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As filed with the Securities and Exchange Commission on August 18, 2006

Registration No. 333-                     .



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933


NETLIST, INC.
(Exact name of Registrant as specified in its charter)


Delaware
(State or other jurisdiction of
Incorporation or organization)
  3674
(Primary standard industrial
classification code number)
  95-4812784
(I.R.S. employer
identification number)

475 Goddard, Irvine, CA 92618
Telephone: (949) 435-0025
(Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices)

Chun K. Hong
President, Chief Executive Officer and Chairman of the Board
475 Goddard, Irvine, CA 92618
Telephone: (949) 435-0025
(Name, address, including zip code, and telephone number, including area code, of agent for service)




Copies to:
James W. Loss, Esq.
Timothy R. Rupp, Esq.
Bingham McCutchen LLP
600 Anton Boulevard, 18 th Floor
Costa Mesa, California
(714) 830-0600
  Patrick A. Pohlen, Esq.
Derek Dundas, Esq.
Latham & Watkins LLP
135 Commonwealth Drive
Menlo Park, CA 94025
(650) 328-4600

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

        If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.     o

        If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o

        If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o

        If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o


CALCULATION OF REGISTRATION FEE


Title of Each Class of
Securities to be Registered

  Amount to
be Registered(1)

  Proposed Maximum
Offering Price
Per Share(2)

  Proposed Maximum
Aggregate
Offering Price

  Amount of
Registration Fee


Common Stock, $0.001 par value per share           $57,500,000   $6,152.50

(1)
Includes over-allotment option of                          .
(2)
Estimated solely for the purposes of computing the registration fee in accordance with Rule 457(a).


         The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the commission, acting pursuant to said section 8(a), may determine.




The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell securities, and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED AUGUST 18, 2006

GRAPHIC

LOGO

             Shares
Common Stock


Netlist, Inc. is selling             shares of our common stock. The selling stockholders named in this prospectus, including members of our management, have granted the underwriters a 30-day option to purchase up to an additional             shares to cover over-allotments, if any. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

This is an initial public offering of our common stock. We currently expect the initial public offering price to be between $                        and $                        per share. We intend to apply for approval for quotation of our common stock on the Nasdaq Global Market under the symbol "NLST."


INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 7.


 
  Per Share
  Total
Public offering price    $              $                        
Underwriting discount    $              $                        
Proceeds, before expenses, to us    $              $                        

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.


Thomas Weisel Partners LLC    
Needham & Company, LLC
    WR Hambrecht + Co

The date of this prospectus is                           , 2006


Inside Front Cover:

        At the top of the page is a colored banner, with two lines of text in black type as follows:

        "Netlist designs and manufactures high performance memory subsystems for the server, high performance computing and communications markets."

        At the top left of the page, partially on top of the banner, is a red stylized "N" logo with the name "Netlist" appearing in black type directly beneath the logo.

        On the left-hand side of the page, below the stylized "N" logo and the name "Netlist," is the following caption in red type:

      "Our memory subsystems bridge
      the gap between industry standard
      approaches and the requirements
      of complex OEM systems"

        Appearing across the center and right-hand side of the page, centered vertically, is a collage of pictures of representative Netlist products, in clockwise order beginning at the bottom, center, as follows: DDR VLP RDIMMs, DDR2 RDIMMs, FBDIMM With IFHS, DDR2 FBDIMMs, DDR2 VLP RDIMM, DDR DIMMs, DRAM Load Simulators, Enterprise Server DIMMs, SO-DIMMs. Each of these pictures is captioned with the exact product name described in the prior sentence.

        At the bottom of the page is a banner of the same color as the banner appearing at the top of the page. This colored banner on the bottom of the page has a series of 9 pictures of applications, appearing from left to right, which are representative of OEM systems in which Netlist's products are used, as follows: communications router, communications blade server, tower server, rack server, blade server, high performance computing cluster, communications switch, rack server (another make), tower server (another make). None of these pictures are captioned.



TABLE OF CONTENTS

 
  Page
Prospectus Summary   1
Risk Factors   7
Special Note Regarding Forward-Looking Statements   23
Use of Proceeds   24
Dividend Policy   24
Capitalization   25
Dilution   26
Selected Consolidated Financial Data   28
Management's Discussion and Analysis of Financial Condition and Results of Operations   30
Business   45
Management   57
Certain Relationships and Related Transactions   67
Principal and Selling Stockholders   69
Description of Capital Stock   71
Shares Eligible for Future Sale   74
Material United States Federal Tax Considerations for Non-U.S. Holders of Common Stock   76
Underwriting   79
Legal Matters   81
Experts   82
Where You Can Find Additional Information   82
Index to Consolidated Financial Statements   F-1

        You should rely only on the information contained or incorporated by reference in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.

        In this prospectus "our company," "we," "us" and "our" refer to Netlist, Inc. and its subsidiaries.

        All trademarks, service marks or trade names appearing in this prospectus are the property of their respective owners.

        Effective January 1, 2003, we changed our fiscal year from a calendar year to a 52- or 53-week fiscal year ending on the Saturday closest to December 31. Each of the first three quarters of our fiscal year end on the last Saturday in each of March, June and September. As a result, each fiscal quarter consists of 13 weeks during a 52-week fiscal year. During a 53-week fiscal year, one quarter will have 14 weeks and three quarters will consist of 13 weeks. For simplicity of presentation, we have expressed the end of each fiscal period presented in this prospectus as ending on the last day of the final month of that period.

        Market data and industry statistics used throughout this prospectus are based on independent industry publications and other publicly available information. We do not guarantee, and we have not independently verified, this information. Accordingly, investors should not place undue reliance on this information.

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PROSPECTUS SUMMARY

         You should read the following summary together with the more detailed information concerning our company, the common stock being sold in this offering and our consolidated financial statements appearing in this prospectus and in the documents incorporated by reference in this prospectus. Read this entire prospectus carefully, especially the risks described under "Risk Factors," before you invest in our common stock.


Netlist, Inc.

        We design and manufacture high performance memory subsystems. We sell our subsystems to original equipment manufacturers, or OEMs, in the server, high performance computing and communications markets. Within these markets, we target applications in which memory plays a key role in enabling overall system performance. Our memory subsystems are incorporated into multiple platforms at International Business Machines Corporation, or IBM, Dell Inc., Gateway, Inc., Lenovo Group Limited, or Lenovo, and Hewlett-Packard Company.

        Electronic systems of all types are continually evolving to keep pace with user demands for higher performance, as measured by speed, functionality or smaller physical size. In order to meet these performance expectations, OEM designers rely on increasing amounts of memory to take advantage of the latest advances in processor technology and operating system functionality. Dynamic random access memory, or DRAM, represents the most common type of memory used across these electronic systems today. In memory-intensive applications, OEMs often seek memory solutions which integrate multiple DRAM integrated circuits, or ICs, into a subsystem that delivers high memory density in a small form factor. These memory subsystems are available in both standard and application-specific configurations. Standard memory modules have proven generally inadequate to meet the demanding customer requirements in our target markets. Our memory subsystems are primarily designed and manufactured to specifically address the high performance needs of our customers' systems more completely than is possible using standard memory modules.

        We collaborate with our OEM customers in the earliest stages of their new product design cycles. This collaboration provides us with unique insight into the OEM's system architecture and performance requirements and expands our systems expertise. In addition, we have developed a portfolio of proprietary technologies and design techniques to meet OEM needs, including efficient planar design, alternative packaging techniques and custom semiconductor logic. As a result of our systems expertise and proprietary technologies, we are able to design application-specific memory subsystems with optimal combinations of high memory density, small form factor, high signal integrity, effective heat dissipation and low cost per bit. We also offer our OEM customers flexible order fulfillment and rapid turnaround times once we begin volume production of a specific product.

        Designing memory subsystems that meet the requirements of high performance electronic systems has become increasingly difficult. One approach to meeting these requirements is to add more memory ICs to a memory module, which requires more space, complicates board and system design and exacerbates signal integrity and heat dissipation issues. A second approach is to use next-generation memory ICs that offer greater memory density, but the high cost and low availability of these ICs discourages their immediate adoption in high performance systems. A third approach is to stack prior generation memory ICs, yet this technique can still constitute a significant portion of the cost of materials for a memory module. These industry standard approaches generally do not by themselves meet the requirements of high performance electronic systems. We leverage our proprietary technology and our extensive systems expertise to bridge this gap between industry standard approaches and the requirements of complex OEM systems.

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        Our memory subsystems offer differentiated features and performance characteristics. For example, our innovative printed circuit board, or PCB, designs enhance signal integrity, allowing our customers to design and market products that operate at the highest commercially available speeds. Another technique we utilize is to embed passive devices within the PCB, thereby freeing valuable board space to reduce form factors and improve signal integrity. Our solutions also address system-level thermal issues encountered at high operating speeds through such innovations as planar designs and proprietary heat dissipation technologies.

        Our objective is to be the leading provider of high performance memory subsystems. Key elements of our strategy include:

    Further Sales Penetration of Existing Customers .    We have established deep relationships, and qualified our products, with leading OEMs. Our current OEM customers have a large and diverse portfolio of system platforms that require high performance memory subsystems. We believe we have an attractive opportunity to provide them with memory solutions for a greater number of their existing and future platforms.

    Establish Relationships with New Customers.     We will continue to dedicate significant sales and marketing resources to establish new relationships with industry-leading OEMs for whom memory subsystem performance is a key determinant of overall system performance.

    Target New Applications and Product Opportunities.     We intend to develop additional memory solutions based on our core technology capabilities for the communications, military, aerospace and industrial markets. In addition, we intend to develop flash memory solutions for OEM applications that require high densities of non-volatile memory.

    Continue to Invest in the Development of Proprietary Technology.     We intend to actively expand our intellectual property portfolio and engineering capabilities by investing in research and development. One targeted area of technology development is the design of custom logic ICs that can be used in memory modules to provide value-added features.

    Establish International Operations and Manufacturing Capabilities.     We plan to establish a manufacturing facility in China during the first half of 2007. We believe that this will allow us to better support leading OEMs with design and manufacturing sites in China, lower our production costs and provide access to new pools of engineering talent.

        We were incorporated in Delaware in June 2000 and commenced operations in September 2000. Our principal executive offices are located at 475 Goddard, Irvine, California 92618, and our telephone number is (949) 435-0025. Our web site is www.netlistinc.com. The information on our web site is not incorporated by reference into this prospectus.

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The Offering


Common stock offered

 

                          shares

Common stock to be outstanding after this offering

 

                          shares

Over-allotment option

 

The selling stockholders have granted the underwriters a 30-day option to purchase up to                     additional shares of common stock to cover over-allotments, if any. The selling stockholders include members of our management. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

Use of proceeds

 

We estimate that our net proceeds from this offering will be approximately $                     million. We intend to use these net proceeds for general corporate purposes, including to: fund our future working capital requirements; reduce our outstanding debt; establish a manufacturing operation in China; expand our research and development activities; and acquire complementary businesses, products or technologies. See "Use of Proceeds."

Risk factors

 

See "Risk Factors" and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.

Proposed Nasdaq Global Market symbol

 

NLST

        The common stock to be outstanding after this offering is based on 11,223,334 shares of common stock outstanding as of June 30, 2006, plus the following number of shares of common stock issuable upon the conversion of our outstanding convertible securities effective immediately prior to the completion of this offering:

    1,000,000 shares issuable upon the conversion of all of our outstanding convertible preferred stock; and

    1,050,000 shares issuable upon the conversion of $1.75 million in aggregate principal amount of our outstanding convertible promissory notes.

        The common stock to be outstanding after this offering excludes the following number of shares of common stock, each described as of June 30, 2006:

    382,500 shares of common stock issuable upon the exercise of outstanding warrants with a weighted-average exercise price of $1.13 per share;

    2,254,500 shares of common stock issuable upon the exercise of outstanding options with a weighted-average exercise price of $1.35 per share; and

    1,122,166 shares of common stock available for future issuance under our 2000 Equity Incentive Plan.

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        Unless otherwise indicated, all information in this prospectus assumes: an initial public offering price of $              per share; no exercise of the underwriters' over-allotment option; and the filing of a restated certificate of incorporation and adoption of restated bylaws prior to the completion of this offering.

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Summary Consolidated Financial Data

        The summary consolidated financial data set forth below should be read in conjunction with the information presented in this prospectus under "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," and with our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus.

        The summary consolidated financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2003, 2004 and 2005 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the years ended December 31, 2001 and 2002 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for the six month periods ended June 30, 2005 and 2006, and the consolidated balance sheet data as of June 30, 2006, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus.

        Our historical results are not necessarily indicative of results for any future period. The "Pro Forma" column of the consolidated balance sheet data reflects the automatic conversion immediately prior to the completion of this offering of $1.75 million of convertible notes and $2.0 million of convertible preferred stock into common stock, and the repayment of $950,000 of convertible debt, plus accrued interest, with proceeds of $1.0 million received from a term loan in August 2006. The "Pro Forma as Adjusted" column of the consolidated balance sheet data adjusts the pro forma amounts to reflect the sale of             shares of common stock offered by us at an assumed initial public offering price of $                         per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
  2001
  2002
  2003
  2004
  2005
  2005
  2006
 
  (in thousands, except per share data)

Consolidated Statement of Operations Data:                                          
Net sales   $ 2,660   $ 13,994   $ 100,375   $ 143,659   $ 79,856   $ 36,495   $ 65,934
Cost of sales(1)     3,035     12,147     86,107     133,503     73,892     34,319     57,447
   
 
 
 
 
 
 
Gross profit (loss)     (375 )   1,847     14,268     10,156     5,964     2,176     8,487
Research and development(1)     220     491     11,759     3,770     2,961     1,876     1,514
Selling, general and administrative(1)     842     1,652     15,218     6,314     5,062     2,300     3,911
   
 
 
 
 
 
 
Operating income (loss)     (1,437 )   (296 )   (12,709 )   72     (2,059 )   (2,000 )   3,062
Net income (loss)   $ (959 ) $ (632 ) $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,306
   
 
 
 
 
 
 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic   $ (0.11 ) $ (0.07 ) $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.12
  Diluted   $ (0.11 ) $ (0.07 ) $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.09
Weighted-average shares outstanding:                                          
  Basic     8,840     9,200     9,831     10,671     10,673     10,672     10,988
  Diluted     8,840     9,200     9,831     10,671     10,673     10,672     15,427

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

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
  2001
  2002
  2003
  2004
  2005
  2005
  2006
Cost of sales   $   $   $ 69   $ 29   $ 56   $ (9 ) $ 14
Research and development         371     9,733     80     (52 )   (22 )   22
Selling, general and administrative     87     424     10,872     141     (65 )   (17 )   111

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  June 30, 2006
 
  Actual
  Pro Forma
  Pro Forma,
as Adjusted

 
  (in thousands)

Consolidated Balance Sheet Data:                  
Cash and cash equivalents   $ 27   $ 77   $  
Total assets     34,516     34,566      
Total debt(1)     14,739     13,039      
Stockholders' equity     4,671     6,421      

(1)
Amounts include revolving line of credit balance as of June 30, 2006 of $10,714,000.

        We use a 52-53 week fiscal year. As a result, a fiscal year or quarter may not end as of the same day as the calendar period. However, for convenience of presentation, the above summary consolidated financial data have been shown as ending on June 30 and December 31 of each applicable period.

6



RISK FACTORS

         You should carefully consider the risks described below before making an investment decision. These risks are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations, operating results, cash flows and financial condition. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to the occurrence of any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this prospectus, including our consolidated financial statements and related notes.

Risks Related to Our Business and Industry

We have a limited operating history, and we expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.

        Our limited operating history makes it difficult to predict our future performance. Our operating results have varied significantly in the past and will continue to fluctuate from quarter-to-quarter or year-to-year in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these quarterly and annual fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:

    the loss of, or a significant reduction in sales to, a key customer;

    the cyclical nature of the industry in which we operate;

    a reduction in the demand for our high performance memory subsystems or the systems into which they are incorporated;

    our ability to develop new or enhanced products that achieve market acceptance in a timely manner;

    the timing of introductions of competing products or technologies;

    our ability to adequately support future growth;

    our ability to procure an adequate supply of key components;

    changes in the prices of our products or in the cost of the materials that we use to build our products;

    our failure to maintain the qualification of our products with our current customers or to qualify future products with our current or prospective customers;

    our establishment and ongoing operation of a new manufacturing facility in China;

    the loss of any of our key personnel;

    delays in fulfilling orders for our products or a failure to fulfill orders;

    disputes regarding intellectual property rights;

    litigation involving our products;

    our customers' failure to pay us on a timely basis; and

    changes in accounting principles or policies.

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        Due to the various factors mentioned above, and others, the results of any prior quarterly or annual periods should not be relied upon as an indication of our future operating performance.

Our three largest customers comprised approximately 68% and 81% of our net sales for 2005 and the first six months of 2006, respectively, and the loss of, or a significant reduction in sales to, any one of these customers could materially harm our business.

        Sales to Dell, IBM and Lenovo represented 35%, 20% and 13%, respectively, of our net sales in 2005, and 33%, 46% and 2%, respectively, of our net sales in the first six months of 2006. We expect that sales to these customers will continue to represent a significant percentage of our net sales for at least the next 12 months. We do not have long-term agreements with these three customers, or with any other customer. Any one of these three customers could decide at any time to discontinue, decrease or delay their purchase of our products. In addition, the prices that these three customers pay for our products are subject to negotiation and could change at any time. The loss of either Dell or IBM as a customer, or a significant reduction in sales to either of them, would significantly reduce our net sales and adversely affect our operating results.

        Our ability to maintain or increase our net sales to our key customers depends on a variety of factors, many of which are beyond our control. These factors include the customers' continued sales of servers and other computing systems that incorporate our memory subsystems and the customers' continued use of our products in their systems.

        Because of these and other factors, we cannot assure you that net sales to these customers will continue or that the amount of such net sales will reach or exceed historical levels in any future period. Because these customers account for a substantial portion of our net sales, the failure of any one of these customers to pay on a timely basis would negatively impact our cash flow.

A limited number of relatively large potential customers dominate the markets for our products.

        Our target markets are characterized by a limited number of large companies. Consolidation in one or more of our target markets may further increase this industry concentration. As a result, we anticipate that sales of our products will continue to be concentrated among a limited number of large customers in the foreseeable future. We believe that our financial results will depend in significant part on our success in establishing and maintaining relationships with, and effecting substantial sales to, these potential customers. Even if we establish these relationships, our financial results will be largely dependent on these customers' sales and business results.

The markets in which we compete are cyclical in nature, and any future downturn could adversely affect our business.

        The markets in which we compete and in which our customers operate have been cyclical and are characterized by wide fluctuations in product supply and demand. These markets have experienced significant downturns, often connected with, or in anticipation of, maturing product cycles, reductions in technology spending and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and the erosion of average selling prices. As a result, our sales will likely decline during these periods. In addition, if we are unable to control our expenses adequately in response to reduced net sales, our results of operations would be negatively impacted.

We are subject to risks relating to product concentration and lack of market diversification.

        In 2005 and the first six months of 2006, we generated 51% and 83%, respectively, of our net sales from sales of our high performance memory subsystems for use in the server market. We

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expect these memory subsystems to continue to account for most of our net sales in the near term. Continued market acceptance of these products for use in servers is critical to our success. If the demand for servers deteriorates or if the demand for our products to be incorporated in servers declines, our operating results would be adversely affected, and we would be forced to diversify our product portfolio and our target markets. We may not be able to achieve this diversification, and our inability to do so may adversely affect our business.

We have historically incurred losses and may continue to incur losses.

        We have incurred net losses each year since the inception of our business. Our cumulative net losses were $21.4 million and $20.1 million as of December 31, 2005 and June 30, 2006, respectively. We may not be able to attain profitability on a quarterly or annual basis in the future.

We use a small number of DRAM IC suppliers and are subject to risks of disruption in the supply of DRAM ICs.

        Our ability to fill customer orders is dependent on a sufficient supply of DRAM ICs, which are an essential component of our memory subsystems. There is a relatively small number of suppliers of DRAM ICs, and we purchase from only a subset of these suppliers. We have no long-term DRAM supply contracts. Our dependence on a small number of these suppliers and our lack of any guaranteed sources of DRAM supply expose us to several risks, including the inability to obtain an adequate supply of DRAM ICs, price increases, delivery delays and poor quality.

        From time to time, shortages in DRAM ICs have required some suppliers to limit the supply of their DRAM ICs. As a result, we may be unable to obtain the DRAM ICs necessary to fill customers' orders for our products in a timely manner. If we are unable to obtain a sufficient supply of DRAM ICs to meet our customers' requirements, these customers may reduce future orders for our products or not purchase our products at all, which would cause our net sales to decline and harm our operating results. In addition, our reputation could be harmed, we may not be able to replace any lost business with new customers, and we may lose market share to our competitors.

        Our customers qualify the DRAM ICs of our suppliers for use in their systems. If one of our suppliers should experience quality control problems, it may be disqualified by one or more of our customers. This would disrupt our supplies of DRAM ICs and reduce the number of suppliers available to us, and may require that we qualify a new supplier.

The price of DRAM ICs is volatile, and excess inventory of DRAM ICs, other components, and finished products could adversely affect our gross margin.

        The prices of our products are adjusted periodically based largely on the market price of DRAM ICs, which constituted more than 82% and 75% of the total cost of our memory subsystems sold during 2005 and the first six months of 2006, respectively. Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. Consequently, we are exposed to the risks associated with the volatility of the price of DRAM ICs during that period. If the market price for DRAM ICs increases, we generally cannot pass this price increase on to our customers for products purchased under an existing purchase order. As a result, our cost of sales could increase and our gross margins could decline. Alternatively, if there is a decline in the price of DRAM ICs, we will need to reduce our selling prices for subsequent purchase orders, which may result in a decline in our expected net sales.

        Customer demand for our products, and thus DRAM ICs, can be difficult to estimate because we do not have long-term commitments from our customers, and our customers may cancel or defer purchase orders for any reason. If we overestimate customer demand, we will have excess

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inventory of DRAM ICs. If there is a subsequent decline in the price of DRAM ICs, the value of our inventory will fall. As a result, we may need to write-down the value of our DRAM IC inventory, which may result in a significant decrease in our gross margin and financial condition. If we underestimate customer demand, we will not have sufficient inventory of DRAM ICs to manufacture our products. This will lead to delays in the delivery of our products, which could cause order cancellations, the loss of customers and a decrease in our net sales.

If the supply of other component materials used to manufacture our products is interrupted, or if our inventory becomes obsolete, our results of operations and financial condition could be adversely affected.

        We use consumables and other components, including PCBs, to manufacture our memory subsystems. We sometimes procure PCBs and other components from single or limited sources to take advantage of volume pricing discounts. Material shortages or transportation problems could interrupt the manufacture of our products from time to time in the future. These delays in manufacturing could adversely affect our results of operations.

        Frequent technology changes and the introduction of next-generation products also may result in the obsolescence of other items of inventory, such as our custom-built PCBs, which could reduce our gross margin and adversely affect our operating performance and financial condition. We may not be able to sell some products developed for one customer to another customer because our products are often designed to address specific customer requirements, and if we are able to sell these products our margin on such products may be reduced.

We may lose our competitive position if we are unable to timely and cost-effectively develop new or enhanced products that meet our customers' requirements and achieve market acceptance.

        Our industry is characterized by intense competition, rapid technological change, evolving industry standards and rapid product obsolescence. Evolving industry standards and technological change or new, competitive technologies could render our existing products obsolete. Accordingly, our ability to compete in the future will depend in a large part on our ability to identify and develop new or enhanced products on a timely and cost-effective basis, and to respond to changing customer requirements. In order to develop and introduce new or enhanced products, we need to:

    identify and adjust to the changing requirements of our current and potential customers;

    identify and adapt to emerging technological trends and evolving industry standards in our markets;

    design and introduce cost-effective, innovative and performance-enhancing features that differentiate our products from those of our competitors;

    develop relationships with potential suppliers of components required for these new or enhanced products;

    qualify these products for use in our customers' products; and

    develop and maintain effective marketing strategies.

        Our product development efforts are costly and inherently risky. It is difficult to foresee changes or developments in technology or anticipate the adoption of new standards. Moreover, once these things are identified, if at all, we will need to hire the appropriate technical personnel, develop the product and identify and eliminate design flaws. As a result, we may not be able to successfully develop new or enhanced products, or we may experience delays in the development and introduction of new or enhanced products. Delays in product development and introduction could

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result in the loss of, or delays in generating, net sales and the loss of market share, as well as damage to our reputation. Even if we develop new or enhanced products, they may not meet our customers' requirements or gain market acceptance. Accordingly, we cannot assure you that our future product development efforts will result in the development of new or enhanced products or that such products will achieve market acceptance.

Our customers require that our products undergo a lengthy and expensive qualification process without any assurance of net sales.

        Our prospective customers generally make a significant commitment of resources to test and evaluate our memory subsystems prior to purchasing our products and integrating them into their systems. This extensive qualification process involves rigorous reliability testing and evaluation of our products, which may continue for six months or longer and is often subject to delays. Qualification by a prospective customer does not ensure any sales to that prospective customer. Even after successful qualification and sales of our products to a customer, changes in our products, our manufacturing facilities, our production processes or our component suppliers may require a new qualification process, which may result in additional delays.

        The qualification process is generally both product-specific and platform-specific, and as a result, our existing customers sometimes require us to requalify our products, or to qualify our new products, for use in new platforms or applications. For example, as our OEM customers transition from prior generation double data rate, or DDR, to current generation DDR2 DRAM architectures, we must design and qualify new products for use by those customers. In the past, this process of design and qualification has taken up to six months to complete, during which time our net sales to those customers declined significantly. After our products are qualified, it can take several months before the customer begins production and we begin to generate net sales. We must devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualify our products with prospective customers in anticipation of sales. If we delay or do not succeed in qualifying a product with a prospective customer, we will not be able to sell that product to that prospect, which would harm our operating results and business.

We may not be able to maintain our competitive position because of the intense competition in our target markets.

        We participate in highly competitive markets, and we expect competition to intensify. Many of our competitors have longer operating histories, significantly greater resources and name recognition, a larger base of customers and longer-standing relationships with customers and suppliers than we have. As a result, some of these competitors are able to devote greater resources to the development, promotion and sale of products and are better positioned than we are to influence customer acceptance of their products over our products. These competitors also may be able to respond better to new or emerging technologies or standards and may be able to deliver products with comparable or superior performance at a lower price. For these reasons, we may not be able to compete successfully against these competitors.

        In addition to the competitors described above, some of our OEM customers have their own internal design groups that may develop solutions that compete with ours. These design groups have some advantages over us, including direct access to their respective companies' technical information and technology roadmaps. Our OEM customers also have substantially greater resources, financial or otherwise, than we do, and may have lower cost structures than ours. As a result, they may be able to design and manufacture competitive products more efficiently or inexpensively. If any of these OEM customers are successful in competing against us, our sales could decline, our margins could be negatively impacted and we could lose market share, any or all of which could harm our business and results of operations.

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        We expect our competitors to continue to improve the performance of their current products, reduce their prices and introduce new or enhanced technologies that may offer greater performance and improved pricing. If we are unable to match or exceed the improvements made by our competitors, our market position would deteriorate and our net sales would decline. In addition, our competitors may develop future generations and enhancements of their products that may render our technologies obsolete or uncompetitive.

        We also expect to face competition from new and emerging companies that may enter our existing or future markets. These potential competitors may have similar or alternative products which may be less costly or provide additional features.

The establishment and ongoing operation of our planned manufacturing facility in China could expose us to new and significant risks.

        We are planning to establish a new manufacturing facility in China. To prepare this facility for operation, we will need to purchase new equipment, replicate our current manufacturing processes and hire additional technical personnel. The difficulties normally associated with this complicated process will be compounded by language and cultural differences, as well as the geographic distance from our current facility. Our management has limited experience in creating or overseeing foreign operations, and this new facility may divert substantial amounts of their time. Further, this new facility may be subject to factory audits by our customers. We may not be able to begin operations at this new facility on a timely basis, or at all. Even if this facility becomes operational and is qualified by our customers, we cannot assure you that we will be able to maintain control over product quality, delivery schedules, manufacturing yields and costs as we increase our output. We will also have to manage a local workforce that may subject us to uncertainties or regulatory policies. Any difficulties in operating this new facility could cause product delivery delays and harm our operating results.

