and Toshiba.                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                  |
| 10.7(2)*    |       | Design and  Production Agreement relating to ID ASIC (the “Production ID Agreement”),  dated July 31, 2008, by and between Netlist, Inc. and Toshiba.                                                                             |
|        |       |                                                                                                                                                                                                                                                  |
| 10.8(2)*    |       | Amendment #1 to the  Production ID Agreement, dated January 28, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                  |
| 10.9(2)*    |       | Amendment #2 to  the Production ID Agreement, dated March 10, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                  |
| 10.10(2)*   |       | Development and  Supply Agreement, dated as of September 10, 2008, by and between  Netlist, Inc. and Diablo Technologies, Inc. (“Diablo”).                                                                                   |
|        |       |                                                                                                                                                                                                                                                  |
| 10.11(2)*   |       | Settlement Agreement and Amendment to Development and Supply  Agreement, dated January 12, 2010, between Netlist, Inc. and  Diablo.                                                                                                         |
|        |       |                                                                                                                                                                                                                                                  |
| 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

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| 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)          Incorporated by reference to the correspondingexhibit number of the registration statement on Form S-1 of the registrant(No. 333-136735) filed with the Securities and Exchange Commission on October 23,2006.

 

(2)          Filed herewith.

 

(3)          The information in Exhibit 32 shall not bedeemed “filed” for purposes of Section 18 of the Securities Exchange Actof 1934, as amended, (the “Exchange Act”), or otherwise subject to theliabilities of that section, nor shall they be deemed incorporated by referencein any filing under the Securities Act of 1933, as amended, or the Exchange Act(including this Report), unless Netlist, Inc. specifically incorporatesthe foregoing information into those documents by reference.

 

* Confidential treatment has been requested withrespect to portions of this exhibit pursuant to Rule 24b-2 of theSecurities Exchange Act of 1934 and these confidential portions have beenredacted from the filing made herewith. A complete copy of this exhibit, including the redacted terms, has beenseparately filed with the Securities and Exchange Commission.

 

33

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| Date: May 17, 2010 |   | 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 M. Sasaki                          |
|                    |   | **Gail M. Sasaki**                          |
|                    |   | **Vice President and Chief  Financial**     |
|                    |   | **Officer**                                 |
|                    |   | **(Principal Financial Officer)**           |

 

34

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**EXHIBIT INDEX**

 
| **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)     |       | Amendment to Loan Documents entered into as of March 24, 2010,  by and between Silicon Valley Bank and Netlist, Inc., a Delaware  Corporation.                                                                                              |
|        |       |                                                                                                                                                                                                                                                  |
| 10.2(2)     |       | Form of Restricted Stock Award issued pursuant to the 2006  Equity Incentive Plan of Netlist, Inc.                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                  |
| 10.3(2)*    |       | Design and  Production Agreement relating to Register ASIC (the “Production Register  Agreement”), dated July 31, 2008, by and between Netlist, Inc. and  Toshiba America Electronic Components, Inc. (“Toshiba”). |
|        |       |                                                                                                                                                                                                                                                  |
| 10.4(2)*    |       | Amendment #1 to  the Production Register Agreement, dated May 22, 2009, by and between  Netlist, Inc. and Toshiba.                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                  |
| 10.5(2)*    |       | Amendment #1 to the  Production Register Agreement, dated January 28, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                  |
| 10.6(2)*    |       | Amendment #2 to the  Production Register Agreement, dated March 10, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                  |
| 10.7(2)*    |       | Design and  Production Agreement relating to ID ASIC (the “Production ID Agreement”),  dated July 31, 2008, by and between Netlist, Inc. and Toshiba.                                                                             |
|        |       |                                                                                                                                                                                                                                                  |
| 10.8(2)*    |       | Amendment #1 to the  Production ID Agreement, dated January 28, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                  |
| 10.9(2)*    |       | Amendment #2 to  the Production ID Agreement, dated March 10, 2010, by and between  Netlist, Inc. and Toshiba.                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                  |
| 10.10(2)*   |       | Development and  Supply Agreement, dated as of September 10, 2008, by and between  Netlist, Inc. and Diablo Technologies, Inc. (“Diablo”).                                                                                   |
|        |       |                                                                                                                                                                                                                                                  |
| 10.11(2)*   |       | Settlement Agreement and Amendment to Development and Supply  Agreement, dated January 12, 2010, between Netlist, Inc. and  Diablo.                                                                                                         |
|        |       |                                                                                                                                                                                                                                                  |
| 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)          Incorporated by reference to the correspondingexhibit number of the registration statement on Form S-1 of the registrant(No. 333-136735) filed with the Securities and Exchange Commission on October 23,2006.

 

(2)          Filed herewith.

 

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(3)          The information in Exhibit 32 shall not bedeemed “filed” for purposes of Section 18 of the Securities Exchange Actof 1934, as amended, (the “Exchange Act”), or otherwise subject to theliabilities of that section, nor shall they be deemed incorporated by referencein any filing under the Securities Act of 1933, as amended, or the Exchange Act(including this Report), unless Netlist, Inc. specifically incorporatesthe foregoing information into those documents by reference.

 

* Confidential treatment has been requested withrespect to portions of this exhibit pursuant to Rule 24b-2 of theSecurities Exchange Act of 1934 and these confidential portions have beenredacted from the filing made herewith. A complete copy of this exhibit, including the redacted terms, has beenseparately filed with the Securities and Exchange Commission.

 

36

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