        We currently anticipate that our new manufacturing facility in China will become operational in the first half of 2007. Although we are currently planning to establish a manufacturing facility in China, we have not completed our analysis and planning, and the establishment of this new manufacturing facility will require approval by our board of directors. Once this facility is established and becomes operational, some of our net sales will be denominated in Chinese Renminbi, or Yuan. The Chinese government controls the procedures by which Yuan is converted into other currencies, and conversion of Yuan generally requires government consent. As a result, Yuan may not be freely convertible into other currencies at all times. If the Chinese government institutes changes in currency conversion procedures, or imposes restrictions on currency conversion, those actions may negatively impact our operations and could reduce our operating results. In addition, fluctuations in the exchange rate between Yuan and U.S. dollars may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. These fluctuations may also adversely affect the comparability of our period-to-period results. If we decide to declare dividends and repatriate funds from our Chinese operations, we will be required to comply with the procedures and regulations of applicable Chinese law. Any changes to these procedures and regulations, or our failure to comply with those procedures and regulations, could prevent us from making dividends and repatriating funds from our Chinese operations, which could adversely affect our financial condition. If we are able to make dividends and repatriate funds from our Chinese operations, these dividends would be subject to U.S. corporate income tax.

We depend on a few key employees, and if we lose the services of any of those employees or are unable to hire additional personnel, our business could be harmed.

        Our success to date has been highly dependent on the experience, relationships and technical knowledge of Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board,

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Jayesh Bhakta, our Vice President of Engineering, and Christopher Lopes, our Vice President of Sales. We believe that our future success will be dependent on our ability to retain the services of these key employees, develop their successors, reduce our reliance on them, and properly manage the transition of their roles should departures occur.

        The loss of these key employees could delay the development and introduction of, and negatively impact our ability to sell our products and otherwise harm our business. We do not have employment agreements with these key employees. We do not carry key man life insurance on any of our key employees.

        Our future success also depends on our ability to attract, retain and motivate highly skilled engineering, manufacturing, other technical and sales personnel. Competition for experienced personnel is intense. We may not be successful in attracting new engineers or other technical personnel, or in retaining or motivating our existing personnel. If we are unable to hire and retain engineers with the skills necessary to keep pace with the evolving technologies in our markets, our ability to continue to provide our current products and to develop new or enhanced products will be negatively impacted, which would harm our business. In addition, the shortage of experienced engineers, and other factors, may lead to increased recruiting, relocation and compensation costs for such engineers, which may exceed our expectations and resources. These increased costs may make hiring new engineers difficult, or may reduce our margins.

        As of June 30, 2006, 41% of our workforce consisted of contract personnel. We invest considerable time and expense in training these contract employees. We may experience high turnover rates in our contract employee workforce, which may require us to expend additional resources in the future. If we convert any of these contract employees into permanent employees, we may have to pay finder's fees to the contract agency.

Our lack of a significant backlog of unfilled orders, and the difficulty inherent in forecasting customer demand, makes it difficult to forecast our short-term production requirements to meet that demand.

        We do not have long-term purchase agreements with our customers. Instead, our customers generally place purchase orders no more than two weeks in advance of their desired delivery date, and these purchase orders generally have no cancellation or rescheduling penalty provisions. This fact, combined with the quick turn-around times that apply to each order, makes it difficult to forecast our production needs and allocate production capacity efficiently. Our production expense levels are based in part on our forecasts of our customers' future product requirements and to a large extent are fixed in the short term. As a result, we likely will be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in those orders. Any significant shortfall of customer orders in relation to our expectations could hurt our operating results, cash flows and financial condition. Also, any rapid increases in production required by our customers could strain our resources and reduce our margins. If such a rapid increase were to occur at any given time, we may not have sufficient short-term manufacturing capacity to meet our customers' immediate demands.

        We attempt to forecast the demand for the DRAM ICs and other components needed to manufacture our products. Lead times for components vary significantly and depend on various factors, such as the specific supplier and the demand and supply for a component at a given time. If we underestimate customer demand or if we have not provided for sufficient manufacturing capacity, we would not be able to manufacture a sufficient quantity of our products and could forego sales opportunities, lose market share and damage our customer relationships.

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If we are unable to manufacture our products efficiently, our operating results could suffer.

        We must continuously review and improve our manufacturing processes in an effort to maintain satisfactory manufacturing yields and product performance, lower our costs and otherwise remain competitive. For example, we began implementing lead-free soldering technologies in our manufacturing processes in the second quarter of 2005, and "Reduction of Hazardous Substances" manufacturing processes in the fourth quarter of 2005, both of which have been fully implemented as of the date of this prospectus. Implementing process improvements in the future could negatively impact our manufacturing yields, which would in turn adversely affect our results of operations.

        As we manufacture more complex products, the risk of encountering delays or difficulties increases. The start-up costs associated with implementing new manufacturing technologies, methods and processes, including the purchase of new equipment, and any resulting manufacturing delays and inefficiencies, could negatively impact our results of operations.

        If we need to add manufacturing capacity, an expansion of our existing manufacturing facility or establishment of a new facility could be subject to factory audits by our customers. For example, our new manufacturing facility in China will need to be audited and approved by our key customers. Any delays or unexpected costs resulting from this audit process could adversely affect our net sales and results of operations. In addition, we cannot be certain that we will be able to increase our manufacturing capacity on a timely basis or meet the standards of any applicable factory audits.

If we fail to protect our proprietary rights, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could adversely affect our operating results.

        We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in the remaining applications will be allowed. To date we have had only four patents issued. We intend to continue filing patent applications with respect to most of the new processes and technologies that we develop. However, patent protection may not be available for some of these processes or technologies.

        It is possible that our efforts to protect our intellectual property rights may not:

    prevent challenges to, or the invalidation or circumvention of, our existing intellectual property rights;

    prevent our competitors from independently developing similar products, duplicating our products or designing around any patents that may be issued to us;

    prevent disputes with third parties regarding ownership of our intellectual property rights;

    prevent disclosure of our trade secrets and know-how to third parties or into the public domain;

    result in valid patents, including international patents, from any of our pending or future applications; or

    otherwise adequately protect our intellectual property rights.

        Others may attempt to reverse engineer, copy or otherwise obtain and use our proprietary technologies without our consent. Monitoring the unauthorized use of our technologies is difficult. We cannot be certain that the steps we have taken will prevent the unauthorized use of our technologies. This is particularly true in foreign countries, such as China, where we intend to

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establish a new manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.

        If some or all of the claims in our patent applications are not allowed, or if any of our intellectual property protections are limited in scope by a court or circumvented by others, we could face increased competition with regard to our products. Increased competition could significantly harm our business and our operating results.

We may be involved in costly legal proceedings to defend against claims that we infringe the intellectual property rights of others or to enforce or protect our intellectual property rights.

        Lawsuits claiming that we are infringing others' intellectual property rights may be brought against us, and we may have to defend against claims of infringement or invalidity. Litigation is inherently uncertain, and an adverse outcome could subject us to significant liability for damages or invalidate our proprietary rights. An adverse outcome also could force us to take specific actions, including causing us to:

    cease selling products that are claimed to be infringing a third party's intellectual property;

    pay royalties on past or future sales;

    seek a license from the third party intellectual property owner to use their technology in our products, which license may not be available on reasonable terms, or at all; or

    redesign those products that are claimed to be infringing a third party's intellectual property.

        There is a limited pool of experienced technical personnel that we can draw upon to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or potential competitors at some point during their careers, and we anticipate that a number of our future employees will have similar work histories. In the past, some of these competitors have claimed that our employees misappropriated their trade secrets or violated non-competition or non-solicitation agreements. Some of our competitors may threaten or bring legal action involving similar claims against us or our existing employees or make such claims in the future to prevent us from hiring qualified candidates. Lawsuits of this type may be brought, even if there is no merit to the claim, simply as a strategy to drain our financial resources and divert management's attention away from our business.

        We also may find it necessary to litigate against others, including our competitors, customers and former employees, to enforce our intellectual property and contractual and commercial rights including, in particular, our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. We could become subject to counterclaims or countersuits against us as a result of this litigation. Moreover, any legal disputes with customers could cause them to cease buying or using our products or delay their purchase of our products and could substantially damage our relationship with them.

        Any litigation, regardless of its outcome, would be time consuming and costly to resolve, divert our management's time and attention and negatively impact our results of operations.

If we are required to obtain licenses to use third party intellectual property and we fail to do so, our business could be harmed.

        Although some of the components used in our final products contain the intellectual property of third parties, we believe that our suppliers bear the sole responsibility to obtain any rights and licenses to such third party intellectual property. While we have no knowledge that any third party licensor disputes our belief, we cannot assure you that disputes will not arise in the future. The operation of our business and our ability to compete successfully depends significantly on our

15



continued operation without claims of infringement or demands resulting from such claims, including demands for payments of money in the form of, for example, ongoing licensing fees.

        If it is determined that we are required to obtain inbound licenses and we fail to obtain licenses, or if such licenses are not available on economically feasible terms, our business, operating results and financial condition could be significantly harmed.

If our products are defective or are used in defective systems, we may be subject to product recalls or product liability claims.

        If our products are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could be subject to product liability claims and product recalls, safety alerts or advisory notices. While we have product liability insurance coverage, it may not be adequate to satisfy claims made against us. We also may be unable to obtain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims or product recalls, regardless of their ultimate outcome, could have an adverse effect on our business, financial condition and reputation, and on our ability to attract and retain customers. In addition, while we may not be contractually obligated to accept returned products, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. Accepting product returns may negatively impact our operating results.

If we acquire other businesses or technologies in the future, these acquisitions could disrupt our business and harm our operating results and financial condition.

        We will evaluate opportunities to acquire businesses or technologies that might complement our current product offerings or enhance our technical capabilities. We have no experience in acquiring other businesses or technologies. Acquisitions entail a number of risks that could adversely affect our business and operating results, including:

    difficulties in integrating the operations, technologies or products of the acquired companies;

    the diversion of management's time and attention from the normal daily operations of the business;

    insufficient increases in net sales to offset increased expenses associated with acquisitions or acquired companies;

    difficulties in retaining business relationships with suppliers and customers of the acquired companies;

    the overestimation of potential synergies or a delay in realizing those synergies;

    entering markets in which we have no or limited experience and in which competitors have stronger market positions; and

    the potential loss of key employees of the acquired companies.

        Future acquisitions also could cause us to incur debt or be subject to contingent liabilities. In addition, acquisitions could cause us to issue equity securities that could negatively impact the ownership percentages of our existing stockholders. Furthermore, acquisitions may result in material charges or adverse tax consequences, substantial depreciation, deferred compensation charges, in-process research and development charges, the amortization of amounts related to deferred stock-based compensation expense and identifiable purchased intangible assets or impairment of goodwill, any or all of which could negatively affect our results of operations.

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If we do not effectively manage our growth, our resources, systems and controls may be strained and our results of operations may suffer.

        We have expanded, and plan to continue to expand, our operations, both domestically and internationally. Any future growth may strain our resources, management information and telecommunication systems, and operational and financial controls. To manage our growth effectively, including our planned development of a new manufacturing facility in China, we must continue to improve and expand our systems and controls. We may not be able to do this in a timely or cost-effective manner, and our current systems and controls may not be adequate to support our future operations. In addition, our officers have relatively limited experience in managing a rapidly growing business or a public company. As a result, they may not be able to provide the guidance necessary to continue our growth or maintain our market position. Any failure to manage our growth or improve or expand our existing systems and controls, or unexpected difficulties in doing so, could harm our business.

Our internal controls over financial reporting may not be effective, and our independent auditors may not be able to certify as to their effectiveness, which could have a significant and adverse effect on our business.

        We plan to evaluate our internal controls over financial reporting to allow management to report on, and our independent auditors to attest to, those internal controls as will be required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the Securities and Exchange Commission, which we collectively refer to as Section 404. This will involve system and process evaluations and testing to comply with the management assessment and auditor certification requirements of Section 404, which will initially apply to us for the year ended December 31, 2007. Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. In the course of our Section 404 evaluations, we may identify conditions that may result in significant deficiencies or material weaknesses and we may conclude that enhancements, modifications or changes to our internal controls are necessary or desirable. Implementing any such controls would divert the attention of our management, could involve significant costs, and may negatively impact our results of operations.

        We note that there are inherent limitations on the effectiveness of internal controls, as they cannot prevent collusion, management override or failure of human judgment. If we fail to maintain an effective system of internal controls or if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls, we may be unable to produce reliable financial reports or prevent fraud, and it could harm our financial condition and results of operations, result in a loss of investor confidence and negatively impact our share price.

If a standardized memory solution which addresses the demands of our customers is developed, our net sales and market share may decline.

        Many of our memory subsystems are specifically designed for our OEM customers' high performance systems. Our business would be harmed if these high performance systems were to become standardized so that DRAM IC manufacturers or other companies could develop and manufacture a commodity memory module addressing the requirements of some or all of these high performance applications. If DRAM IC manufacturers or other companies are able to develop a standardized solution, our future business may be limited to identifying the next generation of high performance memory demands of OEM customers and developing a solution that addresses such demands. Until fully implemented, this next generation of products may constitute a much smaller market, which may reduce our net sales and market share.

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Our failure to comply with environmental laws and regulations could subject us to significant fines and liabilities or cause us to incur significant costs.

        We are subject to various and frequently changing U.S. federal, state and local and foreign governmental laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. We could incur substantial costs, including clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or personal injury, as a result of violations of, or noncompliance with, environmental laws and regulations. These laws and regulations also could require us to incur significant costs to remain in compliance.

Economic, political and other risks associated with international sales and operations could adversely affect our net sales.

        Part of our growth strategy involves making sales to foreign corporations and delivering our products to facilities located in foreign countries. To facilitate this process and to meet the long-term projected demand for our products, we are planning to set up a new manufacturing facility in China. Selling and manufacturing in foreign countries subjects us to additional risks not present with our domestic operations. We will begin operating in business and regulatory environments in which we have little or no previous experience. We will need to overcome language and cultural barriers to effectively conduct our operations in these new environments. In addition, the economies of China and other countries have been highly volatile in the past, resulting in significant fluctuations in local currencies and other instabilities. These instabilities affect a number of our customers and suppliers in addition to our foreign operations and continue to exist or may occur again in the future. International turmoil and the threat of future terrorist attacks both domestically and internationally, have contributed to an uncertain political and economic climate, both in the U.S. and globally, and have negatively impacted the worldwide economy. The occurrence of one or more of these instabilities could adversely affect our foreign operations and some of our customers or suppliers, each of which could adversely affect our net sales. In addition, our failure to meet applicable regulatory requirements or overcome cultural barriers could result in production delays and increased turn-around times, which would adversely affect our business.

Our operations could be disrupted by power outages, natural disasters or other factors.

        Our current manufacturing facility is located in Irvine, California. Due to this geographic concentration, a disruption of our manufacturing operations, resulting from equipment failure, power failures, quality control issues, human error, government intervention or natural disasters, including earthquakes, fires or floods, could interrupt or interfere with our manufacturing operations and consequently harm our business, financial condition and results of operations. Such disruptions would cause significant delays in shipments of our products and adversely affect our operating results.

Risks Related to This Offering

There has been no prior public market for our common stock, and an active trading market may not develop.

        Prior to this offering, there has been no public market for our common stock. The initial public offering price for the shares of our common stock sold in this offering will be determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. An active trading market may not develop following completion of this offering or, if it is developed, may not be sustained. The lack of an

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active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. We cannot assure you that the market price will equal or exceed the public offering price of your shares. An inactive market may also impair our ability to raise capital by selling shares in the future and may impair our ability to acquire complementary companies or technologies by using our shares as consideration.

Our common stock price may fluctuate substantially, and your investment could suffer a decline in value.

        The market price of our common stock may be volatile and could fluctuate substantially due to a number of factors, many of which are beyond our control and some of which are only indirectly related to our business, including:

    actual or anticipated fluctuations in our net sales or operating results;

    the failure to meet the expectations of securities analysts or investors with respect to our financial performance;

    actual or anticipated changes in our growth rate;

    actual or anticipated fluctuations in our competitors' operating results or changes in their growth rate;

    the sale of our common stock or other securities in the future;

    our ability to raise additional capital;

    the trading volume of our common stock;

    changes in securities analysts' financial estimates for, and ratings of, us or our competitors or the industry generally; and

    changes in market conditions within our industry, the industries of our customers, the financial markets and the economy as a whole.

        In addition, the stock market in general has experienced extreme price and volume fluctuations in recent years that have often been unrelated or disproportionate to the operating performance of listed companies. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance.

        If our net sales or operating results for future quarters are below our estimates or the estimates or expectations of securities analysts and investors, our stock price could decline. In the past, securities class action litigation has often been brought against companies following a decline in the market price of their securities. Technology companies have experienced stock price volatility that is greater, on average, than companies in many other industries in recent years and, as a result, have, on average, been subject to a greater number of securities class action claims. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of our management's attention and resources that are needed to successfully run our business.

Our principal stockholders have significant voting power and may take actions that may not be in the best interest of our other stockholders.

        Upon completion of this offering, our executive officers, directors and principal stockholders will beneficially own, in total, approximately    % of our outstanding common stock. As a result, these stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and

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any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of our executive officers, directors and principal stockholders. For example, our executive officers, directors and principal stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders. In addition, this significant concentration of share ownership may adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in companies with stockholders that have the ability to exercise significant control.

Substantial future sales of our common stock may depress our stock price.

        After this offering, we will have             shares of common stock outstanding. The             shares sold in this offering, or             shares if the underwriters' over-allotment option is exercised in full, will be freely tradable without restriction or further registration under federal securities laws unless purchased by our affiliates. Currently outstanding shares of our common stock will be available for sale in the public market after this offering, subject to the current information, manner of sale and volume restrictions of Rule 144 and Rule 701, as follows:

Date

  Number of Shares
  Comment

On the date of this prospectus

 

shares

 

Shares not locked up and eligible for sale under Rule 144

90 days after the date of this prospectus

 

shares

 

Shares not locked up and eligible for resale under Rule 144 and Rule 701

180 days after the date of this prospectus

 

shares

 

Lock-up released; shares eligible for sale under Rule 144 and Rule 701

        The above table assumes the effectiveness of the lock-up agreements under which holders of our common stock have agreed not to sell or otherwise dispose of their shares of common stock. The underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to such lock-up agreements. In addition, as soon as practicable after the completion of this offering, we intend to file a registration statement on Form S-8 under the Securities Act covering             shares of our common stock issuable under our Amended and Restated 2000 Equity Incentive Plan. See "Management—Employee Benefit Plans" for a description of this plan. Shares registered under that registration statement will be available for sale in the open market, subject to the contractual lock-up agreements described in "Shares Eligible for Future Sale—Lock-up Agreements."

We may need to raise additional funds in the future which may not be available on acceptable terms or at all.

        Our future capital requirements are uncertain and will depend on many factors, including:

    market acceptance of, and demand for, our products;

    the costs of developing new products, designs or technologies;

    the costs of establishing new, or expanding our existing, manufacturing facilities;

    the number and timing of acquisitions; and

    the costs associated with the growth of our business, if any.

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        If the proceeds from this offering together with our existing sources of cash and cash flows are not sufficient to fund our activities, we may need to raise additional capital, which may not be available on favorable terms, or at all. Furthermore, if we issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our products and technologies, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements.

You will experience immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering.

        The initial public offering price of our common stock is expected to exceed substantially the net tangible book value per share of our common stock immediately after this offering. Therefore, based on an assumed initial public offering price of $                        per share, if you purchase our common stock in this offering, you will suffer an immediate dilution of $                        per share. If outstanding options and warrants to purchase our common stock are exercised, you will experience additional dilution.

Our management team may invest or spend the net proceeds of this offering in ways with which you may not agree or in ways that may not yield an acceptable return.

        We currently intend to use the net proceeds in the general manner set forth in "Use of Proceeds." At this time, however, we cannot state with certainty how we will use the net proceeds of this offering or our existing cash balance with respect to specific expenditures. Accordingly, our management will have considerable discretion in the application of the net proceeds, and you will not have the opportunity to assess whether the proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase our operating results or market value.

We will incur increased costs as a result of being a public company.

        As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and Nasdaq, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. For example, we intend to create board committees and adopt additional policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements. It may become more expensive for us to maintain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.

Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our stock.

        Following this offering, our certificate of incorporation, as amended, and our bylaws, as amended, will contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. In addition, these

21



provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. The following are examples of provisions which we intend to include in our certificate of incorporation and bylaws, each as amended:

    our board of directors will be authorized, without prior stockholder approval, to designate and issue preferred stock, commonly referred to as "blank check" preferred stock, with rights senior to those of our common stock;

    stockholder action by written consent will be prohibited;

    nominations for election to our board of directors and the submission of matters to be acted upon by stockholders at a meeting will be subject to advance notice requirements; and

    our board of directors will be expressly authorized to make, alter or repeal our bylaws.

        In addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our certificate of incorporation and bylaws, each as amended, and of Delaware law could make it more difficult for stockholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including delaying or impeding a merger, tender offer, or proxy contest or other change of control transaction involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could prevent the consummation of a transaction in which our stockholders could receive a substantial premium over the then-current market price for their shares.

22



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

        This prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. All statements in this prospectus other than statements of historical fact, including statements regarding future events, our future financial performance, business strategy and plans and objectives of management for future operations, are forward-looking statements.

        In some cases, you can identify forward-looking statements by terminology including "anticipates," "believes," "can," "continue," "could," "estimates," "expects," "intends," "may," "might," "must," "plans," "potential," "predicts," "should," "will" or "would," or the negative of these terms or other comparable terminology. Forward-looking statements used in this prospectus address topics such as, among other things:

    our business strategy;

    our development of new products;

    our anticipated growth strategies;

    anticipated trends in our business, trends in the market for memory subsystems and trends in the adoption of new technologies;

    competition and competitive factors or trends in the memory market;

    uncertainty regarding our future operating results, including our projected net sales, financial results, cash flows, pricing, and similar items;

    our intended use of proceeds;

    our ability to continue to control costs and maintain quality;

    anticipated changes in our expenses over future periods;

    the protection or acquisition of, investment in, or legal proceedings regarding, our intellectual property;

    our intention to establish a manufacturing facility in China; and

    the plans, objectives, expectations and intentions expressed in this prospectus that are not historical facts.

        These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks described in this prospectus under "Risk Factors." We cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

23



USE OF PROCEEDS

        We estimate that the net proceeds we will receive from this offering will be approximately $                        million at an assumed initial public offering price of $                        per share, after deducting underwriting discounts and commissions and estimated offering costs. If the over-allotment option is exercised in full, the selling stockholders will receive $                        million in net proceeds at an initial public offering price of $                        per share. We will not receive any proceeds from the sale of shares by the selling stockholders.

        The principal purposes of this offering are to obtain additional capital, to establish a public market for our common stock and to facilitate our future access to public capital markets. We intend to use the net proceeds of this offering:

    for working capital and other general corporate purposes;

    to repay $1.0 million in outstanding indebtedness under our term loan;

    to reduce our outstanding borrowings under our revolving line of credit;

    to establish a manufacturing facility in China;

    to expand our research and development activities; and

    to acquire complementary businesses, products or technologies.

        Our term loan and revolving line of credit each have an interest rate of prime plus one-half percent. Our term loan has a maturity date of the earlier of July 2008 or the completion of this offering. Our revolving line of credit has a maturity date of July 2008. We have used the proceeds to date under our term loan to repay $950,000 in outstanding principal amount, plus accrued interest, on our convertible promissory notes issued in December 2005.

        We are in the preliminary stages of establishing a manufacturing facility in China and cannot estimate with certainty the expenditures that will be required to develop this facility. We currently believe that we may spend up to $6 million to develop this facility over the next 12 months. We may also use a portion of the net proceeds to us to fund possible investments in, or acquisitions of, complementary businesses, products or technologies or to establish joint ventures. We have no current agreements or commitments with respect to any investment, acquisition or joint venture, and we currently are not engaged in negotiations with respect to any investment, acquisition or joint venture.

        Other than amounts to be used to pay offering fees and expenses, the amount and timing of what we spend for the intended uses of proceeds above may vary significantly and will depend on a number of factors, including our future net sales and cash generated by operations and the other factors described in this prospectus under "Risk Factors." We will have broad discretion in the way that we use the net proceeds of this offering. Pending their ultimate use, we intend to invest the net proceeds to us from this offering in short-term, interest-bearing, investment grade securities.


DIVIDEND POLICY

        We have never declared or paid cash dividends on our capital stock. Our current credit facility prohibits the payment of cash dividends. Accordingly, we do not anticipate declaring or paying cash dividends on our capital stock in the foreseeable future. Any payments of cash dividends will be at the discretion of our board of directors, and will depend upon our results of operations, earnings, capital requirements, legal and contractual restrictions, and other factors deemed relevant by our board of directors.

24



CAPITALIZATION

        The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2006, on:

    an actual basis;

    a pro forma basis to reflect the conversion of $1.75 million of our convertible notes and all of our convertible preferred stock into shares of common stock, each of which will occur automatically immediately prior to the completion of this offering, and repayment of $950,000 of our convertible debt with proceeds of $1.0 million received from a new term loan in August 2006; and

    a pro forma as adjusted basis to give effect to receipt of the estimated net proceeds from the sale by us in this offering of             shares of our common stock at an assumed initial public offering price of $             per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

        You should read the following table in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus.

 
  June 30, 2006
 
  Actual
  Pro Forma
  Pro Forma
as Adjusted

 
  (in thousands)


Cash and cash equivalents

 

$

27

 

$

77

 

$

 
   
 
 

Debt:

 

 

 

 

 

 

 

 

 
  Notes payable to others   $ 256   $ 256   $  
  Obligations under capital lease     1,069     1,069      
  Convertible notes payable, net of debt discount of $50,000     2,700          
  Term loan         1,000      
   
 
 

Total debt

 

 

4,025

 

 

2,325

 

 

 
   
 
 
Stockholders' equity:                  
  Series A convertible preferred stock, $2.00 par value; 1,000,000 shares authorized, issued and outstanding, actual; no shares issued and outstanding, pro forma and pro forma as adjusted     2,000          
  Common stock, $0.001 par value; 16,000,000 shares authorized; 11,223,334 shares issued and outstanding, actual; 13,273,334 shares issued and outstanding, pro forma;             shares issued and outstanding, pro forma as adjusted     11     13      
Additional paid-in capital     22,777     26,525      
Note receivable from stockholder     (23 )   (23 )    
Accumulated deficit     (20,094 )   (20,094 )    
   
 
 

Total stockholders' equity

 

 

4,671

 

 

6,421

 

 

 
   
 
 

Total capitalization

 

$

8,696

 

$

8,746

 

$

 
   
 
 

        The table above excludes the following shares, each as of June 30, 2006:

    382,500 shares issuable upon the exercise of warrants with a weighted-average exercise price of $1.13 per share;

    2,254,500 shares issuable upon the exercise of options with a weighted-average exercise price of $1.35 per share; and

    1,122,166 shares available for future grant or issuance under our 2000 Equity Incentive Plan.

25



DILUTION

        Our historical net tangible book value as of June 30, 2006, was approximately $4.7 million, or $0.42 per share of common stock. Historical net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by 11,223,334 shares of common stock outstanding as of June 30, 2006.

        Our pro forma net tangible book value as of June 30, 2006 was approximately $6.4 million, or $0.48 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by 13,273,334 shares of common stock outstanding on a pro forma basis as of June 30, 2006. These pro forma numbers reflect the conversion of $1.75 million of our convertible notes and all of our convertible preferred stock into shares of our common stock.

        Dilution in pro forma net tangible book value per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma as adjusted net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to our sale of             shares of common stock in this offering at an assumed initial public offering price of $             per share, after deducting the underwriting discount and estimated offering expenses payable by us, our adjusted pro forma net tangible book value as of June 30, 2006 would have been $             million, or $             per share of common stock. This amount represents an immediate increase of $             per share in our pro forma net tangible book value. It also represents an immediate dilution to new investors of $             per share. The following table illustrates this per share dilution:

Assumed initial public offering price per share         $  
  Historical net tangible book value per share as of June 30, 2006   $ 0.42      
  Increase in historical net tangible book value per share as of June 30, 2006 attributable to the automatic conversion of our outstanding convertible notes into 1,050,000 shares of common stock     0.10      
  Decrease in historical net tangible book value per share as of June 30, 2006 attributable to the automatic conversion of our convertible preferred stock into 1,000,000 shares of common stock     (0.04 )    
   
     
  Net increase in pro forma net tangible book value per share attributable to conversion of our outstanding convertible notes and our convertible preferred stock     0.06      
   
     

Pro forma as adjusted net tangible book value per share after the offering

 

 

 

 

 

 
         

Dilution per share to new investors

 

 

 

 

$

 
         

        The following table summarizes, on a pro forma basis as of June 30, 2006, the differences between the number of shares of common stock purchased from us, the aggregate cash consideration paid to us, and the average price per share paid by our existing stockholders and by new investors purchasing shares of common stock from us in this offering. These pro forma numbers reflect the automatic conversion of $1.75 million of our outstanding convertible notes and all of our convertible preferred stock into common stock. The calculation below is based on an

26



assumed initial public offering price of $             per share, before deducting the underwriting discount and estimated offering expenses payable by us:

 
  Shares Purchased
  Total Consideration
   
 
  Average
Price Per
Share

 
  Number
  Percent
  Amount
  Percent
Existing stockholders         % $       % $  
New investors                        
 
Total

 

 

 

 

%

$

 

 

 

%

$

 

        This discussion and table assume no exercise of any stock options or warrants outstanding as of June 30, 2006. As of June 30, 2006, there were outstanding options issued under our stock option plan to purchase a total of 2,254,500 shares of common stock with a weighted-average exercise price of $1.35 per share and warrants to purchase a total of 382,500 shares of common stock with a weighted-average exercise price of $1.13 per share. To the extent that any of these options or warrants are exercised, there will be further dilution to new investors. If all of these options and warrants are exercised, the percentage of shares sold by us in this offering compared to the total number of shares outstanding would decrease from    % to    %, the percentage of consideration paid by investors to us in this offering compared to the total consideration paid by all investors would decrease from    % to    % and the dilution per share to new investors would decrease from $             per share to $             per share.

27



SELECTED CONSOLIDATED FINANCIAL DATA

        The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited and unaudited consolidated financial statements and the related notes appearing elsewhere in this prospectus.

        The selected consolidated financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2003, 2004 and 2005, and the consolidated balance sheet data as of December 31, 2004 and 2005, are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the years ended December 31, 2001 and 2002, and the consolidated balance sheet data as of December 31, 2001, 2002 and 2003 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for the six month periods ended June 30, 2005 and 2006, and the consolidated balance sheet data as of June 30, 2006, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus.

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
 
  2001
  2002
  2003
  2004
  2005
  2005
  2006
 
 
  (in thousands, except per share data)

 
Consolidated Statement of Operations Data:                                            
Net sales   $ 2,660   $ 13,994   $ 100,375   $ 143,659   $ 79,856   $ 36,495   $ 65,934  
Cost of sales(1)     3,035     12,147     86,107     133,503     73,892     34,319     57,447  
   
 
 
 
 
 
 
 

Gross profit (loss)

 

 

(375

)

 

1,847

 

 

14,268

 

 

10,156

 

 

5,964

 

 

2,176

 

 

8,487

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Research and development(1)     220     491     11,759     3,770     2,961     1,876     1,514  
  Selling, general and administrative(1)     842     1,652     15,218     6,314     5,062     2,300     3,911  
   
 
 
 
 
 
 
 
   
Total operating expenses

 

 

1,062

 

 

2,143

 

 

26,977

 

 

10,084

 

 

8,023

 

 

4,176

 

 

5,425

 

Operating income (loss)

 

 

(1,437

)

 

(296

)

 

(12,709

)

 

72

 

 

(2,059

)

 

(2,000

)

 

3,062

 
Other expense, net     (154 )   (290 )   (879 )   (1,386 )   (1,200 )   (483 )   (944 )
   
 
 
 
 
 
 
 

Income (loss) before provision (benefit) for income taxes

 

 

(1,591

)

 

(586

)

 

(13,588

)

 

(1,314

)

 

(3,259

)

 

(2,483

)

 

2,118

 
Provision (benefit) for income taxes     (632 )   46     2,317     (340 )   (912 )   (695 )   812  
   
 
 
 
 
 
 
 

Net income (loss)

 

$

(959

)

$

(632

)

$

(15,905

)

$

(974

)

$

(2,347

)

$

(1,788

)

$

1,306

 
   
 
 
 
 
 
 
 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic   $ (0.11 ) $ (0.07 ) $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.12  
  Diluted   $ (0.11 ) $ (0.07 ) $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.09  

Weighted-average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic     8,840     9,200     9,831     10,671     10,673     10,672     10,988  
  Diluted     8,840     9,200     9,831     10,671     10,673     10,672     15,427  

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

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
  2001
  2002
  2003
  2004
  2005
  2005
  2006
Cost of sales   $   $   $ 69   $ 29   $ 56   $ (9 ) $ 14
Research and development         371     9,733     80     (52 )   (22 )   22
Selling, general and administrative     87     424     10,872     141     (65 )   (17 )   111

28


 
  December 31,
   
 
  June 30,
2006

 
  2001
  2002
  2003
  2004
  2005
 
  (in thousands)

Consolidated Balance Sheet Data:                                    
Cash and cash equivalents   $ 59   $ 91   $ 1,907   $ 759   $ 953   $ 27
Total assets     4,283     9,129     22,404     22,110     25,842     34,516
Total debt(1)     3,037     3,778     3,464     9,379     13,921     14,739
Stockholders' equity     621     754     5,981     5,261     2,855     4,671

(1)
Amounts include outstanding revolving line of credit balance as of each respective date.

        We use a 52-53 week fiscal year. As a result, a fiscal year or quarter may not end as of the same day as the calendar period. However, for convenience of presentation, the above summary consolidated financial data have been shown as ending on June 30 and December 31 of each applicable period.

29



MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

         The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Consolidated Financial Data" and our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, estimates and assumptions. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed in this prospectus under "Risk Factors" and elsewhere in this prospectus.

Overview

        We design, manufacture and sell high performance memory subsystems for the server, high performance computing and communications markets. Our memory subsystems consist of DRAM ICs and other components assembled on a PCB. We engage with our OEM customers from the earliest stages of new product definition, which provides us unique insight into their full range of system architecture and performance requirements. This close collaboration has also allowed us to develop a significant level of systems expertise. We leverage a portfolio of proprietary technologies and design techniques, including efficient planar design, alternative packaging techniques and custom semiconductor logic, to deliver memory subsystems with high memory density, small form factor, high signal integrity, attractive thermal characteristics and low cost per bit.

        Due to their importance to overall system architecture and performance, our products must undergo lengthy qualification periods by our OEM customers, which may last up to six months. In addition, in order to penetrate large OEMs, we have typically been required to demonstrate our ability to meet strict standards for quality, customer service and turnaround time by first supplying lower complexity products into a limited range of high volume applications. For example, the initial products we sold to IBM were used in mobile computing applications. The majority of our sales of subsequent products to IBM have been for high-end server applications, our primary market focus. Consistent with the concentrated nature of the OEM customer base in our target markets, a small number of large customers have historically accounted for a significant portion of our net sales. Dell, IBM and Lenovo represented 35%, 20% and 13%, respectively, of our net sales in 2005, and 33%, 46% and 2%, respectively, of our net sales in the first six months of 2006. We expect that these customers will continue to represent a significant percentage of our net sales for at least the next 12 months.

        We commenced operations in September 2000 and initially focused on memory subsystems for the telecommunications markets. Beginning in the second quarter of 2001, we shifted our focus to the server and high performance computing markets, due in large part to the telecommunications market downturn. In 2002, we became a qualified supplier for RLX Technologies, Inc., a blade server manufacturer. One of the products we initially developed for RLX, our proprietary 2-inch form factor, 1-gigabyte memory subsystem, led to the development of a range of additional memory subsystems.

        We began qualifying our 2-inch form factor, 1-gigabyte memory subsystem with Dell in the second quarter of 2002 and started shipping it to Dell in the fourth quarter of 2002. Our sales to Dell continued to increase throughout 2003 and the first three quarters of 2004, as we began to ship more of our memory subsystems to a larger number of Dell facilities in the U.S., Europe and Asia. During this time, we also qualified new products with other leading server and high performance computing OEMs. Beginning in the fourth quarter of 2004, issues associated with the transition from DDR to DDR2 DRAM architectures resulted in a significant decrease in our sales to

30



Dell. Our sales to Dell began to recover in the fourth quarter of 2005. Also during 2005, our sales to IBM and Lenovo began to increase significantly.

        Our sales to IBM continued to grow significantly in the first six months of 2006, driven by high demand for IBM's line of blade servers that incorporates our proprietary very low profile memory subsystem. Sales to Dell also grew significantly as our DDR2 products began to ship in volume. In addition, we began shipments to other leading OEMs, including Gateway and Hewlett-Packard. We have several new products in various stages of qualification that we anticipate will be incorporated into additional platforms currently in development at our customers.

Key Business Metrics

        The following describes certain line items in our statements of operations that are important to management's assessment of our financial performance:

        Net Sales.     Net sales consist primarily of sales of our high performance memory subsystems, net of a provision for estimated returns under our right of return policies, which 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 of future product demand over specific periods of time, they generally place purchase orders with us approximately two weeks in advance of scheduled delivery. Selling prices are typically negotiated monthly, based on competitive market conditions and the current price of DRAM ICs. Purchase orders generally have no cancellation or rescheduling penalty provisions. We often ship our products to our customers' international manufacturing sites. All of our sales to date, however, are denominated in U.S. dollars. We also sell excess component inventory of DRAM ICs to distributors and other users of memory ICs. These sales accounted for 24% and 11% of our net sales in 2005 and the first six months of 2006, respectively. We expect that component inventory sales will decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.

        Cost of Sales.     Our cost of sales includes the cost of materials, manufacturing costs, depreciation and amortization of equipment, inventory valuation provisions, and occupancy costs and other allocated fixed costs. The DRAM ICs incorporated into our products constitute a significant portion of our cost of sales, and thus our cost of sales will fluctuate based on the current price of DRAM ICs. We attempt to pass through such DRAM IC cost fluctuations to our customers by frequently renegotiating pricing prior to the placement of their purchase orders. To the extent we are successful, a large majority of our product cost is variable, and thus our cost of sales and gross margin percentages may not be significantly impacted by changes in sales volume. However, the sales prices of our memory subsystems can also fluctuate due to competitive situations unrelated to the pricing of DRAM ICs, which will affect gross margins. The gross margin on our sales of excess component DRAM IC inventory is much lower than the gross margin on our sales of our memory subsystems. As a result, a decrease in DRAM IC inventory sales as a percentage of our overall sales would result in an improved overall gross margin. We assess the valuation of our inventories on a monthly basis and record a provision to cost of sales as necessary to reduce inventories to the lower of cost or market value.

        Research and Development.     Research and development expense consists primarily of employee and independent contractor compensation and related costs, stock-based compensation, computer-aided design software licenses, reference design development costs, patent-related fees, depreciation or rental of evaluation equipment, and occupancy and other allocated overhead costs. Also included in research and development expense are the costs of material and overhead related to the production of engineering samples of new products under development or products used solely in the research and development process. Our customers typically do not separately

31



compensate us for design and engineering work involved in developing application-specific products for them. All research and development costs are expensed as incurred. As we continue to develop additional proprietary technologies, we anticipate that research and development expenditures will increase.

        Selling, General and Administrative.     Selling, general and administrative expenses consist primarily of employee salaries and related costs, stock-based compensation, independent sales representative commissions, professional services, promotional and other selling and marketing expenses, and occupancy and other allocated overhead costs. A significant portion of our selling efforts is directed at building relationships with OEMs and working through the product approval and qualification process with them. Therefore, the cost of material and overhead related to products manufactured for qualification is included in selling expenses. As we continue to service existing and penetrate new OEM customers, we anticipate that our sales and marketing expenses will increase. We also anticipate that our general and administrative expenses will increase as a percentage of net sales as we incur accounting and legal expenses associated with our ongoing public reporting obligations and compliance with the requirements of the Sarbanes-Oxley Act of 2002.

        Provision (Benefit) for Income Taxes.     Our income tax provision (benefit) is based on the statutory federal tax rate of 35% and is typically impacted by state taxes and other permanent differences, the largest of which relates to the amortization of deferred stock-based compensation expense.

Critical Accounting Policies

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

        Revenue Recognition.     We account for revenue from product sales when there is persuasive evidence of an arrangement, delivery has occurred, the fee is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Under the provisions of Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition , these conditions are typically met upon shipment and transfer of title for customers with free-on-board, or FOB, shipping point terms and upon receipt and transfer of title for customers with FOB destination terms. Most of our international shipments are made to third party inventory warehouses, or hubs, and we recognize revenue when the inventory is pulled from the hub for use in production by the customer.

        Customers are generally allowed limited rights of return for up to 30 days. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve. While these returns have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience similar return rates in the future. Any significant increase in product failure rates and the resulting product returns could have a material adverse effect on our operating results for the period or periods in which such returns materialize.

32



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

        Warranty Reserve.     We offer warranties on our memory subsystems generally ranging from one to three years, depending on the product and negotiated terms of purchase agreements with our customers. Such warranties require us to repair or replace defective product returned to us during such warranty period at no cost to the customer. Our estimates for warranty related costs are recorded at the time of sale based on historical and estimated future product return rates and expected repair or replacement costs. While such costs have historically been insignificant, unexpected changes in failure rates could have a material adverse impact on us.

        Accounts Receivable.     We perform credit evaluations of our customers' financial condition and limit the amount of credit extended to our customers as deemed necessary, but generally require no collateral. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. Generally, these credit losses have been within our expectations and the provisions established. However, we cannot guarantee that we will continue to experience credit loss rates similar to those we have experienced in the past.

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

        Inventories.     We value our inventories at the lower of the actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. We regularly review inventory quantities on hand and on order and record a provision for excess and obsolete inventories based primarily on our estimated forecast of product demand and production requirements for the next three to six months. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories. A significant decrease in demand for our products could result in an increase in the amount of excess inventory quantities on hand. In addition, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventories are determined to be overvalued, we would be required to recognize additional expense in our cost of sales at the time of such determination. Likewise, if our inventories are determined to be undervalued, we may have over-reported our costs of sales in previous periods and would be required to recognize additional gross profit at the time such inventories are sold. Although we make every reasonable effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a material effect on the value of our inventories and our reported operating results.

        Long-Lived Assets.     We review the recoverability of the carrying value of long-lived assets on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is determined based upon the forecasted undiscounted future net cash flows from the operations to which the assets relate, utilizing our best estimates, appropriate assumptions and projections at the time. These projected future cash flows may vary significantly over time as a result of increased 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 be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized to the extent the carrying value exceeded the estimated fair market value of the asset.

33



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

        Prior to January 1, 2006, we accounted for stock-based compensation issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees and related pronouncements. Under this method, compensation expense was recognized over the respective vesting period based on the excess, on the date of grant, of the fair value of our common stock over the grant price, net of forfeitures. Deferred stock-based compensation was amortized on a straight-line basis over the vesting period of each grant. During the years ended December 31, 2003, 2004 and 2005, stock-based compensation expense, net of forfeitures, was $20.7 million, $250,000 and $(61,000), respectively.

        On January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment , which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors related to our 2000 Equity Incentive Plan based on estimated fair values. We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our consolidated financial statements as of and for the six months ended June 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statement of operations. As stock-based compensation expense recognized in the consolidated statement of operations for the six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the six months ended June 30, 2006 of 8% was based on historical forfeiture experience and estimated future employee forfeitures. In our pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, we accounted for forfeitures as they occurred.

        Employee stock-based compensation expense recognized under SFAS No. 123(R) for the six months ended June 30, 2006 was $138,000, determined by the Black-Scholes valuation model. As of June 30, 2006, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options was $743,000, which is expected to be recognized as an expense over a weighted-average period of approximately 4 years. See Note 2 to our consolidated financial statements for additional information.

        Income Taxes.     We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we operate at a loss for an extended period of time or are unable to generate sufficient future taxable income, or if there is a material change in the actual

34



effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to record a valuation allowance against all or a significant portion of our deferred tax assets which could substantially increase our effective tax rate for such period. Any significant changes in statutory tax rates or the amount of our valuation allowance could have a material effect on the value of our deferred tax assets and liabilities, and our reported financial results.

        Our current effective tax rate is approximately 38%. We expect this rate to decrease if we generate profits from our planned manufacturing facility in China in 2007. This decrease is expected to be attributable to the favorable tax treatment available in the region in which we intend to establish our operation. The magnitude of the decrease is not known, as we have not finalized our tax strategy as it relates to the planned China operation.

Results of Operations

        The following table sets forth our consolidated statements of operations for the periods indicated:

 
  Years Ended December 31,
  Six Months Ended June 30,
 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 
 
  (in thousands)

 

Net sales

 

$

100,375

 

$

143,659

 

$

79,856

 

$

36,495

 

$

65,934

 
Cost of sales(1)     86,107     133,503     73,892     34,319     57,447  
   
 
 
 
 
 
Gross profit     14,268     10,156     5,964     2,176     8,487  

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Research and development(1)     11,759     3,770     2,961     1,876     1,514  
  Selling, general and administrative(1)     15,218     6,314     5,062     2,300     3,911  
   
 
 
 
 
 
      Total operating expenses     26,977     10,084     8,023     4,176     5,425  

Operating income (loss)

 

 

(12,709

)

 

72

 

 

(2,059

)

 

(2,000

)

 

3,062

 
Other expense, net     (879 )   (1,386 )   (1,200 )   (483 )   (944 )
   
 
 
 
 
 

Income (loss) before provision (benefit) for income taxes

 

 

(13,588

)

 

(1,314

)

 

(3,259

)

 

(2,483

)

 

2,118

 
Provision (benefit) for income taxes     2,317     (340 )   (912 )   (695 )   812  
   
 
 
 
 
 
Net income (loss)   $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,306  
   
 
 
 
 
 

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

 
  Years Ended December 31,
  Six Months Ended June 30,
 
  2003
  2004
  2005
  2005
  2006

Cost of sales

 

$

69

 

$

29

 

$

56

 

$

(9

)

$

14
Research and development     9,733     80     (52 )   (22 )   22
Selling, general and administrative     10,872     141     (65 )   (17 )   111

35


        The following table sets forth our consolidated statements of operations as a percentage of net sales for the periods indicated:

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%
Cost of sales   85.7   92.9   92.5   94.1   87.1  
   
 
 
 
 
 
Gross profit   14.3   7.1   7.5   5.9   12.9  

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 
  Research and development   11.7   2.6   3.7   5.1   2.3  
  Selling, general and administrative   15.2   4.4   6.4   6.3   6.0  
   
 
 
 
 
 
    Total operating expenses   26.9   7.0   10.1   11.4   8.3  

Operating income (loss)

 

(12.6

)

0.1

 

(2.6

)

(5.5

)

4.6

 
Other expense, net   (0.9 ) (1.0 ) (1.5 ) (1.3 ) (1.4 )
   
 
 
 
 
 

Income (loss) before provision (benefit) for income taxes

 

(13.5

)

(0.9

)

(4.1

)

(6.8

)

3.2

 
Provision (benefit) for income taxes   2.3   (0.2 ) (1.1 ) (1.9 ) 1.2  
   
 
 
 
 
 
Net income (loss)   (15.8 )% (0.7 )% (3.0 )% (4.9 )% 2.0 %
   
 
 
 
 
 

    Six Months Ended June 30, 2006 Compared to the Six Months Ended June 30, 2005

        Net Sales.     Net sales for the six months ended June 30, 2006 were $65.9 million, an increase of $29.4 million, or 81%, over the first six months of 2005. Approximately $26.7 million of the increase was attributable to higher unit sales of our very low profile memory subsystems. In addition, DDR2 server memory subsystem sales increased by $13.9 million and DDR subsystem sales decreased by $6.7 million due to customers transitioning to DDR2 architectures. Finally, sales of laptop and desktop personal computer, or PC, memory subsystems decreased $6.1 million as we focused on sales of higher margin server memory subsystems.

        Sales of our component inventory to distributors and other users of memory ICs represented 11% and 23% of net sales for the six months ended June 30, 2006 and 2005, respectively. We expect that component inventory sales will decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.

        Gross Profit and Gross Margin.     Gross profit for the six months ended June 30, 2006 was $8.5 million, an increase of $6.3 million, or 290%, over the comparable period in 2005. Gross margin increased to 12.9% for the first six months of 2006 from 5.9% for the first six months of 2005. The increase in both gross profit and gross margin is primarily attributable to increased sales of our very low profile memory subsystems, which generate higher margins due to their innovative design, as well as lower margin products becoming a smaller portion of our overall product sales mix.

        Research and Development.     Research and development expenses for the six months ended June 30, 2006 were $1.5 million, a decrease of $0.4 million compared to the same period in 2005. The decrease is related in part to a reduction of personnel that occurred in the third quarter of 2005, as well as a recovery of costs through the liquidation of engineering samples.

36



        Selling, General and Administrative.     Selling, general and administrative expenses for the six months ended June 30, 2006 were $3.9 million, an increase of $1.6 million compared to the same period of 2005. The increase is attributable to higher sales commissions related to increased net sales, increased salaries and related costs due to an increase in personnel, higher costs related to qualification of new products at customers, and a provision for bad debt of approximately $0.4 million related to a single distribution customer.

        Other Expense, Net.     Other expense, net, for the first six months of 2006 was $0.9 million, an increase of $0.5 million compared to 2005 due to higher interest expense related to increased borrowings under our revolving line of credit.

        Provision (Benefit) for Income Taxes.     The provision for income taxes for the first six months of 2006 was $0.8 million compared to an income tax benefit of $0.7 million in 2005. The change was due to our attaining profitability in 2006.

    Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

        Net Sales.     Net sales for the year ended December 31, 2005 were $79.9 million, a decrease of $63.8 million, or 44%, from the year ended December 31, 2004. This decrease was due to a $72.6 million decrease in net sales to one key customer, partially offset by the commencement of shipments of our very low profile subsystem during 2005. The decrease in net sales to the key customer was attributable to its shift in memory technology from DDR to DDR2. Our net sales decreased significantly as the key customer delayed qualifying new suppliers during this transition.

        Sales of our component inventory to distributors and other users of memory ICs represented 24% and 20% of net sales in 2005 and 2004, respectively. The increase in the proportion of component sales was due to the overall decrease in net sales, as sales of component inventory decreased $8.9 million from 2004.

        Gross Profit and Gross Margin.     Gross profit for the year ended December 31, 2005 was $6.0 million a decrease of $4.2 million, or 41%, from 2004. Gross margin increased to 7.5% in 2005 from 7.1% in 2004. The decrease in gross profit was attributable to the overall decrease in net sales. The increase in gross margin was attributable to the higher margins realized on sales of our very low profile memory subsystems compared to our other products.

        Research and Development.     Research and development expenses in 2005 were $3.0 million, a decrease of $0.8 million from 2004. This decrease was attributable to reductions in personnel, a decrease in stock-based compensation expense due to forfeitures of equity awards related to personnel reductions, as well as a recovery of costs through the liquidation of engineering samples.

        Selling, General and Administrative.     Selling, general and administrative costs in 2005 were $5.1 million, a decrease of $1.2 million compared to 2004. This decrease was primarily related to the absence in 2005 of costs incurred in 2004 related to our proposed equity financing through an initial public offering. These offering-related costs totaled $1.0 million in 2004.

        Other Expense, Net.     Other expense, net, in 2005 was $1.2 million, a decrease of $0.2 million compared to 2004. The decrease was related to a reduction in interest expense due to decreased usage of accounts receivable financing related to a key customer.

        Provision (Benefit) for Income Taxes.     The benefit for income taxes in 2005 increased $0.6 million compared to 2004 due to the increased pre-tax losses in 2005.

37



    Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003

        Net Sales.     Net sales for the year ended December 31, 2004 were $143.7 million, an increase of $43.3 million, or 43%, from the year ended December 31, 2003. This increase was entirely due to increased net sales to one key customer of our planar memory subsystem.

        Sales of our component inventory to distributors and other users of memory ICs represented 20% and 20% of net sales in 2004 and 2003, respectively. Although sales of component inventory increased $10.4 million from 2003, the proportion of component sales remained constant due to the overall increase in net sales.

        Gross Profit and Gross Margin.     Gross profit for the year ended December 31, 2004 was $10.2 million, a decrease of $4.1 million, or 29%, from 2003. Gross margin decreased to 7.1% in 2004 from 14.3% in 2003. The decrease in both gross profit and gross margin was attributable to price decreases related to the deteriorating cost advantage of our planar memory subsystem relative to competing alternatives.

        Research and Development.     Research and development expenses in 2004 were $3.8 million, a decrease of $8.0 million from 2003. This decrease was attributable to the absence in 2004 of $9.7 million of stock-based compensation expense incurred in 2003 related to the forgiveness of debt used to purchase restricted stock by one of our company's founders, offset by an increase in personnel and higher material and overhead costs related to production of engineering samples.

        Selling, General and Administrative.     Selling, general and administrative costs in 2004 were $6.3 million, a decrease of $8.9 million compared to 2003. This decrease was primarily related to the absence in 2004 of $10.0 million in stock-based compensation expense incurred in 2003 related to the forgiveness of debt used to purchase restricted stock by one of our company's founders, offset by costs incurred in 2004 related to our proposed equity financing via an initial public offering. These offering-related costs totaled $1.0 million. In addition, we incurred higher material and overhead costs related to qualification of our products at customers.

        Other Expense, Net.     Other expense, net, in 2004 was $1.4 million, an increase of $0.5 million compared to 2003. The increase was related to interest costs due to higher borrowings under our revolving line of credit.

        Provision (Benefit) for Income Taxes.     The benefit for income taxes was $0.3 million in 2004 compared to an income tax provision of $2.3 million in 2003. The change was due to our incurring pre-tax losses in 2004 compared to pre-tax income before stock-based compensation expenses in 2003.

Selected Quarterly Financial Information

        The following table presents our unaudited quarterly statements of operations for each of the four quarters in the year ended December 31, 2005, for the quarter ended March 31, 2006, and for the quarter ended June 30, 2006. You should read the following table in conjunction with our audited and unaudited consolidated financial statements and related notes contained elsewhere in this prospectus. We have prepared the underlying unaudited financial statements on the same basis as our audited consolidated financial statements included in this prospectus, which include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future periods.

38


 
  Three Months Ended,
 
  March 31,
2005

  June 30,
2005

  September 30,
2005

  December 31,
2005

  March 31,
2006

  June 30,
2006

 
  (in thousands, except per share data)


Net sales

 

$

20,956

 

$

15,539

 

$

20,057

 

$

23,304

 

$

26,020

 

$

39,914
Cost of sales     20,087     14,232     18,163     21,410     23,466     33,981
   
 
 
 
 
 
Gross profit     869     1,307     1,894     1,894     2,554     5,933
Operating expenses:                                    
  Research and development     916     960     617     468     666     848
  Selling, general & administrative     1,194     1,106     1,394     1,368     1,803     2,108
   
 
 
 
 
 
    Total operating expenses     2,110     2,066     2,011     1,836     2,469     2,956

Operating income (loss)

 

 

(1,241

)

 

(759

)

 

(117

)

 

58

 

 

85

 

 

2,977
Other expense, net     248     235     254     463     410     534
   
 
 
 
 
 

Income (loss) before provision (benefit) for income taxes

 

 

(1,489

)

 

(994

)

 

(371

)

 

(405

)

 

(325

)

 

2,443
Provision (benefit) for income taxes     (399 )   (296 )   (116 )   (101 )   (83 )   895
   
 
 
 
 
 
Net income (loss)   $ (1,090 ) $ (698 ) $ (255 ) $ (304 ) $ (242 ) $ 1,548
   
 
 
 
 
 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic   $ (0.10 ) $ (0.07 ) $ (0.03 ) $ (0.02 ) $ (0.02 ) $ 0.14
  Diluted   $ (0.10 ) $ (0.07 ) $ (0.03 ) $ (0.02 ) $ (0.02 ) $ 0.11
Weighted-average common shares outstanding:                                    
  Basic     10,672     10,672     10,673     10,673     10,753     11,223
  Diluted     10,672     10,672     10,673     10,673     10,753     15,681

39


        Historically, our quarterly operating results have fluctuated significantly. These fluctuations are primarily attributable to the cyclical nature of the industry in which we operate, including changes in revenue related to additions of new customers, the ramp up of new products, products reaching the end of their life cycles, customers' technology transitions, and other similar reasons. As a result, we believe that the period-to-period comparisons of our net sales and operating results are not necessarily meaningful measures of future operating performance and should not be relied upon as indications of that future performance. We expect that our future operating results will fluctuate from quarter-to-quarter and year-to-year, which may make it difficult to predict our future performance and could cause our stock price to fluctuate and decline.

Liquidity and Capital Resources

    Cash Flows

        The following table summarizes our cash flows for the periods indicated:

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unuadited)

 
 
  (in thousands)

 
Net cash provided by (used in):                                
Operating activities   $ 3,659   $ (6,567 ) $ (4,608 ) $ 566   $ (1,816 )
Investing activities     (1,515 )   (496 )   1,332     (325 )   (291 )
Financing activities     (328 )   5,915     3,470     (979 )   1,181  
   
 
 
 
 
 
  Net increase (decrease) in cash and cash equivalents   $ 1,816   $ (1,148 ) $ 194   $ (738 ) $ (926 )
   
 
 
 
 
 

        Since our inception in 2000, we have financed our operations primarily through issuances of equity and debt securities and cash generated from operations. We received gross proceeds of $2.0 million from the sale of shares of our capital stock in 2000. During 2001 and 2003, we received total proceeds of approximately $1.8 million from the sale of convertible notes. During 2005, we received total proceeds of $1.0 million from the sale of convertible notes. In August 2006, we received proceeds of $1.0 million under a new term loan facility. We have also funded our operations with a revolving line of credit under our bank credit facility, from capitalized lease obligations, financing of receivables and from the sale and leaseback of our manufacturing facility.

        Operating Activities.     Cash used in operating activities for the six months ended June 30, 2006 was $1.8 million compared to cash generated by operating activities of $0.6 million for the six months ended June 30, 2005. This change was due to an increase in cash flow related to net income of $3.1 million offset by a decrease in cash flow related to accounts receivable of $8.7 million due to a higher proportion of net sales being generated by customers with longer payment terms; a decrease in cash flow related to net inventory of $3.4 million as we increased inventory levels to support higher sales volumes; and an increase in cash flow related to accounts payable of $4.0 million as we trade financed our inventory increase and other operating expenses. In addition, cash flow related to income taxes payable increased $0.9 million as we attained profitability in the first half of 2006 and started to accumulate income tax liability that will be paid later in 2006.

        Cash used in operating activities for 2005 was $4.6 million compared to $6.6 million in 2004. This change was attributable to a decrease in cash flow related to net loss of $1.3 million, a decrease in cash flow related to accounts receivable of $0.8 million due to a higher proportion of sales being generated by customers with longer payment terms, and a decrease in cash flow related

40



to inventories of $2.2 million. These declines were offset by an increase in cash flow related to accounts payable of $4.0 million and an increase in cash flow related to income taxes of $2.6 million as we continued to incur losses, did not have to pay income taxes and received a tax refund in 2005 as a result of carrying back net operating losses to prior years.

        Cash used in operating activities in 2004 was $6.6 million compared to cash generated by operating activities of $3.7 million in 2003. This change was primarily due to a decrease in cash flow related to net loss of $5.5 million, before stock compensation charges, a decrease in cash flow related to accounts receivable of $1.4 million due to higher sales volumes, a decrease in cash flow related to accounts payable of $7.5 million, and a decrease in cash flow related to income taxes of $5.8 million as we paid prior tax liabilities and increased refunds receivable due to tax losses in the year. These decreases were offset by an increase in cash flow related to inventories of $10.7 million as we transitioned from building inventory in 2003 to lower inventory levels as volumes with one of our key customers decreased.

        Investing Activities.     Net cash used in investing activities for the six months ended June 30, 2006 was $0.3 million compared to $0.3 million for the six months ended June 30, 2005. This change is not considered significant.

        Net cash provided by investing activities was $1.3 million in 2005 compared to net cash used in investing activities of $0.5 million in 2004. This change is attributable to the proceeds of $1.8 million from the sale of the building containing our manufacturing operation in 2005 to raise capital to fund our operations. We currently lease back the building, and there was no disruption of manufacturing due to this transaction.

        Net cash used in investing activities was $0.5 million in 2004 compared to $1.5 million in 2003. This change is attributable to reductions in capital expenditures as our manufacturing facility became fully equipped and the liquidation of a certificate of deposit of $0.5 million that had previously been required to collateralize a letter of credit.

        Financing Activities.     Net cash provided by financing activities for the six months ended June 30, 2006 was $1.2 million compared to net cash used in financing activities of $1.0 million for the first six months of 2005. This change was primarily due to the increased usage of our revolving line of credit during 2006 to fund growth in our operations compared to the first half of 2005.

        Net cash provided by financing activities in 2005 was $3.5 million compared to $5.9 million in 2004. This change is attributable to approximately $1.4 million less in net borrowings against our revolving line of credit and an increase in net payments on capital leases and other debt of $1.0 million.

        Net cash provided by investing activities in 2004 was $5.9 million compared to net cash used in financing activities of $0.3 million in 2003. This change was primarily attributable to increased usage of our revolving line of credit to finance working capital needs as a result of our accelerating growth.

    Capital Resources

        In July 2006, we amended our credit agreement with our bank. The credit agreement, as amended, provides for a revolving line of credit with borrowings of up to $25 million, a term loan with borrowings of up to $2 million, and an equipment financing line of credit with borrowings of up to $2 million. Prior to July 2006, the credit agreement provided for a revolving line of credit of $15 million and no term loan or equipment line of credit.

        Under the revolving line of credit, we may borrow up to 85% of eligible accounts receivable plus the least of (i) a percentage of eligible inventory determined from time to time by our bank,

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(ii) 80% of the appraised orderly liquidation value of eligible inventory and (iii) $7 million. Interest is payable monthly at prime plus 0.5% (prime plus 3.5% prior to July 2006). Outstanding borrowings under the revolving line of credit were $10.7 million as of June 30, 2006 and $9.5 million as of December 31, 2005. Borrowing availability as of June 30, 2006 was $2.8 million. Had the amended revolving line of credit maximum of $25 million been in effect at June 30, 2006, borrowing availability would have been $7.1 million.

        Under the new equipment financing line of credit, we may borrow up to 80% of the cost of equipment purchases up to the maximum of $2 million. Interest on equipment line of credit advances is prime plus 0.5%. Principal is due monthly through the maturity date of the credit agreement in July 2008, when all unpaid principal and interest is due.

        The term loan is amortized and paid monthly from September 2006 through July 2008. Interest is at prime plus 0.5%. Should we successfully complete an initial public offering of our stock, such as this offering, during the term of the credit agreement, we will be required to fully repay the term loan upon the closing of the initial public offering.

        Under the terms of the credit agreement, as amended, we are required to comply with certain financial and other covenants. The financial covenants require us to achieve minimum book net worth on a monthly basis, minimum net income on a quarterly basis, and limit annual capital expenditures under a defined annual cap. Also, we are required to achieve a minimum debt service coverage ratio in relation to the term loan and equipment line of credit. While we are currently in compliance with all financial covenants and expect to maintain compliance for the foreseeable future, we have in the past been in violation of one or more covenants. We were not in compliance with certain covenants as of December 31, 2005, January 31, 2006 and February 28, 2006. In April 2006, we received a waiver from our lender for all of the above covenant violations. We cannot assure you that we will not violate one or more covenants in the future. If we were to be in violation of covenants under our credit agreement, our lender could choose to accelerate payment on all outstanding loan balances. There can be no assurance that we would be able to quickly obtain equivalent or suitable replacement financing in this event. If we were not able to secure alternative sources of funding, such acceleration would have a material adverse impact on our financial condition.

        We have in the past utilized equipment leasing arrangements to finance capital expenditures. Equipment leases will continue to be a financing alternative that we may pursue in the future.

        We believe our existing cash balances, borrowing availability under our bank credit facility, and the cash expected to be generated from operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our levels of net sales, the timing and extent of expenditures to support research and development activities, the expansion of manufacturing capacity both domestically and internationally and the continued market acceptance of our products. We could be required, or may choose, to seek additional funding through public or private equity or debt financings. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt or equity financing or a combination thereof. These additional funds may not be available on terms acceptable to us, or at all.

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Contractual Obligations

        The following table outlines our principal obligations and commitments, excluding periodic interest payments, as of December 31, 2005:

 
  Within
One Year

  1-3 Years
  4-5 Years
  After 5 Years
  Total
 
  (in thousands)

Scheduled payments under contractual obligations:                              
Long-term debt   $ 290   $ 127   $ 6   $   $ 423
Convertible notes     1,000     1,750             2,750
Capital lease obligations     431     739     115         1,285
Operating leases     216     301     256         773
Purchase commitments     655                 655
   
 
 
 
 
  Total     2,592     2,917     377         5,886

Potential cash requirements under existing commitments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Letters of credit     500                 500
   
 
 
 
 
  Total   $ 3,092   $ 2,917   $ 377   $   $ 6,386
   
 
 
 
 

        We believe that funds expected to be generated from future operations will be sufficient to satisfy these contractual obligations and commercial commitments and that the ultimate payments associated with these commitments will not have a material adverse impact on our liquidity position.

        In addition, as of June 2006, we had certain commitments with one of our executive officers pursuant to an employment agreement with that officer. For further information, see "Management—Employment Agreements."

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        In December 2005, we dismissed Deloitte & Touche LLP as our independent registered public accounting firm and engaged Corbin and Company, LLP as our independent registered public accounting firm. Our board of directors approved this change.

        Prior to the dismissal, we did not consult with Corbin and Company, LLP regarding the application of accounting principles to a specific completed or contemplated transaction or any matter that was either the subject of a disagreement or a reportable event. We also did not consult with Corbin and Company, LLP regarding the type of audit opinion that might be rendered on our consolidated financial statements.

        Deloitte & Touche LLP's report on our consolidated financial statements as of December 31, 2004, and for each of the two years in the period ended December 31, 2004 did not contain an adverse opinion or disclaimer of opinion, nor was it modified as to uncertainty, audit scope, or accounting principles. There were no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.

Quantitative and Qualitative Disclosures About Market Risk

    Interest Rate Risk

        Our exposure to market risk for changes in interest rates relates primarily to our bank credit facility because borrowings under all lines under the facility are variable rate borrowings, generally at prime plus 0.5%. Assuming that all lines under the facility are fully drawn and holding other variables constant, each 1.0% increase in interest rates on our variable rate borrowings will result in

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an increase in annual interest expense and a decrease in our cash flows and income before taxes of approximately $0.3 million per year. We do not use derivative instruments to hedge the interest rate risk related to our credit facility.

        Upon completion of this offering, some of the proceeds may be invested in securities which may be subject to market risk for changes in interest rates. To mitigate this risk, we plan to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, which may include commercial paper, money market funds, government and non-government debt securities. Currently, we are exposed to minimal market risks.

    Off-Balance Sheet Arrangements

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

New Accounting Pronouncements

        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 . SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 did not have a significant impact on our consolidated financial condition or results of operations.

        In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment , which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors using a fair value method and to record such expense in our consolidated financial statements. Effective January 1, 2006, we adopted SFAS No. 123(R) using the modified prospective transition method. The impact of adoption of SFAS No. 123(R) is described in Note 2 to the consolidated financial statements, which are included elsewhere in this prospectus.

        In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that we recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosures. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The adoption of this statement is not expected to have a material impact on our consolidated financial position or results of operations.

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BUSINESS

Overview

        We design and manufacture high performance memory subsystems. We sell our subsystems to OEMs in the server, high performance computing and communications markets. Within these markets, we target applications in which memory plays a key role in enabling overall system performance. Our memory subsystems are incorporated into multiple platforms at IBM, Dell, Gateway, Lenovo and Hewlett-Packard. Our subsystems are designed and manufactured to specifically address the high performance needs of these customers' systems.

        We collaborate with our OEM customers in the earliest stages of their new product design cycles. This collaboration provides us with unique insight into the OEM's system architecture and performance requirements and expands our systems expertise. In addition, we have developed a portfolio of proprietary technologies and design techniques to meet OEM needs, including efficient planar design, alternative packaging techniques and custom semiconductor logic. As a result, we are able to design application-specific memory subsystems with optimal combinations of high memory density, small form factor, high signal integrity, effective heat dissipation and low cost per bit. We also offer our OEM customers flexible order fulfillment and rapid turnaround times.

Industry Background

    Memory is a Critical Element of Virtually All Electronic Systems

        Semiconductor memory is a fundamental element of electronic systems. It is used in virtually every computing, communications, consumer electronics, defense, aerospace and industrial application. Some of the most memory-intensive applications include high-end PCs, servers, workstations, storage systems, routers, and switches. Other memory-intensive applications include mobile phones, personal digital assistants, digital cameras and digital audio players. Memory is particularly important in systems requiring greater processing power and higher functionality, and comprises a significant portion of the total cost of materials. For example, we believe that memory comprises up to two-thirds of the total cost of materials for a typical blade server.

        The market for memory is large and rapidly growing. In 2005, the most common type of memory, DRAM, generated $25.2 billion of revenue, or 51% of global memory revenue, according to the market research firm Gartner Dataquest. Gartner Dataquest further estimates that worldwide DRAM shipments will grow at a compound annual growth rate, or CAGR, of 54.6%, from 238 billion megabytes in 2005, to 1.36 trillion megabytes in 2009.

        The market for servers is growing, and the amount of memory in these servers is increasing. For example, market research firm International Data Corporation, or IDC, expects server shipments to grow from 7.0 million in 2005 to 10.7 million in 2009, representing a CAGR of 10.9%, and the amount of DRAM memory in those servers is expected to increase at a higher CAGR of 26.4%. These market projections underscore the continuing importance of memory in electronic systems.

    Designing Sufficient Memory into Advanced Systems Has Become Increasingly Difficult

        Memory-intensive applications continually evolve to keep pace with end user demands for higher performance, as measured by speed, functionality, or smaller physical size. OEMs develop new technologies and innovative system architectures to meet these requirements. For example, enterprise computing has migrated toward network and Internet computing models that rely upon high performance servers and storage systems. In telecommunications, the emergence of the Internet Protocol has led OEMs to develop switches and routers that offer enhanced functionality and services. Consumer electronics are also converging to offer both communications and

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computing functionality in ever smaller form factors and at lower prices. Each successive generation of these new systems is increasingly sophisticated.

        As OEMs continue to develop new generations of higher performance electronic systems, designing the requisite amount of memory into increasingly complex system architectures has become a significant challenge. Shrinking form factors and higher performance demands require low profile, high-density memory subsystems that operate at high speeds. This poses significant challenges for system designers. For example, shrinking form factors necessitate tight spacing between memory ICs and require new methods of heat dissipation. The migration to more powerful, multi-processor architectures increases this design challenge. System designs must ensure optimal electronic signal integrity and efficient board layout to capture the performance benefits of these technological advances. OEM designs for high performance systems with powerful processors and high density memory typically employ unique system architectures. As a result, these systems require application-specific memory subsystems with distinct memory capacities and configurations.

        Servers illustrate the increasing complexity and importance of innovative memory design in high performance systems. Servers play an important role in the enterprise information technology infrastructure, as they execute a broad range of functions, including email communication, video streaming, data mining, data warehousing and web-based services. These servers require high performance microprocessors and large memory capacities to support multiple functions, concurrent users and increasingly complex applications. Strong market demand, coupled with OEM efforts to increase system performance while reducing total cost of ownership, has fueled the development of innovative server architectures such as low-profile blade servers. According to IDC, blade server shipments are expected to grow from 510,000 in 2005 to approximately 2.9 million in 2009, representing a 53.9% CAGR. Furthermore, IDC projects end-user spending on blade servers will represent 21% of the worldwide server market by 2009.

        Blade servers are characterized by small physical size and shape, which allows for dense configuration in a high performance computing cluster. These clusters occupy less space than traditional rack-mounted servers, and can achieve supercomputing performance at a fraction of the cost. In addition, blade servers are rapidly migrating to 2-way and 4-way processor systems to achieve greater computing performance, but the use of multi-processor architectures requires an accompanying increase in system memory capacity. For example, a server with a 4-way processor could require four times the memory of a typical single processor server. Blade servers' small form factors, typically with a vertical height of less than 1.75 inches, or 1-U, create significant memory subsystem design challenges. Blade servers may have up to 64 gigabytes of memory, and designing such large densities of memory into a low profile system faces numerous physical constraints. For example, high density memories concentrate heat in a tight space, yet temperature variations of as little as a few degrees can lead to systemic failure.

    The Traditional Memory Supply Chain Cannot Deliver High Performance Memory Solutions

        Memory ICs are typically assembled together on a card, or module, before being incorporated into electronic systems. Memory modules save valuable motherboard space in an electronic system, allow for the use of different types and densities of memory in the same system, and facilitate subsequent upgrading of the memory to a different type or density. According to iSuppli, a market research firm, the global DRAM module market was $21.4 billion in 2005, representing 86% of the total DRAM market.

        Most DRAM memory modules sold to OEMs have traditionally been produced by the same companies that manufacture DRAM ICs. In an effort to continually reduce costs and achieve higher memory densities, DRAM manufacturers typically operate their own fabrication facilities and use

46



leading edge manufacturing processes, which require multi-billion dollar capital investments. To maximize capacity utilization and reduce unit costs, DRAM manufacturers have historically focused on the highest volume applications, such as PCs, to recoup their investments. Memory modules used in PCs employ industry standard configurations, are largely commoditized, and require limited systems expertise to develop. Therefore, DRAM manufacturers generally have not focused on developing the systems expertise necessary to produce application-specific memory subsystems that incorporate small form factors, high speed, optimal thermal characteristics and signal integrity.

        DRAM manufacturers have historically attempted to address increased demands for memory in electronic systems by developing new generations of memory ICs with increased density. For example, the density of a 1 gigabyte memory module comprised of eighteen 512 megabit ICs can be doubled to 2 gigabytes by using eighteen 1 gigabit ICs. This approach of using next-generation ICs, however, can be problematic for OEMs. When first introduced, next-generation DRAM ICs are only available in limited supply and typically command a premium price on a per-byte basis compared to current-generation DRAM ICs. Next-generation DRAM ICs can sell at prices up to ten times higher than current-generation ICs at introduction, and it may take as long as five years to achieve price parity between the generations. Thus, the increasing demand for higher density memory solutions exceeds the pace at which memory IC manufacturers are able to cost-effectively produce next-generation memory ICs and reduce the cost of current-generation memory ICs. One approach to addressing the need for high density memories in a more cost-effective manner is the stacking of memory ICs, or chip-stacking. Chip-stacking is a process in which DRAM ICs are stacked prior to assembly of the memory subsystem. For example, a 4 gigabyte memory module can be made with 36 stacks of two 512 megabit ICs. While it can be less expensive than non-stacked solutions, stacking costs can still constitute a significant portion of the cost of materials for a memory module.

        Other industry dynamics are reducing the DRAM manufacturers' focus on the high density DRAM subsystems market. In an effort to achieve greater diversification and profitability, the largest DRAM manufacturers have dedicated increasing design resources and manufacturing capacity to non-DRAM products such as flash memory and complementary metal oxide semiconductor, or CMOS, image sensors, further decreasing their desire and ability to supply high performance, application-specific memory subsystems that may sell in relatively low volumes. In addition, an increasing portion of global DRAM supply is being manufactured by integrated device manufacturers and third party foundries that lack back-end capability beyond wafer fabrication. In contrast to traditional DRAM manufacturers with fully integrated operations, these companies generally lack the internal packaging and assembly capabilities to produce modules. The most recently established DRAM manufacturers have focused on commodity-driven, mass-production business models rather than the memory module market.

    A Need for High Performance Memory Subsystem Suppliers Exists Today

        Historically, many OEMs designed and manufactured their memory ICs and subsystems in-house. However, the increasing complexity of systems, proliferation of different platforms, continuing evolution of industry standards, increasing need for customization and OEM desire to reduce capital investments are driving OEMs to purchase ICs and subsystems from specialized suppliers focused on developing innovative subsystem solutions. These suppliers require extensive systems expertise to engage with the OEM customer throughout the product development cycle to produce a highly differentiated memory solution that addresses the issues and constraints specific to a particular high-end system. Since industry-standard products are inadequate, these solution providers must employ innovative technologies, such as efficient planar design, alternative packaging techniques and custom semiconductor logic design capabilities, to develop memory subsystems customized for OEMs' specific systems. OEMs also require these suppliers to meet a number of

47


additional criteria beyond innovation, such as low cost, rapid time-to-market and high product quality.

Our Solution

        We provide high performance memory subsystems to the server, high performance computing and communications markets. We utilize our innovative and proprietary technology, as well as our extensive systems expertise, to bridge the gap between industry standard approaches and the requirements of complex OEM systems. Our application-specific solutions provide customers with the following key benefits:

        Highly Differentiated Memory Solutions Through Deep Customer Engagement.     We work closely with our OEM customers, from the earliest stages of new product definition through the ramp up to mass production, to develop and deliver application-specific memory subsystems which address the full range of system architecture and performance requirements. Our close, collaborative relationships with our OEM customers give us early insight both into their current needs and into future technology trends. In addition, our in-depth systems expertise, coupled with our ability to customize solutions, enables our OEM customers to offer differentiated products that feature high levels of performance while improving reliability and, in some cases, reducing cost.

        High Performance Through Proprietary Technologies and Design Techniques.     We have developed a portfolio of proprietary technologies and design techniques to achieve optimal electronic signal strength and integrity, high memory density and improved heat dissipation. For example, our innovative printed circuit board, or PCB, designs enhance electronic signal integrity, allowing our customers to design and market products that operate at the highest commercially available speeds, such as the DDR2 specification, which is designed to operate at speeds up to 800 MHz. Another technique we utilize is to embed passive devices within the PCB, thereby freeing valuable board space to reduce form factors and improve signal integrity. Our solutions also address the system-level thermal issues encountered at high operating speeds via such innovations as planar designs and proprietary heat dissipation technologies that allow us to minimize heat concentrations within the system.

        High Quality and Reliability.     We perform a full range of product reliability testing and share the results with our customers on an on-going basis. We use advanced design tools to simulate accurately the system performance targets of our customers and to ensure that our products comply with our customers' specifications. All of our memory subsystems undergo both functional and system burn-in testing prior to delivery to our customers. We complement our test capabilities with advanced imaging technology to inspect the quality of our micro ball grid array, or microBGA, assemblies. We believe that our testing procedures significantly enhance the quality and reliability of our products.

        Rapid Order Fulfillment Capability.     We operate our manufacturing facility in a manner that maximizes our ability to meet changing customer demand. Our turn-around times are typically one week or less, and in some cases as few as two days, which allows us to match unforeseen customer demand and to provide our OEM customers with timely access to products.

        Cost-Effective Memory Solutions.     We provide high performance memory subsystems at what we believe to be the lowest cost per bit for many applications. Our portfolio of proprietary technologies and design techniques allow us to use cost-effective, current generation DRAM ICs and in some cases avoid additional costs from chip-stacking to significantly lower the cost of our memory subsystems. Additionally, the superior thermal characteristics and electronic signal integrity of our subsystems helps OEMs reduce costs through simplified system design.

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Our Strategy

        Our objective is to be the leading provider of high performance memory subsystems. Key elements of our strategy include:

        Further Sales Penetration of Existing Customers.     Our current OEM customer base has a large and diversified portfolio of system platforms that require high performance memory solutions. Today, we sell our products into a relatively small number of those platforms. As our relationships continue to develop with each of our existing customers, we will seek to provide them with memory solutions for a greater number of their existing and future platforms. A memory subsystem supplier's track record of quality and reliability is an important factor in a customer's purchase decision for each individual platform. We believe that our demonstrated ability to deliver high quality products meeting stringent customer demands will facilitate the adoption of our products into additional platforms with these OEMs. We believe that in some cases we will be able to migrate into these additional platforms with products that are already qualified for use by the customer, thereby significantly decreasing the time and expense required to bring that particular product to market with that customer.

        Establish Relationships with New Customers.     We will continue to dedicate significant sales and marketing resources to establish new relationships with industry-leading OEMs. We are particularly focused on customers for whom memory subsystem performance is a key determinant of overall system performance. Our sales team, which includes field applications engineers, engages with OEMs to understand their memory subsystem requirements, identify and deliver the optimal solution to meet those requirements, and assist with the implementation of that solution within the OEMs' overall system architecture. We believe that engaging with these prospective customers at an early stage of their system development will facilitate the adoption of our products, grow sales volumes and help us to gain additional insight into market and technology trends.

        Target New Applications and Product Opportunities.     We believe that we have established a reputation as a technology leader in the design, development and manufacture of high performance memory subsystems. To date, we have applied our technology successfully to a broad range of server products, from rack-mounted and tower servers to low-profile blade servers and other space constrained server applications. We intend to develop additional memory solutions based on our core technology capabilities for the communications, military, aerospace and industrial markets. In addition, we intend to explore the development of flash memory solutions targeting OEM applications that require high densities of non-volatile memory.

        Continue to Invest in the Development of Proprietary Technology.     We intend to actively expand our intellectual property portfolio and engineering capabilities by investing in research and development. We have filed, and intend to continue to file, patent applications covering our current and future intellectual property. One targeted area of technology development is the design of custom logic ICs that can be used in memory subsystems to provide value-added features. As new technologies are developed, we intend to expand our product offerings to incorporate the performance enhancements they enable.

        Establish International Operations and Manufacturing Capabilities.     We plan to establish a manufacturing facility in China during the first half of 2007. We believe that this international expansion will allow us to improve our support of major OEMs with manufacturing sites in China, lower our production costs and provide access to engineering talent residing in China. We have identified a specific site for our China operations and have commenced recruiting local personnel. We believe that our presence in China will help us develop products and participate more effectively in the high growth regional markets.

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Our Products

        We design and manufacture high performance memory subsystems for the server, high performance computing and communications markets. We currently sell memory subsystems with speeds up to 667 MHz, capacities up to 8 gigabytes, and form factors as small as 0.72 inches, or 18.3 millimeters, in height. Our products for the server market address a broad variety of memory capacity and configuration requirements, as well as a broad range of server types, including tower, rack-mounted, and blade servers. Our current products primarily support DDR and DDR2 DRAM technologies.

        The following table lists representative products from our major families of high performance memory subsystems:

DDR2 Registered Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
256MB   30 mm   400/533   RAID Memory
1GB   18.3 mm   400/533/667   Blade Servers
1GB   30 mm   400/533/667   1U, 2U+ Servers, Networking
2GB   30 mm   400/533/667   1U, 2U+ Servers, Networking
2GB   18.3 mm   400/533/667   Blade Servers, Networking
4GB   30 mm   400/533/667   1U, 2U+ Servers, Workstations
4GB   18.3 mm   400/533/667   Blade Servers

DDR2 Fully Buffered Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   30 mm   400/533/667   1U, 2U+ Servers, Workstations
2GB   30 mm   400/533/667   1U, 2U+ Servers, Workstations
2GB   18.3 mm   400/533/667   Blade Servers
4GB   30 mm   400/533/667   1U, 2U+ Servers

DDR2 Unbuffered Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   30 mm   400/533/667   Workstations
2GB   30 mm   400/533/667   Workstations

DDR2 Small Outline Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   30 mm   400/533/667   Notebooks, Networking
2GB   30 mm   400/533/667   Notebooks, Networking

DDR Registered Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   1.2"   400   1U, 2U+ Servers
1GB   0.72"   400   Blade Servers, Networking
2GB   1.2"   400   1U, 2U+ Servers
2GB   0.72"   400   Blade Servers, Networking
4GB   2"   400   1U, 2U+ Servers
4GB   1.2"   400   1U, 2U+ Servers
8GB   1.2"   400   1U, 2U+ Servers

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DDR Unbuffered Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   1.2"   400   1U, 2U+ Servers, Workstations
2GB   1.2"   400   1U, 2U+ Servers, Workstations

DDR Small Outline Dual In-line Memory Modules

Density

  Height
  Speed (MHz)
  Applications
1GB   1.2"   400   Notebooks, Networking

Technology

        We have a portfolio of proprietary technologies and design techniques and have assembled an engineering team with expertise in semiconductor, PCB, memory subsystem and system design. Our technology competencies include:

        Very Low Profile Designs.     We were the first company to create a 1 gigabyte memory subsystem in a form factor of less than one inch in height. We believe our proprietary board design technology is particularly useful in the rapidly growing blade server market, where efficient use of motherboard space is critical. Our technology has allowed us to decrease the system board space required for memory, and improve thermal performance and operating speeds, by enabling our customers to use alternative methods of component layout.

        Proprietary PCB Designs.     We utilize advanced, proprietary techniques to optimize electronic signal strength and integrity within a PCB. These techniques include the use of 8- or 10-layer boards, matching conductive trace lengths, a minimized number of conductive connectors, or vias, and precise load balancing to, among other things, help reduce noise and crosstalk between adjacent traces. In addition, our proprietary designs for the precise placement of intra-substrate components allow us to assemble memory subsystems with significantly smaller physical size, enabling OEMs to develop products with smaller footprints for their customers.

        Planar Design.     Our planar solutions are designed to provide high density solutions in a more cost-effective manner than traditional chip-stacking. We believe traditional chip-stacking can represent up to 30% or more of the total cost of a memory subsystem. Our planar solutions achieve the same densities as chip-stacked modules but do so by leveraging our PCB design expertise to place ICs in two rows in the same plane rather than on top of each other. Our planar memory subsystem designs feature high memory capacity with improved thermal characteristics by dissipating heat uniformly throughout the PCB.

        Advanced Planar Designs.     We plan to extend our planar design capabilities to develop very high density memory subsystems. These advanced planar designs may allow us to build modular solutions at lower costs compared to other packaging technologies. Additionally, these advanced planar solutions may remove heat generated by memory components in a more effective manner and can be used to build memory subsystems in a number of densities and form factors.

        IC Design Expertise.     We have designed blocks of custom logic that can be implemented in a stand-alone IC or integrated with other functional blocks in other ICs. We use these custom logic blocks to effectively increase density and reduce costs by allowing the use of two current-generation, lower density DRAM ICs in lieu of a single next-generation higher density IC.

        Innovative Design Verification Tools.     We use our innovative and proprietary DRAM load simulators during the product development stage to carefully assess DRAM IC load balancing requirements in our memory subsystems. Our DRAM load simulators are mounted in a memory subsystem in place of DRAM ICs to test the electronic signal strength and integrity of the memory

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design without disrupting signal quality. This provides us with more accurate feedback than that provided by conventional means because we are able to measure the signals at the precise point of origination.

        Thermal Management Designs.     We design our memory subsystems to ensure effective heat dissipation. We use thermal cameras to obtain thermal profiles of the memory subsystem during the design phase, allowing us to rearrange components to enhance thermal characteristics and, if necessary, replace components that do not meet specifications. We use thermal simulation and modeling software to create comprehensive heat transfer models of our memory subsystems, which enables our engineers to quickly develop accurate solutions to potential thermal issues. We also develop and use proprietary heat spreaders to enhance the thermal management characteristics of our memory subsystems.

Customers

        We primarily market and sell our products to leading OEMs in the server, high performance computing and communications markets. Our memory subsystems are incorporated into multiple platforms at IBM, Dell, Gateway, Lenovo and Hewlett-Packard. Sales to IBM, Dell and Lenovo generated approximately 20%, 35% and 13%, respectively, of our net sales in 2005, and 46%, 33% and 2%, respectively, of our net sales in the first six months of 2006.

        The following chart summarizes some of our representative customers in our principal end markets for the first six months of 2006(1):

Servers

  Workstations
  Mobile Computing
Dell, Gateway,
Google, IBM
  Dell,
Hewlett-Packard
  Hewlett-Packard,
Lenovo

High Performance Computing


 

Communications

PSSC Labs, Verari,
Western Scientific
  Force10, Stoke,
Tekelec

(1)
Listing does not include all representative markets or customers due to contractual confidentiality provisions.

        Our sales are made primarily pursuant to standard purchase orders that may be rescheduled or canceled on relatively short notice. Thus, we do not have a significant backlog.

Sales and Marketing

        We market and sell our products through a direct sales force and a network of independent sales representatives. Our sales activities focus primarily on developing strong relationships at the technical, marketing and executive management levels within market-leading OEMs. These OEMs design systems for a variety of applications that require a significant number of high performance memory subsystems, representing substantial opportunities for us. We have been successful in developing OEM relationships through our ability to provide high performance memory subsystems. Our direct sales group and field application engineers work closely with our OEM customers at an early stage of their design cycles to solve their design challenges and to design our products into their systems.

        We believe in the timely communication and exchange of information with our customers. We utilize well-trained, highly technical program management teams to successfully drive new product development and quickly respond to our customers' needs and expectations. Our program

52



management teams provide quick response times and act as a single point-of-contact for routine issues during the sales process. Additionally, they address the long-term business and technology goals of our customers. We employ a team approach to business development whereby our sales team and independent representatives identify, qualify and prioritize customer prospects through offices in a number of locations worldwide.

        Our marketing efforts are twofold: creating awareness of the benefits of our proprietary technologies and design techniques in the development of application-specific memory subsystems, and building our brand awareness with our current and potential customers.

Manufacturing

        We currently manufacture all of our products at our facility in Irvine, California. Our advanced engineering and design capabilities, combined with our in-house manufacturing processes, allow us to assemble our memory subsystems reliably and in high volume. Our advanced, customized manufacturing facility is capable of surface mount assembly, subsystem testing, system-level burn-in testing, programming, marking, labeling and packaging. At each stage of the production cycle, including product prototyping, qualification sample production and high-volume manufacturing and delivery, we focus on providing our customers with rapid response and short manufacturing turn-around times. Manufacturing cycle times for our products are typically one week or less, and in some cases as few as two days, from receipt of order.

        We plan to expand our manufacturing capabilities by opening a new facility near Shanghai, China, which we expect will begin production in the first half of 2007. This facility will be configured in the same manner as our Irvine facility and, once operating, will significantly increase our manufacturing capacity. We believe that this facility will enable us to achieve better operating leverage through lower material and labor costs. This facility will also put our products in closer proximity to a number of our end customers allowing us to fulfill customer orders more quickly.

        We acquire components and materials such as DRAM ICs from third party suppliers and assemble them into finished subsystems. We believe that one of our key strengths is the procurement and efficient management of components for our subsystems, which benefits our customers in the form of lower costs and increased product availability. We have developed strong supplier relationships with key DRAM IC manufacturers, which we believe gives us direct and ready access to the critical components that we need for our production activities. We typically qualify our products with our customers using several manufacturers of DRAM ICs. The flexibility to choose from several DRAM IC providers allows us to minimize product cost and maximize product availability.

        We schedule production based on purchase order commitments and anticipated orders. In addition, we use advanced inventory management and material resource planning techniques to manage our supply chain. Using electronic data interchange with our suppliers, we are able to react quickly to changes in raw material availability. We release raw materials to the manufacturing floor by means of an on-line computerized system, which allows for internal quality analysis, direct access to inventory information and production floor material tracking. We have a flexible manufacturing system, and we have the capability to sell excess quantities of DRAM ICs to mitigate inventory risks. Our sales of excess inventory to distributors and other users of memory ICs generated $19.1 million, or 24%, and $7.4 million, or 11%, respectively, of our net sales for 2005 and the first six months of 2006.

        Our quality assurance engineers work with our suppliers to ensure that the raw materials we receive meet our high quality standards. These engineers also perform onsite quality control audits and use our internal test and inspection systems to verify that purchased components and materials

53



meet our specifications. Our supplier quality program and incoming material quality control program are important aspects of our overall manufacturing process.

        We strive to reduce product failures to the lowest possible rate. To achieve this goal, we perform ongoing reliability testing on our memory subsystems and share the results of that testing with our customers. We believe that this improves the system design process and allows for the elimination of potential problems at the earliest possible stage. In addition, we have implemented procedures that require all of our memory subsystems to undergo functional and system burn-in testing prior to delivery to the customer. We complement our test capabilities with advanced imaging technology to inspect the quality of our microBGA assemblies.

        We are certified in ISO 9001:2000 Quality Management Systems, ISO 14001:1996 Environmental Management Standards, and OSHAS 18001:1999 Occupational Health and Safety Management Systems.

Competition

        Our products are primarily targeted for the server, high performance computing and communications markets. These markets are intensely competitive, as numerous companies vie for business opportunities at a limited number of large OEMs. Our primary competitors are memory module providers such as SimpleTech, Inc., SMART Modular Technologies, Inc., and Viking Interworks, a division of Sanmina-SCI Corporation. We also face competition from DRAM manufacturers in a limited range of applications. As we enter new markets and pursue additional applications for our products, we may face competition from a larger number of competitors.

        Many of our competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines, lower cost structures, greater brand recognition and longer standing relationships with customers and suppliers. Some of our competitors may also have a greater ability to influence industry standards than we do, as well as more extensive patent portfolios.

        Some of our customers and suppliers may have proprietary products or technologies which are competitive with our products, or could develop internal solutions or enter into strategic relationships with, or acquire, existing high-density memory module providers. Any of these actions could reduce our customers' demand for our products. Some of our significant suppliers of memory ICs may be able to manufacture competitive products at lower costs by leveraging internal efficiencies, or could choose to reduce our supply of memory ICs, adversely affecting our ability to manufacture our memory subsystems on a timely basis, if at all.

        Our ability to compete in our current target markets and in future markets will depend in large part on our ability to successfully develop, introduce and sell new and enhanced products on a timely and cost-effective basis, and to respond to changing market requirements. We believe that the principal competitive factors in the selection of high performance memory subsystems by potential customers are:

    understanding of OEM system and business requirements;

    timeliness of new product introductions;

    design characteristics and performance;

    quality and reliability;

    track record of volume delivery;

    credibility with the customer;

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    fulfillment capability and flexibility; and

    price.

        We believe that we compete favorably with respect to these factors. We expect, however, that our current and future competitors could develop competing products that could cause a decline in sales or loss of market acceptance of our products.

Research and Development

        The market for high performance memory subsystems is characterized by rapid and continuous technology development and product innovation. We believe that the continued and timely development of new products and the enhancement of existing products are critical to maintaining our competitive position. Our research and development engineers focus on new product design and development, the development of thermal and electronic signal integrity solutions, new product testing techniques and methodologies and improvements to our manufacturing processes.

        Our engineering staff continually explores practical applications of new technologies, works with our OEM customers and provides support services throughout the product life cycle, including architecture definition, component selection, schematic design, layout, manufacturing and test engineering. An important aspect of our research and development effort is to understand the challenges presented by our OEM customers' requirements and satisfy them by utilizing our industry knowledge, proprietary technologies and technical expertise.

        We believe that to remain competitive we must continue to focus on developing advanced memory subsystem technologies to address our customers' increasingly complex memory subsystem requirements. Our total expenditures for research and development were $11.8 million, $3.8 million and $3.0 million for the years ended December 31, 2003, 2004 and 2005, respectively, and $1.9 million and $1.5 million for the six months ended June 30, 2005 and June 30, 2006, respectively. Included in total research and development expense was stock-based compensation expense of $9.7 million, $0.1 million and $(0.1) million for the years ended December 31, 2003, 2004 and 2005, respectively. Stock-based compensation expense for the six months ended June 30, 2005 and 2006 was not significant.

        We use advanced design tools to develop products that operate at high frequencies. These design tools enable real-time simulation and behavioral modeling of our designs using the input/output buffer information specification of our suppliers' components. These simulation tools help us reduce or eliminate electronic signal reflections, clock skews, signal jitter and noise, all of which can reduce system performance and reliability.

Intellectual Property

        Our high performance memory subsystems are developed in part using our proprietary intellectual property, and we believe that the strength of our intellectual property rights will be important to the success of our business. We utilize patent and trade secret protection, confidentiality agreements with customers and partners, disclosure and invention assignment agreements with employees and consultants and other contractual provisions to protect our intellectual property and other proprietary information.

        As of June 30, 2006, we had four patents issued and ten patent applications pending. Our issued patents and patent applications relate to PCB design and layout techniques, packaging techniques, and the use of custom logic in high performance memory subsystems. We intend to actively pursue the filing of additional patent applications related to our technology advancements. While we believe that our patent and other intellectual property rights are important to our success, our technical expertise and ability to introduce new products in a timely manner also will continue

55



to be important factors in maintaining our competitive position. Accordingly, we believe that our business is not materially dependent upon any one claim in any of our pending patent applications.

        Despite our precautions, a third party may reverse engineer, copy or otherwise obtain and use our products, services or technology without authorization, develop similar technology independently or design around any patents issued to us. There can be no assurance that our efforts taken to prevent misappropriation or infringement of our intellectual property by third parties have been or will be successful.

Employees

        As of June 30, 2006, we had 88 full-time employees, including 49 employees in operations, 16 employees in research and development, 13 employees in sales and marketing, and 10 employees engaged in other administrative functions. Our operations department performs manufacturing, procurement and planning activities. We use contract employees in our operations department from time to time to effectively manage our manufacturing workflow. As of June 30, 2006, our operations department had 62 contract employees engaged full-time in manufacturing. We are not party to any collective bargaining agreements with any of our employees. We have never experienced a work stoppage, and we believe our employee relations are good.

Facilities

        Our corporate headquarters are located in approximately 7,000 square feet of space in Irvine, California, under a lease that expires in June 2007. We also lease approximately 8,000 square feet of space for our manufacturing facility located in Irvine, California. This lease expires in November 2010. In addition, we lease offices on a monthly basis in corporate office centers located in Austin, Texas, Raleigh, North Carolina and Dublin, Ireland. We believe that our current facilities are adequate for our current and expected operations for the next 12 months and that additional space can be obtained if needed.

Legal Proceedings

        From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. To date, no legal proceeding has had a material effect on us and, as of the date of this prospectus, we are not party to any material legal proceeding. However, we believe that protecting our intellectual property is integral to our future success and competitive advantage, and as such, we may be involved in material legal proceedings relating to our intellectual property on a regular basis in the future.

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MANAGEMENT

Executive Officers and Directors

        Our executive officers and directors, and their ages and positions, are as follows:

Name

  Age
  Position
Chun K. Hong   45   President, Chief Executive Officer and Chairman of the Board
Jayesh Bhakta   48   Vice President of Engineering
Lee Kim   47   Vice President, Chief Financial Officer and Secretary
Christopher Lopes   46   Vice President of Sales
Nam Ki Hong   43   Director
Thomas F. Lagatta   48   Director
Alan H. Portnoy   61   Director
David M. Rickey   50   Director
Preston Romm   52   Director

         Chun K. Hong has been our President and Chief Executive Officer since our inception, and assumed the title of Chairman of the Board in January 2004. From September 2000 to September 2001, Mr. Hong served as President and Chief Operating Officer of Infinilink Corporation, a DSL equipment company. Mr. Hong assisted us on a part-time basis until his departure from Infinilink, at which time he assumed full-time responsibilities with us. In the third quarter of 2001, Infinilink filed for bankruptcy under Chapter 7. From July 1998 until September 2000, Mr. Hong served as Executive Vice President of Viking Components, Inc., a memory subsystems manufacturing company. From November 1997 to June 1998, he was General Manager of Sales at LG Semicon Co., Ltd., a public semiconductor manufacturing company in South Korea. From April 1992 to October 1997, Mr. Hong served as Director of Sales at LG Semicon America, Incorporated, a subsidiary of LG. From December 1983 to March 1992, Mr. Hong held various management positions at LG subsidiaries in South Korea. Mr. Hong received his B.S. in economics from Virginia Commonwealth University and his M.S. in technology management from Pepperdine University's Graduate School of Management.

         Jayesh Bhakta has been our Vice President of Engineering since he joined us full-time in January 2001. From November 2000 to January 2001, Mr. Bhakta was a staff engineer with aerospace manufacturer Hydro-Aire, Inc., a Crane Co. subsidiary. From November 1993 to October 2000, Mr. Bhakta was Chief Engineer at Viking Components. Prior to Viking Components, Mr. Bhakta was a senior design engineer and Engineering Manager with SMT Products Corp. Mr. Bhakta has represented us at the Joint Electron Device Engineering Council, or JEDEC, since he joined us, and has represented us on the board of directors of JEDEC for the last year. Mr. Bhakta holds a B.S. in electrical engineering from the University of California at Los Angeles.

         Lee Kim has been our Vice President, Chief Financial Officer and Secretary since January 2006. Since October 2003, Mr. Kim has been a partner in Tatum LLC, a national professional services firm providing senior financial executive-level services. From February 1999 to May 2003, Mr. Kim was Senior Vice President and Chief Financial Officer of Epicor Software Corporation, a publicly-traded developer of enterprise resource planning software for mid-market companies. From October 1997 to February 1999, he served as Vice President, Corporate Controller and Chief Accounting Officer of FileNet Corporation, a publicly-traded developer of enterprise content management software. From April 1993 to October 1997, Mr. Kim served as Director of Finance of Wonderware Corporation, a publicly-traded developer of supervisory control and data acquisition software. Mr. Kim began his career with Deloitte Haskins & Sells (now known as Deloitte & Touche LLP), serving in the audit practice from July 1981 to December 1987. Mr. Kim received his B.S. in Economics, majoring in accounting, from the Wharton School of the University of Pennsylvania in May 1981.

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         Christopher Lopes has been our Vice President of Sales since our inception. From November 1997 to August 2000, Mr. Lopes was an account executive, and then the Director of OEM Sales, North America, at Viking Components. From June 1996 to November 1997, Mr. Lopes was an account executive with Platinum Associates, a manufacturer's representative sales company. From August 1990 to June 1996, Mr. Lopes was an account executive with Philips Semiconductors. Mr. Lopes began his career as a design engineer with Lockheed Martin Corporation. Mr. Lopes received his B.S. in electrical engineering from California State University, Sacramento and his M.B.A. from Santa Clara University.

         Nam Ki Hong , who is the brother of our President, Chief Executive Officer and Chairman of the Board, Chun K. Hong, has served as a member of our board of directors since March 2004. Mr. Hong has served as Chairman of the board of directors of Northpoint Investment Partners, Pte. Ltd., a private investment firm based in Singapore, since September 2003. From September 2000 to November 2002, he served as Executive Director of Morgan Stanley & Co. International Ltd., Seoul Branch. From June 1998 to August 2000, he served as a First Vice President of Merrill Lynch International Inc., Seoul Branch. From September 1994 to May 1998, he served as a Vice President and portfolio manager of J.P. Morgan Investment Management Inc., based in Singapore. Prior to joining J.P. Morgan, Mr. Hong was as an equity research analyst of J. Henry Schroder Wagg & Co. Ltd., in Seoul. Mr. Hong holds a B.S.E. in chemical engineering from Princeton University and an M.B.A. from Columbia University. Mr. Hong is a Chartered Financial Analyst.

         Thomas F. Lagatta has served as a member of our board of directors since January 2006. Mr. Lagatta has served as Senior Vice President of Worldwide Sales for Broadcom Corp. since June 2006. Prior to that, he had served as the Enterprise Computing Group's Senior Vice President and General Manager since 2003. He joined Broadcom in 2002. Prior to that, Mr. Lagatta served as Vice President and General Manager of Anadigics, Inc., a semiconductor manufacturer. Before Anadigics, Mr. Lagatta served as Vice President of Business Development at Avnet, Inc. Prior to Avnet, Mr. Lagatta served in various senior management and technical positions for over 11 years at Symbios Logic, a storage systems company. Mr. Lagatta received a B.S.E.E. from Ohio State University and an M.S.E.E. from the University of Southern California.

         Alan H. Portnoy has served as a member of our board of directors since March 2004. Mr. Portnoy has served as President of Macronix America, Inc., since May 1996. From June 1995 to April 1996, he served as Managing Director for PNY Electronics, Inc., a memory module manufacturer. Mr. Portnoy was the Chief Operating Officer of LG Semicon America from 1988 to 1994, a Vice President for General Instruments Corporation from 1987 to 1988, a Senior Vice President for Silicon Systems from 1981 to 1987, and a Vice President for Macrodata Corporation from 1975 to 1980. Mr. Portnoy began his career with Fairchild Semiconductor. Mr. Portnoy presently serves on the board of Macro-Port, Inc. Mr. Portnoy received his B.S. in electrical engineering from the Rensselaer Polytechnic Institute and his M.S in Industrial Administration from Carnegie-Mellon University.

         David M. Rickey has served as a member of our board of directors since March 2004. Mr. Rickey served as Chairman of Applied Micro Circuits Corporation, or AMCC, from August 2000 to March 2005 and as the President and Chief Executive Officer from February 1996 to March 2005. From 1993 to 1995, he served as the Vice President of Operations of AMCC. During his time away from AMCC, Mr. Rickey served as the Vice President of Operations of NexGen, Inc. For eight years beginning in 1985, Mr. Rickey was employed by Northern Telecom, Inc. Mr. Rickey began his career at International Business Machines Corporation. Mr. Rickey presently serves on the board at Cytori Therapeutics, Inc. Mr. Rickey graduated Summa Cum Laude from Marietta College with a B.S. in Mathematics. He also has a B.S. in Metallurgy and Materials Science from Columbia University, and an M.S. in Material Science and Engineering from Stanford University.

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         Preston Romm has served as a member of our board of directors since March 2004. Mr. Romm has served as Vice President of Finance and Chief Financial Officer of Iomega Corporation since March 2006. Prior to that, he served as Vice President of Finance and Chief Financial Officer of Dot Hill Systems beginning in November 1999. From January 1997 to November 1999, Mr. Romm served as Vice President of Finance, Chief Financial Officer and Secretary of Verteq, Inc., a semiconductor equipment manufacturer. From November 1994 to January 1997, Mr. Romm served as Vice President of Finance and Chief Financial Officer of STM Wireless, Inc. From July 1990 to November 1994, Mr. Romm served as Vice President and Controller of MTI Technology Corporation. Mr. Romm holds a B.S. from the University of Maryland and an M.B.A. from American University.

Board of Directors

        Our board of directors currently consists of six directors. All of our directors will stand for election at each annual meeting of stockholders.

        Our board of directors has established an audit committee, a compensation committee and a nominating and governance committee. The composition and responsibilities of these committees are as follows:

        Audit Committee.     Our audit committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our audit committee reviews the qualifications, independence and performance of our independent auditor, and approves the terms of engagement of our independent auditor. The members of our audit committee are Messrs. Portnoy, Rickey and Romm. Mr. Romm serves as chairperson of the audit committee. Each member of our audit committee meets the requirements for independence under the Nasdaq Marketplace Rules and applicable rules and regulations of the Securities and Exchange Commission, and our board of directors reviews the qualifications of our audit committee members from time to time to determine whether they continue to meet these independence requirements. Mr. Romm qualifies as an "audit committee financial expert," as defined in Rule 401(h) of Regulation S-K of the Securities Exchange Act of 1934, as amended.

        Compensation Committee.     Our compensation committee discharges the responsibilities of our board of directors relating to compensation and benefits of our executive officers and directors and reviews our general policy relating to compensation and benefits. The members of our compensation committee are Messrs. Lagatta, Portnoy and Rickey. Mr. Rickey serves as chairperson of the compensation committee.

        Nominating and Governance Committee.     Our nominating and governance committee considers and makes recommendations to our board of directors regarding candidates to serve as members of our board of directors, reviews our general policy relating to selection of director candidates and members of committees of our board of directors, and reviews and makes recommendations to our board of directors regarding corporate governance principles. The members of our nominating and governance committee are Messrs. Lagatta, Rickey and Romm. Mr. Romm serves as chairperson of the nominating and governance committee.

Compensation Committee Interlocks and Insider Participation

        None of the members of our compensation committee is or has been one of our officers or employees. No member of our board of directors or compensation committee currently serves, or served during 2005, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee.

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Director Compensation

        Our non-employee directors receive annual base compensation of $30,000, paid in four quarterly installments, and compensation of $1,000 for each regularly scheduled board meeting, or committee meeting not held on the same day as a board meeting, that is attended. The chairperson of our audit committee receives an additional $5,000 per year. All of our directors, including our non-employee directors, are reimbursed for their reasonable out-of-pocket expenses incurred in attending board and board committee meetings. Our non-employee directors are also granted an option to purchase 25,000 shares of our common stock under our 2000 Equity Incentive Plan upon appointment or initial election to the board of directors, and will receive a grant of an option to purchase 10,000 shares of our common stock on August 1st of each year in which they continue to be a board member. These grants are subject to vesting over four years, contingent upon continued service as a director on the vesting date. Our employee directors do not receive cash compensation or option grants for their services as directors.

Indemnification of Directors and Officers and Limitation of Liability

        We intend to amend and restate our certificate of incorporation and bylaws prior to the completion of this offering. Our amended and restated certificate of incorporation will eliminate the personal liability of each of our directors for monetary damages resulting from any breach of his fiduciary duty as a director, except for liability:

    for any breach of the director's duty of loyalty to us or our stockholders;

    for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law;

    for unlawful payments of dividends or unlawful stock repurchases, redemptions or other distributions; or

    for any transaction from which the director derived an improper personal benefit.

        Our amended and restated bylaws will provide that:

    we are required to indemnify our directors and officers to the fullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions;

    we are required to advance expenses, as incurred, to our directors and officers in connection with a legal proceeding to the fullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions; and

    the indemnification rights conferred in the bylaws are not exclusive.

        We have entered into indemnification agreements with most of our current directors and executive officers. We intend to enter into indemnification agreements with all of our directors and executive officers prior to the completion of this offering. Subject to limited exceptions, these agreements require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to us, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. We also intend to enter into indemnification agreements with our future directors and executive officers.

        We intend to obtain directors' and officers' insurance to cover our directors, officers and some of our employees for liabilities, including liabilities under securities laws prior to the completion of this offering. We believe that these indemnification provisions and agreements and this insurance are necessary to attract and retain qualified directors and executive officers.

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        The exculpation of liability and indemnification provisions in our certificate of incorporation and indemnification agreements may discourage stockholders from bringing a lawsuit against our directors for any breach of their fiduciary duties. They may also reduce the likelihood of derivative litigation against our directors and officers, even though an action, if successful, might benefit us and other stockholders. Furthermore, a stockholder's investment may be adversely affected to the extent that we pay the costs of settlement and damage awards against directors and officers as required by these indemnification provisions. At present, there is no pending litigation or proceeding involving any of our directors, officers or employees for which indemnification is sought, and we are not aware of any threatened litigation that may result in claims for indemnification.

Code of Ethics

        We intend to adopt and post on our website, prior to the completion of this offering, a Code of Ethics that applies to all directors, officers and employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer.

Executive Compensation

        The following table presents information regarding the compensation received for the year ended December 31, 2005, by our chief executive officer and each of our other named executive officers. The compensation table excludes other compensation in the form of perquisites and other personal benefits to a named executive officer where that compensation constituted less than the lesser of $50,000 or 10% of his total annual salary and bonus for such period.


Summary Compensation Table

 
  Annual Compensation
  Long Term Compensation
   
Name and Principal Position

  Salary
  Bonus
  Other
Annual
Compensation

  Restricted
Stock
Awards

  Securities
Underlying
Options

  All Other
Compensation

Chun K. Hong
President, Chief Executive Officer and Chairman of the Board
  $ 323,733   $   $   $     $
Jayesh Bhakta
Vice President of Engineering
    153,002                  
Lee Kim(1)
Vice President, Chief Financial Officer and Secretary
                     
Christopher Lopes
Vice President of Sales
    202,204                  
Daniel Skaggs(2)
Vice President of Finance
    162,000               30,000    

(1)
Mr. Kim joined us in January of 2006. For a summary of Mr. Kim's terms of compensation, see "—Employment Agreements."

(2)
Mr. Skaggs' employment terminated in February 2006.

Option Grants in 2005

        The following table presents information regarding grants of stock options that we made during 2005 to the named executive officers. We granted these options to the named executive officers under our 2000 Equity Incentive Plan. All of the options listed on the following table expire ten

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years from the date of grant and were granted at an exercise price equal to the fair market value of our common stock as determined in good faith by our board of directors on the date of grant. The percentage of total options granted to employees in 2005 is based on options to purchase a total of 691,000 shares of our common stock that were granted to employees for the year ending December 31, 2005.

 
  Individual Grants
Name

  Number of
Securities
Underlying
Options
Granted

  % of Total
Options Granted
to
Employees in
Fiscal Year

  Exercise
Price
Per Share

  Expiration
Date(1)

Chun K. Hong          
Jayesh Bhakta          
Lee Kim          
Christopher Lopes          
Daniel Skaggs(1)   30,000   4.3 % $ 2.55  

(1)
Mr. Skaggs' employment terminated in February 2006. Mr. Skaggs did not exercise his vested options within the 90-day period following his termination in accordance with the provisions of his option grant, and his options therefore terminated as of the end of that 90-day period and are no longer outstanding.

Aggregate Option Exercises in 2005

        None of the named executive officers exercised any stock options or stock appreciation rights in fiscal year 2005. The following table presents the number of shares of our common stock subject to unexercised options held by the named executive officers at December 31, 2005, and the value of the unexercised options that were in-the-money at that date. This value is calculated based on the difference between $1.48, the estimated fair market value of our common stock at December 31, 2005, and the exercise price for the shares underlying the option, multiplied by the number of shares.

 
  Number of Securities Underlying Unexercised Options at December 31,2005
  Value of Unexercised In-the-Money Options at December 31, 2005
Name

  Exercisable
  Unexercisable
  Exercisable
  Unexercisable
Chun K. Hong          
Jayesh Bhakta          
Lee Kim          
Christopher Lopes          
Daniel Skaggs(1)   68,799   65,000   $ 43,262  

(1)
Mr. Skaggs' employment terminated in February 2006. Mr. Skaggs did not exercise his vested options within the 90-day period following his termination in accordance with the provisions of his option grant, and his options therefore terminated as of the end of that 90-day period and are no longer outstanding.

Recent Option Grants to Management

        In August 2006, the compensation committee of our board of directors granted options to purchase the following numbers of shares of our common stock to the following members of our management: Chun K. Hong, 500,000; Lee Kim, 100,000 (85,000 of which were granted directly to

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him and 15,000 of which were granted in the form of a warrant to a company with which he is affiliated pursuant to an agreement between that company and us); Jayesh Bhakta, 100,000; Christopher Lopes, 100,000; and Paik Ki Hong, our Vice President of Procurement, 100,000. Each of these options has an exercise price of $7.00 per share. The options granted to Chun K. Hong and Lee Kim vest quarterly over four years. The options granted to the other three employees vest upon the termination of the lock-up period included in agreements that they entered into with us in August 2006 provided that they have not terminated their employment with us prior to that time. These agreements provide that they will not sell any of their shares of common stock during the two-year period following the termination of their lock-up agreements with the underwriters other than the sale of up to 25,000 shares each quarter pursuant to a written trading plan that complies with SEC Rule 10b5-1 and is approved by us.

Employment Agreements

        We entered into an employment agreement with Lee Kim, our Vice President, Chief Financial Officer and Secretary, at the time of his hiring in January 2006. Mr. Kim's employment agreement provides for an initial base salary of $200,000. We agreed to reimburse Mr. Kim for the costs of his health and welfare plan premiums in an amount up to $750.00 per month. Our employment relationship with Mr. Kim is at-will, and either we or Mr. Kim may terminate the employment relationship on 30 days' written notice. If Mr. Kim is terminated by us for any reason other than cause within his first year of employment, he will be entitled to a severance payment equal to one months' salary; if he is terminated by us for any reason other than cause after his first year of employment, he will be entitled to a severance payment equal to four months' salary; if he is terminated by us for any reason other than cause after his second year of employment, he will be entitled to a severance payment equal to six months' salary; and for each six months of employment after his second year of employment, if he is terminated by us for any reason other than cause he will be entitled to an additional one month's salary, capped at twelve months total. If Mr. Kim is terminated by us without cause, or without 30 days' prior notice, or if Mr. Kim resigns for cause, Mr. Kim will be entitled to the applicable severance compensation described above, plus one additional month's salary, and all of Mr. Kim's cash bonuses and stock options will immediately vest and become payable and exercisable, as applicable. If Mr. Kim is terminated by us without cause, or if Mr. Kim resigns for cause, as a result of, or within six months following, a change in control of our company, he will be entitled to a payment in the amount of 12 months' salary. In conjunction with Mr. Kim's hiring, we agreed to pay a portion of any cash or equity compensation earned by him as our employee to a company with which he is affiliated.

Employee Benefit Plans

    Amended and Restated 2000 Equity Incentive Plan

        We intend to amend and restate our existing 2000 Equity Incentive Plan in its entirety prior to the completion of this offering. In this prospectus we make reference to our 2000 Equity Incentive Plan, as it will be amended and restated, as the Amended and Restated 2000 Equity Incentive Plan. The Amended and Restated 2000 Equity Incentive Plan will be administered by the compensation committee of our board of directors. The compensation committee will have the authority to administer the plan, including the power to determine eligibility to receive awards, the types and number of shares of stock subject to the awards, the price and timing of awards, the acceleration or waiver of any vesting, and the imposition of performance or forfeiture restrictions. The compensation committee, however, does not have the authority to waive any performance restrictions for performance-based awards. The compensation committee may reprice or otherwise amend the terms of any award granted under the plan, prospectively or retroactively, consistent with the terms of the plan. It also may at any time offer to buy out for a cash payment an award

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previously granted, or authorize the recipient of an award to elect to cash out an award previously granted. As used in this prospectus, the term "administrator" means the compensation committee.

        Shares Reserved for Issuance.     Subject to certain adjustments, we initially will be able to issue a maximum of              shares of common stock pursuant to awards granted under the Amended and Restated 2000 Equity Incentive Plan. That maximum number will automatically increase on a fixed date each year by the least of:

    percent of the total number of shares of common stock outstanding on the date immediately preceding the date of the increase;

    shares; and

    such smaller number of shares as may be determined by our board of directors prior to that date.

        The following types of shares issued under the Amended and Restated 2000 Equity Incentive Plan may again become available for the grant of new awards under the plan:

    shares that are forfeited to us or repurchased by us at less than fair market value; and

    shares tendered to us to pay the exercise price of an option.

        Participants.     Any of our employees, our non-employee directors, and any consultants and advisors to us, as determined by the administrator, may be selected to participate in the Amended and Restated 2000 Equity Incentive Plan. We may award these individuals with one or more of the following:

    stock options;

    stock appreciation rights;

    restricted stock and stock unit awards;

    performance units;

    stock grants; and

    performance-based awards.

        Stock Options.     Stock options may be granted under the Amended and Restated 2000 Equity Incentive Plan, including incentive stock options, as defined under Section 422 of the Code, and nonqualified stock options. The option exercise price of all stock options granted under the Amended and Restated 2000 Equity Incentive Plan will be determined by the administrator, except that any incentive stock option or any option intended to qualify as performance-based compensation under Section 162(m) of the Code will not be granted at a price that is less than 100% of the fair market value of the stock on the date of grant. Stock options may be exercised as determined by the administrator, but in no event after the tenth anniversary date of grant.

        Upon the exercise of a stock option, the purchase price must be paid in full in either cash or its equivalent. The administrator may also allow payment by tendering previously acquired shares of our common stock with a fair market value at the time of exercise equal to the exercise price, provided such shares have been held for at least six months prior to tender and broker-assisted cashless exercises and may authorize loans for the purpose of exercise as permitted under applicable law.

        Stock Appreciation Rights.     Stock appreciation rights, or SARs, entitle a participant to receive a payment equal in value to the difference between the fair market value of a share of stock on the date of exercise of the SAR over the grant price of the SAR. The administrator may pay that amount

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in cash, in shares of our common stock, or in a combination of both. The terms, methods of exercise, methods of settlement, form of consideration payable in settlement, and any other terms and conditions of any SAR will be determined by the administrator at the time of the grant of award and will be reflected in the award agreement.

         Restricted Stock and Stock Units. A restricted stock award or restricted stock unit award is the grant of shares of our common stock either currently (in the case of restricted stock) or at a future date (in the case of restricted stock units), at a price determined by the administrator (including zero), that is nontransferable and is subject to substantial risk of forfeiture until specific conditions or goals are met. Conditions may be based on continuing employment or achieving performance goals. During the period of restriction, participants holding shares of restricted stock may, if permitted by the administrator, have full voting and dividend rights with respect to those shares. The restrictions will lapse in accordance with a schedule or other conditions determined by the administrator.

         Performance Units. A performance unit award is a contingent right to receive the value of a pre-determined number of shares of our common stock if certain performance goals are met. The value of performance units will depend on the degree to which the specified performance goals are achieved, but are generally based on the value of our common stock. The administrator may, in its discretion, pay earned performance units in cash, or stock, or a combination of both.

         Stock Grants. A stock grant is an award of shares of common stock without restrictions. Stock grants may only be made in limited circumstances, such as in lieu of other earned compensation.

        Performance-Based Awards.     Grants of performance-based awards enable us to treat other awards granted under the Amended and Restated 2000 Equity Incentive Plan as "performance-based compensation" under Section 162(m) of the Code and preserve the deductibility of these awards for federal income tax purposes. Because Section 162(m) of the Code only applies to those employees who are "covered employees" as defined in Section 162(m) of the Code, only covered employees and those likely to become covered employees are eligible to receive performance-based awards. Participants are only entitled to receive payment for a performance-based award for any given performance period to the extent that pre-established performance goals set by the administrator for the period are satisfied. These pre-established performance goals must be based on one or more of the following performance criteria: pre- or after-tax net earnings, sales growth, operating earnings, operating cash flow, return on net assets, return on stockholders' equity, return on assets, return on capital, stock price growth, stockholder returns, gross or net profit margin, earnings per share, price per share and market share. These performance criteria may be measured in absolute terms or as compared to any incremental increase or as compared to results of a peer group. With regard to a particular performance period, the administrator will have the discretion to select the length of the performance period, the type of performance-based awards to be granted, and the goals that will be used to measure the performance for the period. In determining the actual size of an individual performance-based award for a performance period, the administrator may reduce or eliminate (but not increase) the award. Generally, a participant will have to be employed on the date the performance-based award is paid to be eligible for a performance-based award for that period.

        Amendment and Termination.     Our board of directors may terminate, amend, or modify the Amended and Restated 2000 Equity Incentive Plan at any time; however, stockholder approval will be obtained for any amendment to the extent necessary and desirable to comply with any applicable law, regulation or stock exchange rule. We may not make any grants under the Amended and Restated 2000 Equity Incentive Plan after             , 2016.

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        Adoption by Stockholders.     We intend to seek approval of the Amended and Restated 2000 Equity Incentive Plan by the holders of a majority of the outstanding shares of our common stock and preferred stock prior to the completion of this offering.

    401(k) Plan

        We sponsor a defined contribution plan, or 401(k) Plan, intended to qualify under Section 401(a) of the Internal Revenue Code. Employees are eligible to participate in this plan provided they are employed full-time and have reached 21 years of age. Participants may make pre-tax contributions to the plan subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions and the investment earnings. Under the plan's current terms, we may match the contributions of a participant, to the extent they do not exceed 6% of the participant's compensation, on a discretionary basis. Our contributions, if any, would generally be deductible by us when made. Contributions are held in trust as required by law.

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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        The following is a description of certain relationships and related transactions to which we have been a party, in which the amount involved in each transaction or series of related transactions exceeds $60,000, and in which any of our directors, former or current executive officers or, to our knowledge, holders of more than 5% of our capital stock had or will have a direct or indirect material interest.

Related Parties

    Loans to Related Parties

        Our Vice President of Procurement, Paik Ki Hong, is the brother of Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board, and of Nam Ki Hong, one of our directors. Mr. P. K. Hong received salary and bonuses in the amount of $125,693 for the year 2005. As of December 31, 2005 and June 30, 2006, Mr. P. K. Hong owed $22,865 in outstanding principal and accrued and unpaid interest on a full-recourse promissory note issued to us by Mr. P. K. Hong as part of the exercise price of then-vested options to acquire shares granted to him pursuant to our 2000 Equity Incentive Plan. This note bears interest at a rate of 7% per annum and is due on February 17, 2008.

        In November 2000, we made loans to each of Christopher Lopes, our Vice President of Sales, and Jayesh Bhakta, our Vice President of Engineering, in connection with their respective purchases of shares of restricted stock. The original principal amount of each of these loans was $199,000, and they each accrued interest at a rate of 7% annually. As of December 31, 2003, the outstanding principal and accrued and unpaid interest on each of these loans totaled $246,299. On December 31, 2003, we forgave the entire outstanding principal amount, as well as accrued and unpaid interest due to us, on those loans. In addition, we gave each of Mr. Lopes and Mr. Bhakta a cash bonus of $165,100, which was intended to be equal to the tax liability incurred by each of these individuals with respect to the forgiveness of each of their loans.

    Loans From and Guaranties by Executive Officers

        In August and October 2002, Chun K. Hong made loans to us to finance our working capital needs in exchange for two promissory notes in the original principal amount of $97,894 and $70,000, respectively. Interest on each of these notes accrued at a rate of 7% per annum and all principal and accrued interest was due in July 2004 and October 2004, respectively. We prepaid interest under these notes on a monthly basis as it accrued. As a result, the total outstanding balance of these notes on December 31, 2003 was $167,894. On that date, we offset $167,894 of prior advances made to Mr. Hong, as described below, against that outstanding balance, effectively canceling each of these notes.

        Mr. Hong has personally guarantied the repayment of $1,750,000 in aggregate principal amount of our outstanding convertible promissory notes. Messrs. Hong, Lopes and Bhakta have each personally guarantied the repayment of up to $1,000,000 of borrowings under the existing credit agreement with our bank. The guaranties of our bank debt will terminate upon the completion of this offering.

        In November 2002, Julie Skaggs, the wife of Daniel Skaggs, our former Vice President of Finance, made a loan to us to finance our working capital needs in exchange for a promissory note in the original principal amount of $100,000. Interest on this note accrued at a rate of 15% per annum and all principal and accrued interest was due in 2004. We repaid this loan in December 2003.

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    Advances to Executive Officers and Other Management

        We made a series of advances in 2001 and 2002 in the aggregate amount of $152,000, $90,000, $5,000 and $81,120 to Chun K. Hong, Christopher Lopes, Jayesh Bhakta, and Paik Ki Hong, respectively. These advances accrued interest at a rate of 7% annually. As of December 31, 2003, the outstanding balances of these advances, including accrued and unpaid interest, totaled $174,340, $101,336, $5,454 and $90,244, respectively. On that same date, we offset $167,894 of the advances to Mr. C. K. Hong against the two notes owed to him, as described above, reducing the amount of his advances at year end to $6,446. On that same date, we forgave the entire remaining outstanding amounts of the advances to Messrs. C. K. Hong, Lopes, Bhakta and P. K. Hong. We also gave cash bonuses of $2,665, $82,691, $2,133 and $74,304 to Messrs. C. K. Hong, Lopes, Bhakta and P. K. Hong, respectively, which amounts were intended to be equal to the respective tax liabilities to be incurred by each of these individuals in connection with the forgiveness of each of their advances.

    Other Transactions

        In August 2006, Jayesh Bhakta, Christopher Lopes, and Paik Ki Hong entered into lock-up agreements with us as part of an overall compensation package. These agreements provide that they will not sell any of their shares of common stock during the two-year period following the termination of their lock-up agreements with the underwriters other than the sale of up to 25,000 shares each quarter pursuant to a written trading plan that complies with SEC Rule 10b5-1 and is approved by us. In return, we agreed that each of them would receive a $100,000 bonus upon completion of this offering (which must be repaid to us if he terminates his employment prior to the end of the two-year lock-up period), and that each of them would be able to sell, as part of the over-allotment option in connection with this offering, if that over-allotment option is exercised by the underwriters, the number of shares of our common stock that would provide them with gross proceeds of $750,000. Upon signing these agreements, each of these employees also received an option to purchase 100,000 shares of our common stock at an exercise price of $7.00 per share as part of this compensation package.

Stock Options Granted to Directors and Executive Officers

        For more information in addition to that described under "—Other Transactions" above regarding director and executive officer compensation and the grant of stock options to directors and executive officers, please see the following subsections under "Management" above: "—Director Compensation," "—Executive Compensation," "—Option Grants in 2005" and "—Recent Option Grants to Management."

Indemnification Agreements

        We enter into indemnification agreements with all of our executive officers and directors. See the information provided in this prospectus under "Management—Indemnification of Officers and Directors and Limitation of Liability."

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PRINCIPAL AND SELLING STOCKHOLDERS

        The following table sets forth information regarding the beneficial ownership of our common stock as of July 31, 2006, and as adjusted to reflect the sale of common stock offered by us in this offering, for:

    each named executive officer;

    each of our current directors;

    all of our current executive officers and directors as a group;

    each person known by us to beneficially own more than 5% of our outstanding shares of our common stock; and

    each stockholder that will sell shares in this offering if the underwriters' over-allotment option is exercised.

        In the following table, the percentage ownership of shares beneficially owned prior to this offering is based on 11,223,334 shares of our common stock outstanding as of July 31, 2006, and the percentage of shares beneficially owned after this offering is based on             shares of our common stock outstanding after this offering, and, in each case, assuming:

    the conversion of all of our outstanding shares of preferred stock into 1,000,000 shares of our common stock; and

    the conversion of $1.75 million in outstanding principal amount of our outstanding convertible promissory notes into 1,050,000 shares of our common stock.

        Beneficial ownership is determined in accordance with the rules and regulations of the Securities and Exchange Commission and does not necessarily indicate beneficial ownership for any other purpose. Under these rules, beneficial ownership includes those shares of common stock over which the stockholder has sole or shared voting or investment power. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days of July 31, 2006, are deemed outstanding for purposes of computing the percentage beneficially owned by the person holding those options or warrants, but are not deemed outstanding for purposes of computing the percentage beneficially owned by any other person.

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  Shares Beneficially Owned Prior to Offering
   
  Shares Beneficially Owned After Offering(3)
Name of Beneficial Owner(1)

  Shares Being
Offered(2)

  Number
  Percent
  Number
  Percent
Directors and Executive Officers:                    
Chun K. Hong(4)   6,000,000   45.2 %          
Christopher Lopes   1,000,000   7.5 %          
Jayesh Bhakta   1,000,000   7.5 %          
Lee Kim              
Nam Ki Hong(5)   115,000   *          
Thomas F. Lagatta              
Alan H. Portnoy(6)   15,000   *          
David M. Rickey(6)   15,000   *          
Preston Romm(6)   15,000   *          
All executive officers and directors as a group (9 persons)   8,160,000   60.7 %          
5% Stockholders:                    
Jae Dong Lee(7)   1,400,000   10.5 %          
Paik Ki Hong(8)   1,000,000   7.1 %          
Serim Paper Manufacturing Co., Ltd(9)   675,000   5.1 %        
Jun S. Cho(10)   1,020,000   7.7 %          

*
Represents beneficial ownership of less than 1%.

(1)
Unless otherwise indicated, the address of each director, executive officer and person beneficially owning more than 5% of the outstanding shares of our common stock is c/o Netlist Inc., 475 Goddard, Irvine, California 92618.

(2)
Consists entirely of shares subject to the underwriter's over-allotment option, and assumes that the over-allotment option is exercised in full.

(3)
Assumes that the over-allotment option is exercised in full.

(4)
Includes 2,772,798 shares of common stock held by Mr. Hong as trustee of The Chun Ki Hong Qualified Annuity Trust—2004; and 3,000,000 million shares of common stock held by Mr. Hong as trustee of the Hong-Cha Community Property Trust. Mr. Hong disclaims beneficial ownership of shares held for these trusts.

(5)
The number of shares beneficially owned both before and after this offering includes 115,000 shares of common stock issuable upon the exercise of options that are or will be vested and immediately exercisable within 60 days of July 31, 2006.

(6)
The number of shares beneficially owned both before and after this offering includes 15,000 shares of common stock issuable upon the exercise of options that are or will be vested and immediately exercisable within 60 days of July 31, 2006.

(7)
Mr. Jae Dong Lee's address is 8-108, Hannam Heights Apt., Oksu-Dong Seongdong-gu, Seoul, Korea. Mr. Lee served on our board of directors from our inception through March 2004.

(8)
Mr. Paik Ki Hong has served as our Vice President of Procurement since March 2006. Prior to that he had served as our Director of Procurement since March 2001. He is the brother of Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board. The number of shares beneficially owned both before and after this offering by Mr. Paik Ki Hong includes 900,000 shares of common stock issuable upon the exercise of options that are or will be vested and immediately exercisable within 60 days of the date of this prospectus.

(9)
Serim Paper Manufacturing's address is 505, Shinsa-dong, Gangnam-gu, Seoul, Korea. The number of shares beneficially owned before the offering is comprised entirely of shares of common stock issuable upon the conversion of convertible promissory notes outstanding as of the date of this prospectus.

(10)
The number of shares beneficially owned both before and after the offering includes 500,000 shares of common stock held by Mr. Cho as trustee of the Chun Ki Hong 2004 Trust, which shares were transferred to this trust by Mr. C.K. Hong in August 2004, and 500,000 shares of common stock held by Mr. Cho as trustee of the Won Kyung Cha 2004 Trust, which shares were transferred to this trust by Won Kyung Cha, the wife of Mr. C.K. Hong, in August 2004. Mr. Cho disclaims beneficial ownership of shares held for these trusts.

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DESCRIPTION OF CAPITAL STOCK

General

        The following information assumes the filing, prior to the completion of this offering, of our amended and restated certificate of incorporation and our amended and restated bylaws.

        Immediately following the completion of this offering, our authorized capital stock will consist of             shares of common stock, par value $0.001 per share, and              shares of undesignated preferred stock, par value $0.001 per share.

Common Stock

        As of July 31, 2006, we had outstanding 11,223,334 shares of our common stock held by 17 holders of record.

    Dividend Rights

        Subject to preferences that may apply to any then outstanding shares of preferred stock, the holders of outstanding shares of our common stock are entitled to receive dividends out of assets legally available for distribution at the times and in the amounts, if any, that our board of directors may determine from time to time.

    Voting Rights

        Each holder of our common stock is entitled to one vote for each share of our common stock held on all matters submitted to a vote of stockholders. We have not provided for cumulative voting for the election of directors in our certificate of incorporation. This means that the holders of a majority of the shares voted can elect all of the directors then standing for election. In addition, our certificate of incorporation and bylaws provide that all actions to be taken by our stockholders will require the approval of a majority of the shares entitled to vote at a meeting at which a quorum is present. For a description of these actions, see "—Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws."

    No Preemptive, Conversion or Redemption Rights

        Our common stock is not entitled to preemptive rights and is not subject to conversion or redemption.

    Right to Receive Liquidation Distributions

        Upon our liquidation, dissolution or winding-up, the holders of our common stock are entitled to share in all assets remaining after payment of all liabilities and the liquidation preferences of any then outstanding shares of preferred stock. Each outstanding share of our common stock is, and all shares of our common stock to be issued in this offering when they are paid for will be, fully paid and nonassessable.

Preferred Stock

        Immediately prior to the completion of this offering, each outstanding share of our existing series of preferred stock designated as Series A Convertible Preferred Stock will be converted into one share of common stock.

        Our board of directors is authorized, subject to limitations imposed by Delaware law, to issue up to             shares of preferred stock, in one or more series, without stockholder approval. Our board of directors is authorized to establish from time to time the number of shares to be included

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in each series, and to fix the rights, preferences and privileges of the shares of each wholly unissued series and any of its qualifications, limitations or restrictions. Our board of directors can also increase or decrease the number of shares of any series, but not below the number of shares of that series then outstanding, without any further vote or action by the stockholders.

        The board of directors may authorize the issuance of preferred stock with voting or conversion rights that could harm the voting power or other rights of the holders of common stock. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, have the effect of delaying, deferring or preventing a change of control and might harm the market price of our common stock and the voting and other rights of the holders of common stock. We have no current plans to issue any shares of preferred stock.

Common Stock Warrants

        In January 2003, we issued a warrant to purchase an aggregate of 60,000 shares of our common stock at an exercise price of $1.25 per share to a single holder. This warrant expires in January 2013. In February 2003, we issued warrants to purchase an aggregate of 300,000 shares of our common stock at an exercise price of $1.00 per share to a total of three holders. These warrants have five-year terms and expire on February 12, 2008. In May 2006 and August 2006, we issued warrants to purchase 22,500 shares and 15,000 shares of our common stock at exercise prices of $2.55 per share and $7.00 per share, respectively, to a single holder. These warrants have a 10-year term and vest over a four-year period.

Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws

        The provisions of Delaware law and of our amended and restated certificate of incorporation and bylaws described below may have the effect of delaying, deferring or discouraging another party from acquiring control of us.

    Delaware Law

        We will be subject to the provisions of Section 203 of the Delaware General Corporation Law regulating corporate takeovers. In general, those provisions prohibit a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date of the transaction in which the person became an interested stockholder, unless:

    the transaction is approved by the board of directors before the date the interested stockholder attained that status;

    upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced; or

    on or after the date the business combination is approved by the board of directors and authorized at a meeting of stockholders by at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder.

        Section 203 defines "business combination" to include the following:

    any merger or consolidation involving the corporation and the interested stockholder;

    any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder;

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    subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder;

    any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or

    the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation.

        In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by any of these entities or persons.

        A Delaware corporation may opt out of this provision either with an express provision in its original certificate of incorporation or in an amendment to its certificate of incorporation or bylaws approved by its stockholders. However, we have not opted out of this provision. The statute could prohibit or delay mergers or other takeover or change in control attempts and, accordingly, may discourage attempts to acquire us.

Charter and Bylaws

        Following the completion of this offering, our amended and restated certificate of incorporation and bylaws will provide that:

    no action can be taken by stockholders except at an annual or special meeting of the stockholders called in accordance with our bylaws, and stockholders may not act by written consent;

    our board of directors will be expressly authorized to make, alter or repeal our bylaws;

    our board of directors will be authorized to issue preferred stock without stockholder approval;

    a stockholder seeking to bring business before an annual meeting of stockholders, or to nominate candidates for election as directors at an annual meeting of stockholders, must provide timely notice of this intention in writing; and to be timely, a stockholder's notice must be delivered to our secretary not less than 120 days prior to the first anniversary of the date of our proxy statement delivered to stockholders in connection with the preceding year's annual meeting, or if the date of this annual meeting is more than 30 days before the date of the preceding year's annual meeting, or if no proxy statement was delivered to our stockholders in connection with the preceding year's annual meeting, such notice must be delivered not later than 10 days following the date on which public announcement of the date of the annual meeting is made; and

    we will indemnify officers and directors against losses that they may incur in investigations and legal proceedings resulting from their services to us, which may include services in connection with takeover defense measures.

Transfer Agent and Registrar

        The transfer agent and registrar for our common stock will be U.S. Stock Transfer Corporation and its address is 1745 Gardena Avenue, Glendale, CA 91204-2991.

Listing

        We intend to apply to have our common stock approved for trading and quotation on the Nasdaq Global Market under the proposed trading symbol "NLST."

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SHARES ELIGIBLE FOR FUTURE SALE

        Before this offering, there has not been a public market for our common stock. Future sales of substantial amounts of our common stock, including shares issued upon exercise of outstanding options and warrants, in the public markets after this offering could adversely affect market prices prevailing from time to time. As described below, only a limited number of shares currently outstanding will be available for sale immediately after this offering due to contractual and legal restrictions on resale. Nevertheless, future sales of substantial amounts of our common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market after the restrictions lapse, or the possibility of the sales, could cause the prevailing market price of our common stock to fall or impair our ability to raise equity capital in the future.

        Upon completion of this offering, we will have outstanding             shares of our common stock, assuming that there are no exercises of outstanding options after                          , 2006. Of these shares, all of the             shares sold in this offering will be freely tradable in the public market without restriction or further registration under the Securities Act, unless these shares are held by "affiliates," as that term is defined in Rule 144 under the Securities Act. For purposes of Rule 144, an "affiliate" of an issuer is a person that, directly or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the issuer. Shares purchased by an affiliate may not be resold except pursuant to an effective registration statement or an exemption from registration, including the exemption under Rule 144 of the Securities Act described below. Our shares outstanding prior to this offering are "restricted securities," as that term is defined in Rule 144 under the Securities Act. These restricted securities may be sold in the public market only if they are registered or if they qualify for an exemption from registration under Rule 144 or 701 under the Securities Act. These rules are summarized below. Subject to the lock-up agreements described below and the current information, manner of sale and volume restrictions of Rule 144 and Rule 701, these restricted securities will be available for sale in the public market as follows:

Date

  Number of Shares
  Comment
On the date of this prospectus   shares   Shares not locked up and eligible for sale under Rule 144

90 days after the date of this prospectus

 

shares

 

Shares not locked up and eligible for resale under Rule 144 and Rule 701

180 days after the date of this prospectus

 

shares

 

Lock-up released; shares eligible for sale under Rule 144 and Rule 701

Lock-up Agreements

        We and the selling stockholders, our executive officers and directors and substantially all of our other existing security holders have agreed, subject to limited exceptions, not to offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any of their shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock; or enter into any swap or other arrangement that transfers to another, in whole or in part, any economic consequences of ownership of our common stock (other than with respect to shares being sold by a selling stockholder in this offering) during the period ending 180 days after the date of this prospectus without the prior written consent of Thomas Weisel Partners LLC, on behalf of the underwriters. If (a) during the last 17 days of this 180-day period, we release earnings results or announce material news or a material event or (b) prior to the expiration of this 180-day period, we announce that we will release earnings results

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during the 15-day period following the last day of the 180-day period, then in either case the above restrictions will continue to apply until 18-days after the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Thomas Weisel Partners LLC waives, in writing, such extension. These restrictions apply to shares of our capital stock which are now owned or which are acquired after the date of this prospectus by the person executing the lock-up agreement, or over which that person later acquires the power of disposition.

Rule 144

        In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year from the later of the date on which those shares of common stock were acquired from us or from an affiliate of ours, including the holding period of any prior owner other than an affiliate of ours, would be entitled to sell, within any three-month period, a number of shares that is not more than the greater of:

    1% of the number of shares of our common stock then outstanding, which will equal approximately             shares immediately after this offering; or

    the average weekly trading volume of our common stock on the Nasdaq Global Market during the four calendar weeks before a notice of the sale on Form 144 is filed.

        Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and the availability of current public information about us.

Rule 144(k)

        In addition, under Rule 144(k), a person who is not one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years from the later of the date these shares of our common stock were acquired from us or from an affiliate of ours, including the holding period of any prior owner other than an affiliate, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless they are subject to other restrictions on their sale, those shares may be sold immediately upon the completion of this offering.

Rule 701

        In general, under Rule 701 of the Securities Act as currently in effect, any of our employees, consultants or advisors who purchases shares from us in connection with a compensatory stock or option plan or other written agreement is eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with the manner of sale provisions, notice requirements, current public information requirements, or volume limitations of Rule 144. Based upon the number of shares of our common stock outstanding as of                          , 2006, an aggregate of approximately             shares of our common stock are eligible to be sold pursuant to Rule 701, subject to the vesting provisions that may be contained in individual option agreements.

Stock Plans

        We intend to file a registration statement on Form S-8 under the Securities Act covering all shares of our common stock subject to options outstanding or reserved for issuance under our Amended and Restated 2000 Equity Incentive Plan. We expect to file this registration statement as soon as practicable after this offering. However, none of the shares registered on Form S-8 will be eligible for resale until the expiration of any 180-day lock-up agreements to which they are subject.

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MATERIAL UNITED STATES FEDERAL TAX
CONSIDERATIONS FOR NON-UNITED STATES HOLDERS

        The following is a general discussion of certain material U.S. federal income and estate tax considerations of the ownership and disposition of our common stock by a beneficial owner thereof that is a "Non-U.S. Holder." A "Non-U.S. Holder" is a person or entity that, for U.S. federal income tax purposes, is a non-resident alien individual, a foreign corporation or a foreign estate or trust. The test for whether an individual is a resident of the U.S. for federal estate tax purposes differs from the test used for federal income tax purposes. Some individuals, therefore, may be "Non-U.S. Holders" for purposes of the federal income tax discussion below, but not for purposes of the federal estate tax discussion, and vice versa.

        This discussion is based on the U.S. Internal Revenue Code of 1986, as amended, judicial decisions and administrative regulations and interpretations in effect as of the date of this prospectus, all of which are subject to change, including changes with retroactive effect. This discussion does not address all aspects of U.S. federal income and estate taxation that may be relevant to Non-U.S. Holders in light of their particular circumstances (including, without limitation, Non-U.S. Holders who are pass-through entities or who hold their common stock through pass-through entities) and does not address any tax consequences arising under the laws of any state, local or non-U.S. jurisdiction. Prospective holders should consult their own tax advisors with respect to the federal income and estate tax consequences of holding and disposing of our common stock in light of their particular situations and any consequences to them arising under the laws of any state, local or non-U.S. jurisdiction.

Dividends

        Subject to the discussion below, distributions, if any, made to a Non-U.S. Holder of our common stock out of our current or accumulated earnings and profits generally will constitute dividends for U.S. tax purposes and will be subject to withholding tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. To obtain a reduced rate of withholding under a treaty, a Non-U.S. Holder generally will be required to provide us with a properly-executed IRS Form W-8BEN certifying the Non-U.S. Holder's entitlement to benefits under that treaty. Treasury Regulations provide special rules to determine whether, for purposes of determining the applicability of a tax treaty, dividends paid to a Non-U.S. Holder that is an entity should be treated as paid to the entity or to those holding an interest in that entity. To the extent such distributions exceed our current and accumulated earnings and profits for U.S. tax purposes, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock.

        There will be no withholding tax on dividends paid to a Non-U.S. Holder that are effectively connected with the Non-U.S. Holder's conduct of a trade or business within the United States if a properly-executed IRS Form W-8ECI, stating that the dividends are so connected, is provided to us. Instead, the effectively connected dividends will be subject to regular U.S. income tax, generally in the same manner as if the Non-U.S. Holder were a U.S. citizen or resident alien or a domestic corporation, as the case may be, unless a specific treaty exemption applies. A corporate Non-U.S. Holder receiving effectively connected dividends may also be subject to an additional "branch profits tax," which is imposed, under certain circumstances, at a rate of 30% (or such lower rate as may be specified by an applicable treaty) of the corporate Non-U.S. Holder's effectively connected earnings and profits, subject to certain adjustments. If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the U.S. Internal Revenue Service.

76



Gain on Disposition of Common Stock

        A Non-U.S. Holder generally will not be subject to U.S. federal income tax with respect to gain realized on a sale or other disposition of our common stock unless:

    the gain is effectively connected with a trade or business of such holder in the United States and a specific treaty exemption does not apply to eliminate the tax;

    if a tax treaty would otherwise apply to eliminate the tax, the gain is attributable to a permanent establishment of the Non-U.S. Holder in the U.S.;

    in the case of Non-U.S. Holders who are nonresident alien individuals and hold our common stock as a capital asset, such individuals are present in the United States for 183 or more days in the taxable year of the disposition and certain other conditions are met;

    the Non-U.S. Holder is subject to tax pursuant to the provisions of the Code regarding the taxation of U.S. expatriates; or

    we are or have been a "United States real property holding corporation" within the meaning of Code Section 897(c)(2) at any time within the shorter of the five-year period preceding such disposition or such holder's holding period.

        We believe that we are not, and do not anticipate becoming, a United States real property holding corporation. Even if we are treated as a United States real property holding corporation, gain realized by a Non-U.S. Holder on a disposition of our common stock will not be subject to U.S. federal income tax so long as: (a) the Non-U.S. Holder owned directly or indirectly, no more than five percent of our common stock at all times within the shorter of (x) the five year period preceding the disposition or (y) the holder's holding period; and (b) our common stock is regularly traded on an established securities market. There can be no assurance that our common stock will continue to qualify as being regularly traded on an established securities market.

        If you are a Non-U.S. Holder described in (i) or (ii) above, you will be required to pay tax on the net gain derived from the sale at regular graduated U.S. federal income tax rates, and corporate Non-U.S. Holders described in (i) or (ii) above may be subject to the branch profits tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. If you are an individual Non-U.S. Holder described in (iii) above, you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by U.S. source capital losses (even though you are not considered a resident of the United States).

Information Reporting Requirements and Backup Withholding

        Generally, we must report to the U.S. Internal Revenue Service the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the holder. Pursuant to tax treaties or certain other agreements, the U.S. Internal Revenue Service may make its reports available to tax authorities in the recipient's country of residence.

        Backup withholding will generally not apply to payments of dividends made by us or our paying agents to a Non-U.S. Holder if the holder has provided its federal taxpayer identification number, if any, or the required certification that it is not a U.S. person (which is generally provided by furnishing a properly-executed IRS Form W-8BEN), unless the payor otherwise has knowledge or reason to know that the payee is a U.S. person.

        Under current U.S. federal income tax law, information reporting and backup withholding will apply to the proceeds of a disposition of our common stock effected by or through a U.S. office of a broker unless the disposing holder certifies as to its non-U.S. status or otherwise establishes an exemption. Generally, U.S. information reporting and backup withholding will not apply to a

77



payment of disposition proceeds where the transaction is effected outside the United States through a non-U.S. office of a non-U.S. broker. However, U.S. information reporting requirements (but not backup withholding) will apply to a payment of disposition proceeds where the transaction is effected outside the United States by or through an office outside the United States of a broker that fails to maintain documentary evidence that the holder is a Non-U.S. Holder and that certain conditions are met, or that the holder otherwise is entitled to an exemption, and the broker is:

    a U.S. person;

    a foreign person which derived 50% or more of its gross income for certain periods from the conduct of a trade or business in the United States;

    a "controlled foreign corporation" for U.S. federal income tax purposes; or

    a foreign partnership (a) at least 50% of the capital or profits interest in which is owned by U.S. persons, or (b) that is engaged in a U.S. trade or business.

        Backup withholding will apply to a payment of disposition proceeds if the broker has actual knowledge that the holder is a U.S. person.

        Backup withholding is not an additional tax. Rather, the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund may be obtained, provided that the required information is furnished to the U.S. Internal Revenue Service.

Federal Estate Tax

        The estates of nonresident alien individuals are subject to U.S. federal estate tax on property with a U.S. situs. Because we are a U.S. corporation, our common stock will be the U.S. situs property and therefore will be included in the taxable estate of a nonresident alien decedent. This U.S. federal estate tax liability of the estate of a nonresident alien may be affected by a tax treaty between the United States and the decedent's country of residence.

         THE PRECEDING DISCUSSION OF U.S. FEDERAL TAX CONSIDERATIONS IS FOR GENERAL INFORMATION ONLY. IT IS NOT TAX ADVICE. EACH PROSPECTIVE HOLDER SHOULD CONSULT HIS, HER OR ITS OWN TAX ADVISOR REGARDING THE PARTICULAR U.S. FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES OF PURCHASING, HOLDING AND DISPOSING OF OUR COMMON STOCK.

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UNDERWRITING

        Subject to the terms and conditions set forth in an underwriting agreement, each of the underwriters named below has severally agreed to purchase from us the aggregate number of shares of common stock set forth opposite their respective names below:

Underwriters

  Number of Shares
Thomas Weisel Partners LLC    
Needham & Company, LLC    
WR Hambrecht + Co., LLC    
  Total    

        The underwriting agreement provides that the obligations of the several underwriters are subject to various conditions, including approval of legal matters by counsel. The nature of the underwriters' obligations commits them to purchase and pay for all of the shares of common stock listed above if any are purchased.

        The underwriting agreement provides that we and the selling stockholders will indemnify the underwriters against liabilities specified in the underwriting agreement under the Securities Act, or will contribute to payments that the underwriters may be required to make relating to these liabilities.

        Thomas Weisel Partners LLC expects to deliver the shares of common stock to purchasers on or about                          , 2006.

Over-Allotment Option

        The selling stockholders have granted a 30-day over-allotment option to the underwriters to purchase up to a total of              additional shares of our common stock at the public offering price, less the underwriting discount, as set forth on the cover page of this prospectus. If the underwriters exercise this option in whole or in part, then each of the underwriters will be separately committed, subject to the conditions described in the underwriting agreement, to purchase the additional shares of our common stock from the selling stockholders in proportion to the underwriters' respective commitments set forth in the table above.

Determination of Offering Price

        Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined through negotiations between us and the representatives of the underwriters. In addition to prevailing market conditions, the factors to be considered in determining the initial public offering price will include:

    the valuation multiples of publicly traded companies that the representatives believe are comparable to us;

    our financial information;

    our history and prospects and the outlook for our industry;

    an assessment of our management, our past and present operations, and the prospects for, and timing of, our future net sales;

    the present state of our business and the progress of our operating plan; and

    the above factors in relation to market values and various valuation measures of other companies engaged in activities similar to ours.

79


        We cannot assure you that an active or orderly trading market will develop for our common stock or that our common stock will trade in the public markets subsequent to this offering at or above the initial offering price.

Commissions and Discounts

        The underwriters propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus, and at this price less a concession not in excess of $                        per share of common stock to other dealers specified in a master agreement among underwriters who are members of the National Association of Securities Dealers, Inc. The underwriters may allow, and the other dealers specified may reallow, concessions not in excess of $                        per share of common stock to these other dealers. After this offering, the offering price, concessions and other selling terms may be changed by the underwriters. Our common stock is offered subject to receipt and acceptance by the underwriters and to the other conditions, including the right to reject orders in whole or in part.

        The following table summarizes the compensation to be paid to the underwriters by us and the proceeds, before expenses, payable to us and the selling stockholders:

 
   
  Total
 
  Per Share
  Without
Over-Allotment

  With
Over-Allotment

Public offering price   $              $           $  
Underwriting discount                  
Proceeds, before expenses, to us                
Proceeds, before expenses, to the selling stockholders                

Indemnification of Underwriters

        We and the selling stockholders will indemnify the underwriters against some civil liabilities, including liabilities under the Securities Act and liabilities arising from breaches of our representations and warranties contained in the underwriting agreement. If we or the selling stockholders are unable to provide this indemnification, we and the selling stockholders will contribute to payments the underwriters may be required to make in respect of those liabilities.

No Sales of Similar Securities

        The underwriters will require all of our directors and officers and the selling stockholders to agree not to offer, sell, agree to sell, directly or indirectly, or otherwise dispose of any shares of common stock or any securities convertible into or exchangeable for shares of common stock except for the shares of common stock offered in this offering without the prior written consent of Thomas Weisel Partners LLC for a period of 180 days after the date of this prospectus. If (a) during the last 17 days of this 180-day period, we release earnings results or announce material news or a material event or (b) prior to the expiration of this 180-day period, we announce that we will release earnings results during the 15-day period following the last day of the 180-day period, then in either case the above restrictions will continue to apply until 18-days after the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Thomas Weisel Partners LLC waives, in writing, such extension.

        We have agreed that for a period of 180 days after the date of this prospectus, we will not, without the prior written consent of Thomas Weisel Partners LLC, offer, sell or otherwise dispose of any shares of common stock, except for the shares of common stock offered in this offering, the

80



shares of common stock issuable upon exercise of outstanding options on the date of this prospectus and the shares of our common stock that are issued under the Option Plans.

Nasdaq Global Market Listing

        After pricing of this offering, we expect that our common stock will be quoted on the Nasdaq Global Market under the symbol "NLST."

Short Sales, Stabilizing Transactions and Penalty Bids

        In order to facilitate this offering, persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of our common stock during and after this offering. Specifically, the underwriters may engage in the following activities in accordance with the rules of the Securities and Exchange Commission.

        Short sales.     Short sales involve the sales by the underwriters of a greater number of shares than they are required to purchase in the offering. Covered short sales are short sales made in an amount not greater than the underwriters' over-allotment option to purchase additional shares from the selling stockholders in this offering. The underwriters may close out any covered short position by either exercising their over-allotment option to purchase shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. Naked short sales are any short sales in excess of such over-allotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in this offering.

        Stabilizing transactions.     The underwriters may make bids for or purchases of the shares for the purpose of pegging, fixing or maintaining the price of the shares, so long as stabilizing bids do not exceed a specified maximum.

        Penalty bids.     If the underwriters purchase shares in the open market in a stabilizing transaction or syndicate covering transaction, they may reclaim a selling concession from the underwriters and selling group members who sold those shares as part of this offering. Stabilization and syndicate covering transactions may cause the price of the shares to be higher than it would be in the absence of these transactions. The imposition of a penalty bid might also have an effect on the price of the shares if it discourages presales of the shares.

        The transactions above may occur on the Nasdaq Global Market or otherwise. Neither we nor the underwriters make any representation or prediction as to the effect that the transactions described above may have on the price of the shares. If these transactions are commenced, they may be discontinued without notice at any time.


LEGAL MATTERS

        Bingham McCutchen LLP, Orange County, California, will pass upon the validity of the issuance of the shares of our common stock offered by this prospectus. Latham & Watkins LLP, Menlo Park, California, will pass upon certain legal matters for the underwriters in connection with this offering.

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EXPERTS

        The consolidated financial statements included in this prospectus, and the related financial statement schedule included elsewhere in the registration statement, of Netlist, Inc. and subsidiaries as of December 31, 2004 and for each of the two years in the period ended December 31, 2004, have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their reports appearing herein and elsewhere in the registration statement, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing.

        The consolidated financial statements included in this prospectus, and the related financial statement schedule included elsewhere in the registration statement, of Netlist, Inc. and subsidiaries as of December 31, 2005 and for the year then ended, included in this prospectus, have been audited by Corbin & Company, LLP, an independent registered public accounting firm, as stated in their report appearing herein, and elsewhere in the registration statement, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.


WHERE YOU CAN FIND ADDITIONAL INFORMATION

        We have filed with the Securities and Exchange Commission a registration statement on Form S-1, including exhibits, under the Securities Act with respect to the common stock to be sold in this offering. This prospectus, which constitutes a part of that registration statement, does not contain all of the information in that registration statement or the exhibits. Statements made in this prospectus regarding the contents of any contract, agreement or other document are only summaries. With respect to each contract, agreement or other document filed as an exhibit to the registration statement, we refer you to the exhibit for a more complete description of the matter involved. You may read and copy all or any portion of the registration statement or any reports, statements or other information filed with the Securities and Exchange Commission at the Securities and Exchange Commission's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.

        You can request copies of these documents upon payment of a duplicating fee by writing to the Securities and Exchange Commission. You may call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of its public reference room. Our filings, including the registration statement, will also be available to you on the web site maintained by the Securities and Exchange Commission at http://www.sec.gov.

        We intend to furnish our stockholders with annual reports containing consolidated financial statements audited by our independent auditors, and to make available to our stockholders quarterly reports for the first three quarters of each year containing unaudited interim consolidated financial statements.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
  Page
Report of Independent Registered Public Accounting Firm for the Fiscal Year Ended 2005   F-2
Report of Independent Registered Public Accounting Firm for the Fiscal Years Ended 2003 and 2004   F-3

Consolidated Financial Statements

 

 
Consolidated Balance Sheets as of December 31, 2004 and 2005, and as of June 30, 2006(1)   F-4
Consolidated Statements of Operations for the years ended December 31, 2003, 2004 and 2005, and for the six month periods ended June 30, 2005 and 2006(1)   F-5
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2004 and 2005, and for the six month period ended June 30, 2006(1)   F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005, and for the six month periods ended June 30, 2005 and 2006(1)   F-7
Notes to Consolidated Financial Statements   F-10

(1)
Balance sheet data as of June 30, 2006, consolidated statements of operations data for the six month periods ended June 30, 2005 and 2006, consolidated statements of stockholders' equity for the six month period ended June 30, 2006, and consolidated statements of cash flows for the six month periods ended June 30, 2005 and 2006, are each unaudited.

F-1



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Netlist, Inc.

        We have audited the accompanying consolidated balance sheet of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2005, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

        We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit on its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Netlist, Inc. and subsidiaries as of December 31, 2005, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

/s/   CORBIN & COMPANY, LLP     
Irvine, California
May 11, 2006
   

F-2



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Netlist, Inc.

        We have audited the accompanying consolidated balance sheet of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2004, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

        We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Netlist, Inc. as of December 31, 2004, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.

/s/   DELOITTE & TOUCHE LLP      
Costa Mesa, California
March 1, 2006

F-3



NETLIST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except per share amounts)

 
  December 31,
   
 
 
  June 30,
2006

 
 
  2004
  2005
 
 
   
   
  (unaudited)

 
ASSETS                    
Current assets:                    
  Cash and cash equivalents   $ 759   $ 953   $ 27  
  Accounts receivable, net of allowance for sales returns and doubtful accounts of $232 (2004), $109 (2005) and $432 (2006) (unaudited), respectively     8,813     13,140     20,274  
  Inventories     7,342     6,816     9,420  
  Income taxes receivable     493     259      
  Deferred taxes     729     902     1,551  
  Prepaid expenses and other current assets     295     434     225  
   
 
 
 
    Total current assets     18,431     22,504     31,497  
Property and equipment, net     3,372     2,437     2,229  
Deferred taxes     250     759     654  
Other assets     57     142     136  
   
 
 
 
    Total assets   $ 22,110   $ 25,842   $ 34,516  
   
 
 
 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

 
Current liabilities:                    
  Accounts payable   $ 5,724   $ 6,645   $ 11,243  
  Revolving line of credit     5,443     9,463     10,714  
  Current portion of long-term debt     370     720     590  
  Current portion of deferred gain on sale and leaseback transaction         116     116  
  Current portion of convertible notes payable, net of debt discount of $50 as of June 30, 2006         1,000     2,200  
  Income taxes payable             894  
  Accrued expenses and other current liabilities     1,746     1,841     2,448  
   
 
 
 
    Total current liabilities     13,283     19,785     28,205  
   
 
 
 
Long-term debt, net of current portion     1,816     988     735  
Deferred gain on sale and leaseback transaction, net of current portion         464     405  
Convertible notes payable, net of current portion     1,750     1,750     500  
   
 
 
 
    Total liabilities     16,849     22,987     29,845  
   
 
 
 
Commitments and contingencies (Note 9)                    
Stockholders' equity:                    
  Series A convertible preferred stock, $2.00 par value—1,000 shares authorized, issued and outstanding (liquidation preference of $2,000)     2,000     2,000     2,000  
  Common stock, $0.001 par value—16,000 shares authorized; 10,672 (2004), 10,673 (2005) 11,223 (2006) (unaudited) shares issued and outstanding     11     11     11  
  Additional paid-in capital     23,325     22,604     22,777  
  Note receivable from stockholder     (22 )   (23 )   (23 )
  Deferred stock-based compensation     (1,000 )   (337 )    
  Accumulated deficit     (19,053 )   (21,400 )   (20,094 )
   
 
 
 
    Total stockholders' equity     5,261     2,855     4,671  
   
 
 
 
    Total liabilities and stockholders' equity   $ 22,110   $ 25,842   $ 34,516  
   
 
 
 

See accompanying notes to consolidated financial statements.

F-4



NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(in thousands, except per share amounts)

 
  Years Ended December 31,
  Six Months
Ended June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 

Net sales

 

$

100,375

 

$

143,659

 

$

79,856

 

$

36,495

 

$

65,934

 

Cost of sales(1)

 

 

86,107

 

 

133,503

 

 

73,892

 

 

34,319

 

 

57,447

 
   
 
 
 
 
 

Gross profit

 

 

14,268

 

 

10,156

 

 

5,964

 

 

2,176

 

 

8,487

 
   
 
 
 
 
 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Research and development(1)     11,759     3,770     2,961     1,876     1,514  
  Selling, general and administrative(1)     15,218     6,314     5,062     2,300     3,911  
   
 
 
 
 
 
   
Total operating expenses

 

 

26,977

 

 

10,084

 

 

8,023

 

 

4,176

 

 

5,425

 
   
 
 
 
 
 

Operating income (loss)

 

 

(12,709

)

 

72

 

 

(2,059

)

 

(2,000

)

 

3,062

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Interest expense     (772 )   (1,071 )   (1,221 )   (491 )   (949 )
  Other income (expense), net     (107 )   (315 )   21     8     5  
   
 
 
 
 
 
   
Total other expense, net

 

 

(879

)

 

(1,386

)

 

(1,200

)

 

(483

)

 

(944

)
   
 
 
 
 
 

Income (loss) before provision (benefit) for income taxes

 

 

(13,588

)

 

(1,314

)

 

(3,259

)

 

(2,483

)

 

2,118

 

Provision (benefit) for income taxes

 

 

2,317

 

 

(340

)

 

(912

)

 

(695

)

 

812

 
   
 
 
 
 
 

Net income (loss)

 

$

(15,905

)

$

(974

)

$

(2,347

)

$

(1,788

)

$

1,306

 
   
 
 
 
 
 
Net income (loss) per common share:                                
  Basic   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.12  
  Diluted   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.09  
Weighted-average common shares outstanding:                                
  Basic     9,831     10,671     10,673     10,672     10,988  
  Diluted     9,831     10,671     10,673     10,672     15,427  

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

  Cost of sales   $ 69   $ 29   $ 56   $ (9 ) $ 14
  Research and development     9,733     80     (52 )   (22 )   22
  Selling, general and administrative     10,872     141     (65 )   (17 )   111

See accompanying notes to consolidated financial statements.

F-5



NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

(in thousands)

 
  Series A Preferred Stock
   
   
   
   
   
   
   
 
 
  Common Stock
   
   
   
   
   
 
 
  Additional Paid-in Capital
  Notes Receivable From Stockholders
  Deferred Stock-Based Compensation
  Accumulated Deficit
  Net Stockholders' Equity
 
 
  Shares
  Amount
  Shares
  Amount
 
Balance, January 1, 2003   1,000   $ 2,000   10,550   $ 11   $ 1,648   $ (460 ) $ (271 ) $ (2,174 ) $ 754  
  Issuance of stock options and warrants to nonemployees                 1,037         (1,037 )        
  Issuance of stock options to employees                 2,931         (2,931 )        
  Restricted stock deferred compensation                 19,020         (19,020 )        
  Amortization of deferred stock-based compensation                         20,674         20,674  
  Exercise of stock options         100         20     (20 )            
  Interest from stockholder notes receivable                     (34 )           (34 )
  Forgiveness of stockholder notes receivable                     492             492  
  Net loss                             (15,905 )   (15,905 )
   
 
 
 
 
 
 
 
 
 
Balance, December 31, 2003   1,000     2,000   10,650     11     24,656     (22 )   (2,585 )   (18,079 )   5,981  
  Forfeiture of stock options and warrants                 (1,335 )       943         (392 )
  Amortization of deferred stock-based compensation                         642         642  
  Exercise of stock options         22         4                 4  
  Interest from stockholder notes receivable                     (1 )           (1 )
  Payment of interest on stockholder note receivable                     1             1  
  Net loss                             (974 )   (974 )
   
 
 
 
 
 
 
 
 
 
Balance, December 31, 2004   1,000     2,000   10,672     11     23,325     (22 )   (1,000 )   (19,053 )   5,261  
  Issuance of stock options to nonemployees                 6         (6 )        
  Forfeiture of stock options and warrants                 (730 )       454         (276 )
  Amortization of deferred stock-based compensation                         215         215  
  Exercise of stock options         1         3                 3  
  Interest from stockholder note receivable                     (1 )           (1 )
  Net loss                             (2,347 )   (2,347 )
   
 
 
 
 
 
 
 
 
 
Balance, December 31, 2005   1,000     2,000   10,673     11     22,604     (23 )   (337 )   (21,400 )   2,855  
  Reclassification of deferred stock-based compensation upon adoption of SFAS No. 123(R) (unaudited)                 (337 )       337          
  Estimated relative fair value of beneficial conversion feature on convertible note payable (unaudited)                 50                 50  
  Stock-based compensation (unaudited)                 147                 147  
  Exercise of warrants (unaudited)         550         110                 110  
  Tax benefit from exercise of warrants (unaudited)                 203                 203  
  Net income (unaudited)                             1,306     1,306  
   
 
 
 
 
 
 
 
 
 
Balance, June 30, 2006 (unaudited)   1,000   $ 2,000   11,223   $ 11   $ 22,777   $ (23 ) $   $ (20,094 ) $ 4,671  
   
 
 
 
 
 
 
 
 
 

See accompanying notes to consolidated financial statements.

F-6



NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)

 
  Years Ended December 31,
  Six Months
Ended June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 
Cash flows from operating activities:                                
  Net income (loss)   $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,306  
  Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:                                
    Depreciation and amortization     584     867     1,031     473     484  
    Amortization of deferred gain on sale and leaseback transaction                     (59 )
    Deferred income taxes     (345 )   218     (682 )   (164 )   (544 )
    Loss (gain) on disposal of assets     33     43     (11 )       15  
    Stock-based compensation     20,674     250     (61 )   (48 )   147  
    Interest on notes receivable from stockholders     (34 )       (1 )        
    Forgiveness of notes receivable from stockholders     492                  
    Changes in operating assets and liabilities:                                
      Accounts receivable     (2,209 )   (3,570 )   (4,327 )   1,574     (7,134 )
      Inventories     (7,973 )   2,704     526     804     (2,604 )
      Income taxes receivable         (493 )   234     (533 )   259  
      Prepaid expenses and other current assets     18     (116 )   99     (105 )   209  
      Other assets     (38 )   (7 )   (85 )   (97 )   6  
      Accounts payable     4,436     (3,032 )   921     566     4,598  
      Income taxes payable     2,627     (2,634 )           894  
      Accrued expenses and other current liabilities     1,299     177     95     (116 )   607  
   
 
 
 
 
 

Net cash provided by (used in) operating activities

 

 

3,659

 

 

(6,567

)

 

(4,608

)

 

566

 

 

(1,816

)
   
 
 
 
 
 

F-7


 
  Years Ended December 31,
  Six Months
Ended June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 
Cash flows from investing activities:                                
  Acquisition of property and equipment     (2,019 )   (557 )   (484 )   (325 )   (336 )
  Proceeds from sale of equipment         61     19         45  
  Restricted cash     504                  
  Proceeds from sale and leaseback of facility             1,797          
   
 
 
 
 
 
 
Net cash provided by (used in) investing activities

 

 

(1,515

)

 

(496

)

 

1,332

 

 

(325

)

 

(291

)
   
 
 
 
 
 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Borrowings on lines of credit     2,925     146,488     82,015     37,929     60,567  
  Payments on lines of credit     (3,692 )   (141,045 )   (77,995 )   (38,724 )   (59,316 )
  Borrowings from debt     300     820              
  Payments on debt     (361 )   (348 )   (1,553 )   (184 )   (383 )
  Proceeds from convertible notes payable     500         1,000          
  Proceeds from exercise of stock options and warrants             3         110  
  Tax benefit from exercise of warrants                     203  
   
 
 
 
 
 
 
Net cash provided by (used in) financing activities

 

 

(328

)

 

5,915

 

 

3,470

 

 

(979

)

 

1,181

 
   
 
 
 
 
 

Net increase (decrease) in cash and cash equivalents

 

 

1,816

 

 

(1,148

)

 

194

 

 

(738

)

 

(926

)

Cash and cash equivalents, beginning of period

 

 

91

 

 

1,907

 

 

759

 

 

759

 

 

953

 
   
 
 
 
 
 

Cash and cash equivalents, end of period

 

$

1,907

 

$

759

 

$

953

 

$

21

 

$

27

 
   
 
 
 
 
 

F-8


 
  Years Ended December 31,
  Six Months
Ended June 30,

 
  2003
  2004
  2005
  2005
  2006
 
   
   
   
  (unaudited)

Supplemental disclosure of cash flow information:                              
  Cash paid during the period for:                              
    Interest   $ 794   $ 1,061   $ 1,169   $ 523   $ 897
   
 
 
 
 
    Income taxes   $ 34   $ 3,400   $ 2   $   $
   
 
 
 
 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Purchase of equipment through capitalized lease obligations   $ 182   $ 184   $ 837   $ 837   $
   
 
 
 
 
  Purchase of insurance policies through notes payable   $   $   $ 238   $   $
   
 
 
 
 
  Deferred gain on sale and leaseback of facility   $   $   $ 580   $   $
   
 
 
 
 
  Estimated relative fair value of beneficial conversion feature on convertible note payable   $   $   $   $   $ 50
   
 
 
 
 

See accompanying notes to consolidated financial statements.

F-9



NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—DESCRIPTION OF BUSINESS

Description of Business

        Netlist, Inc. (the "Company") was incorporated on June 12, 2000 in Delaware. Netlist designs and manufactures high performance memory subsystems for the server, high performance computing and communications markets. The Company's solutions are targeted at applications where memory plays a key role in meeting system performance requirements.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

        The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Principles of Consolidation

        The consolidated financial statements include the accounts of Netlist, Inc. and its wholly owned subsidiaries, Netlist Holdings, GP, Inc., Netlist Holdings, LP, Inc., Netlist Technology Texas LP, and Netlist International. All intercompany balances and transactions have been eliminated in consolidation.

Interim Financial Information

        The interim financial information as of June 30, 2006 and for the six months ended June 30, 2006 and 2005 is unaudited and has been prepared on the same basis as the audited financial statements. In the opinion of management, such unaudited information includes all adjustments consisting only of normal recurring adjustments necessary for a fair presentation of the interim information. Operating results for the six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. All references to June 30, 2006 or to the six months ended June 30, 2005 and 2006 in the notes to the financial statements are unaudited.

Fiscal Year

        Effective January 1, 2003, the Company changed its fiscal year from a calendar year to a 52/53-week fiscal year ending on the Saturday closest to December 31. The 2003, 2004 and 2005 fiscal years ended on December 27, 2003, January 1, 2005 and December 31, 2005, respectively, and consisted of 52 weeks. For simplicity of presentation, the accompanying consolidated financial statements have been shown as ending on the last day of the calendar month.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management include, among others, provisions for uncollectible receivables and sales returns, valuation of inventories,

F-10



recoverability of long-lived assets and realization of deferred tax assets. Actual results could differ from these estimates.

Cash and Cash Equivalents

        Cash and cash equivalents consist of cash on hand and highly liquid investments purchased with original maturities of three months or less.

Fair Value of Financial Instruments

        The fair values of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate carrying values due to their short maturities. The fair value of the Company's debt instruments approximates their carrying values based on rates currently available to the Company.

Concentration of Credit Risk

        Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. The Company invests primarily in money market funds and high quality commercial paper instruments. Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. The Company's trade accounts receivable are primarily derived from sales to original equipment manufacturers ("OEMs") in the computer industry. The Company performs credit evaluations of its customers' financial condition and limits the amount of credit extended when deemed necessary but generally requires no collateral. The Company believes that the concentration of credit risk in its trade receivables is moderated by the Company's credit evaluation process, relatively short collection terms and the high level of credit worthiness of its customers.

Inventories

        Inventories are valued at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. At each balance sheet date, the Company evaluates its ending inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product type. Among other factors, the Company considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.

Property and Equipment

        Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which generally range from three to 40 years. Leasehold improvements are recorded at cost and amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term.

F-11



Impairment of Long-Lived Assets

        The Company evaluates long-lived assets held and used by the Company for impairment on an annual basis or whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. At December 31, 2005 and June 30, 2006 (unaudited), the Company's management believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company's products will continue, which could result in future impairment of long-lived assets.

Revenue Recognition

        The Company's revenues primarily consist of product sales of high performance memory subsystems to OEMs. Revenues also include sales of excess inventories to distributors and other users of memory ICs totaling approximately $20,412,000, $28,016,000, $19,127,000 during the years ended December 31, 2003, 2004 and 2005, respectively, and approximately $8,212,000 (unaudited) and $7,374,000 (unaudited) during the six months ended June 30, 2005 and 2006, respectively.

        The Company recognizes revenues in accordance with the Securities and Exchange Commission's Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition . Under the provisions of SAB No. 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Such conditions are typically met upon shipment and transfer of title for customers with FOB Shipping Point terms and upon receipt for customers with FOB Destination terms. Most of the Company's international shipments are made to third-party inventory warehouses, or hubs, and the Company recognizes revenue when the inventory is pulled from the hub for use in production by the customer. Customers are generally allowed limited rights of return for up to 30 days. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve.

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

Warranties

        The Company offers warranties generally ranging from one to three years, depending on the product and negotiated terms of purchase agreements with its customers. Such warranties require the Company to repair or replace defective product returned to the Company during such warranty period at no cost to the customer. An estimate by the Company for warranty related costs is recorded by the Company at the time of sale based on its historical and estimated product return rates and expected repair or replacement costs. Such costs have historically been insignificant.

F-12



Beneficial Conversion Feature

        The convertible feature of one of the Company's convertible notes provides for a rate of conversion that is below market value (see Note 7). Such feature is normally characterized as a "beneficial conversion feature" ("BCF"). Pursuant to Emerging Issues Task Force ("EITF") Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratio and EITF No. 00-27 Application of EITF Issue No. 98-5 to Certain Convertible Instruments , the estimated relative fair value of the BCF has been recorded as a discount from the face amount of the convertible note. The Company is amortizing the discount using the effective interest method through maturity of such instrument.

Stock-Based Compensation

        The Company accounts for equity issuances to non-employees in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation , and EITF No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services . All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the third-party performance is complete or the date on which it is probable that performance will occur.

        Prior to January 1, 2006, the Company accounted for stock-based compensation issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees , and related pronouncements (see Note 12). Under this method, compensation expense was recognized over the respective vesting period based on the excess, on the date of grant, of the estimated fair value of the Company's common stock over the grant price, net of forfeitures. Deferred stock-based compensation expense was amortized on a straight-line basis over the vesting period of each grant. During the years ended December 31, 2003, 2004 and 2005, stock-based compensation expense, net of forfeitures, was approximately $20,674,000, $250,000 and $(61,000), respectively.

        Under SFAS No. 123, entities were required to recognize as expense over the vesting period the fair value of all stock-based awards on the date of the grant. Alternatively, SFAS No. 123 allowed entities to continue to apply the provisions of APB No. 25 and provide pro forma net income (loss) disclosures for employee stock option grants as if the fair value based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of APB No. 25 and provide pro forma disclosures required by SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure .

        Had compensation cost for the Company's stock-based awards to employees been determined based on the estimated fair value at the grant dates consistent with the fair value method of SFAS No. 123, the Company's net income (loss) for the years ended December 31, 2003, 2004 and 2005,

F-13



and the six months ended June 30, 2005 would have approximated the pro forma amounts indicated below (in thousands, except per share amounts):

 
  Years Ended December 31,
   
 
 
  Six Months Ended June 30,
2005

 
 
  2003
  2004
  2005
 
 
   
   
   
  (unaudited)

 

Net loss, as reported

 

$

(15,905

)

$

(974

)

$

(2,347

)

$

(1,788

)
Plus: stock-based employee compensation expense included in reported net loss, net of tax     20,115     185     (44 )   175  
Less: stock-based employee compensation expense determined under fair value based method, net of tax     (1,000 )   (470 )   354     (123 )
   
 
 
 
 
Pro forma net income (loss)   $ 3,210   $ (1,259 ) $ (2,037 ) $ (1,736 )
   
 
 
 
 
Net income (loss) per common share as reported:                          
  Basic   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 )
   
 
 
 
 
  Diluted   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 )
   
 
 
 
 
Pro forma:                          
  Basic   $ 0.33   $ (0.12 ) $ (0.19 ) $ (0.16 )
   
 
 
 
 
  Diluted   $ 0.22   $ (0.12 ) $ (0.19 ) $ (0.16 )
   
 
 
 
 

        The fair value of options granted under the Company's equity incentive plan during the years ended December 31, 2003 and 2005, and the six months ended June 30, 2005 was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the single option approach using the following weighted-average assumptions:

 
  Years Ended December 31,
   
 
  Six Months Ended June 30,
2005

 
  2003
  2004
  2005
 
   
   
   
  (unaudited)


Weighted-average risk-free rate

 

2.73%

 

n/a

 

4.13%

 

4.13%
Expected term   10 years   n/a   10 years   10 years
Expected stock volatility   80%   n/a   24%   24%
Dividend yield     n/a    

        There were no options granted during 2004.

        Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payment , which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to

F-14



recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. SFAS No. 123(R) supersedes the Company's previous accounting under APB No. 25 for periods beginning in fiscal 2006. In March 2005, the SEC issued SAB No. 107, Share-Based Payment , relating to SFAS No. 123(R). The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).

        The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company's fiscal year 2006. The Company's consolidated financial statements as of and for the six months ended June 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, the Company's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).

        SFAS No. 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company's consolidated statement of operations. Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 as allowed under SFAS No. 123. Under this method, stock-based compensation expense had been recognized in the Company's consolidated statements of operations for option grants to employees and consultants below the fair market value of the underlying stock at the date of grant.

        Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company's consolidated statement of operations for the six months ended June 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As stock-based compensation expense recognized in the consolidated statement of operations for the six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the six months ended June 30, 2006 of approximately 8% was based on historical forfeiture experience and estimated future employee forfeitures. The estimated term of option grants for the six months ended June 30, 2006 was six years. In the Company's pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

        Pursuant to SFAS No. 123(R), deferred stock-based compensation expense with a balance of $337,000 at December 31, 2005 was eliminated against additional paid-in capital upon the adoption of SFAS No. 123(R) on January 1, 2006. The deferred stock-based compensation expense was primarily related to stock awards granted to various employees and directors prior to the adoption of SFAS No. 123(R).

F-15



        The fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model. The Black-Scholes model requires subjective assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility for the six months ended June 30, 2006 is based on the historical volatilities of the common stock of comparable publicly traded companies. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.

 
  Six Months Ended
June 30, 2006

 
 
  (unaudited)

 
Expected term   6 years  
Expected volatility   40 %
Risk-free interest rate   4.50-5.00 %
Expected dividends    

        A summary of option activity as of June 30, 2006 and changes during the six months then ended, is presented below (dollars and shares in thousands, except per share data):

 
  Shares
  Weighted-
Average
Exercise
Price

  Weighted-
Average
Remaining
Contractual
Term
(Years)

  Aggregate
Intrinsic
Value

Options outstanding at January 1, 2006   2,190   $ 1.26          
Options granted (unaudited)   258   $ 2.55          
Options exercised (unaudited)     $          
Options forfeited (unaudited)   (193 ) $ 1.82          
   
 
         
Options outstanding at June 30, 2006 (unaudited)   2,255   $ 1.35   7.26   $ 12,641
   
 
 
 
Options exercisable at June 30, 2006 (unaudited)   1,310   $ 0.77   4.15   $ 8,107
   
 
 
 

        The weighted-average grant date fair value of options granted during the six months ended June 30, 2006 was $1.61 (unaudited) per option. The total intrinsic value of options exercised during the six months ended June 30, 2006 was zero (unaudited) as no options were exercised during the period.

F-16



        A summary of the status of the Company's non-vested stock options as of June 30, 2006 and changes during the six months then ended is presented below (shares in thousands):

 
  Shares
  Weighted-
Average Grant
Date Fair Value
Per Share

Non-vested stock options at January 1, 2006   932   $ 1.04
Non-vested stock options granted (unaudited)   258   $ 1.61
Vested stock options (unaudited)   (118 ) $ 1.08
Forfeited/cancelled stock options (unaudited)   (127 ) $ 2.63
   
 
Non-vested stock options at June 30, 2006 (unaudited)   945   $ 1.03
   
 

        As of June 30, 2006, there was approximately $743,000 (unaudited) of total unrecognized compensation cost, net of estimated expected forfeitures, related to employee and director stock option compensation arrangements. That cost is expected to be recognized on a straight-line basis over the next 4 years. The total fair value of shares vested during the six months ended June 30, 2006 was approximately $138,000 (unaudited).

        As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company's income before provision for income taxes and net income for the six months ended June 30, 2006 were approximately $88,000 (unaudited) lower than if it had continued to account for share-based compensation under APB No. 25. Basic net income per share for the six months ended June 30, 2006 was approximately $0.01 (unaudited) lower than if the Company had continued to account for share-based compensation under APB No. 25. Diluted net income per share for the six months ended June 30, 2006 was not affected by the adoption of SFAS No. 123(R).

        The following table summarizes stock-based compensation expense related to employee and director stock options under SFAS No. 123(R) for the six months ended June 30, 2006, which was allocated as follows (in thousands):

 
  Six Months Ended
June 30, 2006

 
  (unaudited)

Stock-based compensation expense included in:      
  Cost of sales   $ 14
  Research and development     22
  Selling, general and administrative     102

Income Taxes

        The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes . Under SFAS No. 109, deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at currently effective tax rates, of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the consolidated financial statements. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized.

F-17



Comprehensive Income (Loss)

        Comprehensive income (loss) includes all changes in stockholders' equity during a period from non-owner sources. For the years ended December 31, 2003, 2004, and 2005 and for the six months ended June 30, 2005 (unaudited) and 2006 (unaudited) there were no differences between the Company's net income (loss) and its comprehensive income (loss).

Net Income (Loss) Per Share

        Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average shares outstanding during the period. Diluted net income per share is calculated by dividing the net income (loss) by the weighted-average shares and dilutive potential shares outstanding during the period. Dilutive potential shares consist of dilutive shares issuable upon the exercise of outstanding stock options computed using the treasury stock method and shares issuable upon the conversion of notes payable using the "if converted" method. All potentially dilutive shares of approximately 5,071,000, 4,001,000, 3,632,000 and 3,449,000 (unaudited) during the years ended December 31, 2003, 2004 and 2005, and the six months ended June 30, 2005, respectively, have been excluded from diluted loss per share as their effect would be anti-dilutive for the periods then ended. Potentially dilutive shares of approximately 4,439,000 (unaudited) for the six months ended June 30, 2006 have been included in the diluted net income per share computation for the period then ended.

F-18



        The following table sets forth for all periods presented the computation of basic and diluted net income (loss) per share, including the reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per share (in thousands, except per share data):

 
  Years Ended December 31,
  Six Months Ended June 30,
 
  2003
  2004
  2005
  2005
  2006
 
   
   
   
  (unaudited)

Basic income (loss) per share:                              
  Net income (loss)   $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,306
   
 
 
 
 
  Weighted-average common shares outstanding, basic     9,831     10,671     10,673     10,672     10,988
   
 
 
 
 
  Basic income (loss) per share   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.12
   
 
 
 
 
Diluted income (loss) per share:                              
  Net income (loss)   $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,306
  Convertible notes interest expense (net of tax)                     141
   
 
 
 
 
  Adjusted net income (loss) available to common stockholders   $ (15,905 ) $ (974 ) $ (2,347 ) $ (1,788 ) $ 1,447
   
 
 
 
 
Weighted-average common shares outstanding, basic     9,831     10,671     10,673     10,672     10,988
  Effect of dilutive securities:                              
    Stock options and warrants                     1,968
    Convertible preferred stock                     1,000
    Convertible notes payable                     1,471
   
 
 
 
 
  Weighted-average common shares outstanding, diluted     9,831     10,671     10,673     10,672     15,427
   
 
 
 
 
  Diluted net income (loss) per share   $ (1.62 ) $ (0.09 ) $ (0.22 ) $ (0.17 ) $ 0.09
   
 
 
 
 

New Accounting Pronouncements

        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 . SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 did not have a significant impact on the Company's consolidated financial condition or results of operations.

F-19


        In December 2004, the FASB issued SFAS No. 123(R). This statement requires companies to measure the cost of all employee stock-based compensation awards using a fair value method and to record such expense in its financial statements. The adoption of SFAS No. 123(R) also requires additional accounting and disclosures relating to the income tax and cash flow effects resulting from share-based payment arrangements. The Company adopted the provisions of SFAS No. 123(R) on January 1, 2006 using the modified prospective method. The impact of the adoption of SFAS No. 123(R) is described above.

        In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that the Company recognize in the financial statements the impact of tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The adoption of this statement is not expected to have a material impact on the Company's consolidated financial position or results of operations.

NOTE 3—INVENTORIES

        Inventories consist of the following (in thousands):

 
  December 31,
   
 
  June 30,
2006

 
  2004
  2005
 
   
   
  (unaudited)

Raw materials   $ 4,115   $ 2,551   $ 4,231
Work in process     1,345     1,027     1,771
Finished goods     1,882     3,238     3,418
   
 
 
    $ 7,342   $ 6,816   $ 9,420
   
 
 

F-20


NOTE 4—PROPERTY AND EQUIPMENT

        Property and equipment consist of the following (dollars in thousands):

 
   
  December 31,
   
 
 
  Estimated Useful Lives
  June 30,
2006

 
 
  2004
  2005
 
 
   
   
   
  (unaudited)

 
Machinery and equipment   3-7 yrs.   $ 2,608   $ 3,595   $ 3,529  
Land       600          
Buildings and improvements   40 yrs.     715          
Furniture and fixtures   5 yrs.     203     205     205  
Computer equipment and software   3-7 yrs.     944     1,241     1,400  
       
 
 
 
          5,070     5,041     5,134  
Less accumulated depreciation and amortization         (1,698 )   (2,604 )   (2,905 )
       
 
 
 
        $ 3,372   $ 2,437   $ 2,229  
       
 
 
 

        Included in property and equipment are assets under capital leases with a cost of $1,764,000, $2,618,000 and $2,486,000 (unaudited) and accumulated amortization of $508,000, $896,000 and $1,046,000 (unaudited) at December 31, 2004 and 2005 and June 30, 2006, respectively.

NOTE 5—CREDIT AGREEMENT

        The Company has entered into an agreement (the "Credit Agreement"), as amended, with a bank which provides for a line of credit facility. As of December 31, 2005 and June 30, 2006, maximum borrowings were $15,000,000, limited to the sum of 85% of eligible accounts receivable, plus 31% of eligible inventories. Any borrowings are collateralized by a general first priority lien against all Company assets, both tangible and intangible, and the personal guarantees of three senior Company executives. Interest is payable monthly at the prime rate plus 0.50% in 2004 (5.75% at December 31, 2004) and in 2005 and 2006 at the prime rate plus 4.75% for eligible foreign accounts (12.00% and 13.00% at December 31, 2005 and June 30, 2006, respectively) and for all other advances at the prime rate plus 3.50% (10.75% and 11.75% at December 31, 2005 and June 30, 2006, respectively). Outstanding borrowings on this line of credit at December 31, 2004 and 2005 and June 30, 2006 were $5,443,000, $9,463,000 and $10,714,000 (unaudited), respectively. Borrowing availability under the line of credit was approximately $2,400,000 and $2,800,000 (unaudited) at December 31, 2005 and June 30, 2006, respectively.

        The Credit Agreement, as amended, contains certain restrictions and covenants. Under these restrictions and covenants, the Company must maintain certain levels of tangible net worth, achieve minimum monthly and quarterly profitability, and limit capital expenditures. The Company was not in compliance with certain covenants at December 31, 2005. Effective April 18, 2006, the Company executed the Fourth Amendment to Amended and Restated Credit and Security Agreement and Waiver of Defaults (the "Fourth Amendment"). The Fourth Amendment provides for, among other things, a waiver of noncompliance as of the dates above and added an additional requirement for the Company to consummate a private equity offering not later than March 31, 2007, with minimum net proceeds of $4,000,000. As of June 30, 2006, the Company was in compliance with all covenants.

F-21



        Subsequent to June 30, 2006, the Company further amended the Credit Agreement (see Note 16).

NOTE 6—LONG-TERM DEBT

        Long-term debt consists of the following (in thousands):

 
  December 31,
   
 
 
  June 30,
2006

 
 
  2004
  2005
 
 
   
   
  (unaudited)

 
Obligations under capital leases (see Note 9)   $ 895   $ 1,285   $ 1,069  
Mortgage note payable to bank     965          
Notes payable to others     326     423     256  
   
 
 
 
      2,186     1,708     1,325  
Less current portion     (370 )   (720 )   (590 )
   
 
 
 
    $ 1,816   $ 988   $ 735  
   
 
 
 

Mortgage Note Payable

        In November 2000, the Company obtained an SBA-backed 25-year mortgage note payable collateralized by its manufacturing facility in Irvine, California. This note bore interest at the prime rate plus 1.0% (6.25% at December 31, 2004), with principal and interest payments due monthly through 2025. In December 2005, the mortgage was paid in full in connection with the sale and leaseback transaction of the manufacturing facility (see Note 9).

Notes Payable to Others

        In November 2002, the Company entered into a $100,000 unsecured loan agreement with an individual, bearing interest at 7% payable annually, principal due, as amended, in June 2006. In January 2004, $4,000 of the principal amount was used to exercise certain stock options. The balance of this note was $96,000 at December 31, 2004 and 2005, and June 30, 2006. The note is currently due on demand.

        In January 2003, the Company entered into a $300,000 loan agreement with a financing company, collateralized by assets owned by an employee related to the majority stockholder. This note bears interest at 14% per annum and matures in January 2009. Principal and interest payments of approximately $6,000 are due and payable monthly. The balance of this note was $230,000, $185,000 and $160,000 (unaudited) at December 31, 2004 and 2005, and June 30, 2006, respectively.

        In August 2005, the Company entered into an agreement with a financing company in connection with financing certain insurance policies. The financing agreement required monthly principal and interest payments of approximately $25,000 through maturity on June 30, 2006. Interest was payable at 8.55% per annum. The outstanding principal balance on this financing was $142,000 at December 31, 2005. During the six months ended June 30, 2006, the balance was repaid in full (unaudited).

F-22



Capital Leases

        The Company has purchased manufacturing and computer equipment through the use of various capital leases. These leases require aggregate monthly payments of $49,360 and mature at various dates through May 2010. The interest rates on these leases vary between 4.3% and 10.4% (see Note 9).

        As of December 31, 2005, maturities of long-term debt were as follows (in thousands):

Years Ending
December 31,

   
2006   $ 720
2007     522
2008     350
2009     91
2010     25
   
    $ 1,708
   

        Interest expense related to long-term debt was $156,000, $177,000, $250,000, $114,000 (unaudited) and $89,000 (unaudited) for the years ended December 31, 2003, 2004 and 2005 and for the six months ended June 30, 2005 and 2006, respectively.

NOTE 7—CONVERTIBLE NOTES PAYABLE

        In April 2001, the Company issued two convertible promissory notes, each in the original principal amount of $625,000, to Serim Paper Manufacturing Co., Ltd. ("Serim Paper") and HeungHwa Industries Co., Ltd. ("HeungHwa"), bearing interest at 7.50% per annum (collectively, the "$625,000 Notes"). In February 2003, the Company issued an additional $500,000 convertible note to Serim Paper, bearing interest at 6.50% per annum (the "$500,000 Note"). The $625,000 Notes and the $500,000 Note are guaranteed by the Company's majority stockholder and were originally convertible, at the option of the holder, into shares of a new series of preferred stock at a price equal to the lower of $2.50 per share or the per share fair market value of the new preferred stock. In the event of a public offering of the Company's common stock at a price in excess of the conversion price, the notes will automatically convert into shares of the Company's common stock at the conversion price.

        In October 2002 and April 2004, the Company exchanged the $625,000 Notes (or the applicable successor notes) for new notes with the same terms and new maturity dates. In August 2004, the Company exchanged the $500,000 Note (or the applicable successor note) for a new note with the same terms and a new maturity date. Effective October 2005, the Company exchanged the $625,000 Notes (or applicable successor notes) for new notes which provide for a conversion price of $1.667 per share (estimated fair value of the preferred stock at the effective date of exchange) with new maturity dates of April 3, 2007. Effective February 2006, the Company exchanged the $500,000 Note (or applicable successor note) for a new note which provides for a conversion price of $1.667 per share (estimated fair value of the preferred stock at the effective date of exchange) with a new maturity date of August 12, 2007.

F-23



        In December 2005, the Company issued $1,000,000 in secured convertible promissory notes (the "2005 Notes"), bearing interest at 9.96% per annum. The 2005 Notes are secured (subordinated to the Credit Agreement) by substantially all the Company's assets. The 2005 Notes are convertible, at the option of the holder, at any time after the earlier of (i) the maturity date or (ii) the consummation of a private placement offering of common stock of the Company with gross aggregate proceeds to the Company of at least $1,000,000, and prior to repayment or automatic conversion (see below). The 2005 Notes are convertible into shares of the Company's common stock at either the offering price in a private placement offering of the Company's common stock, or if no offering, at the fair value of a share of common stock as determined by the Company's Board of Directors. In the event of a merger transaction with a public company concurrent with a private placement offering with gross aggregate proceeds of at least $5,000,000, the outstanding principal and accrued but unpaid interest will automatically be converted into shares of the Company's common stock at a rate of 67.5% of the price per share at which such shares are sold in the private placement offering. In accordance with EITF No. 00-27, since the terms of the contingent conversion option do not permit the Company to compute the additional number of shares that it would need to issue upon conversion of the notes if the contingent event occurs and the conversion price is adjusted, the Company determined the value of the beneficial conversion feature as of the commitment date and will record the beneficial conversion amount as additional interest expense only if the contingent event occurs. The estimated value of the beneficial conversion feature at the commitment date was approximately $500,000.

        The 2005 Notes had an original maturity date of February 28, 2006. In March 2006, the note holders agreed to extend the maturity date to May 31, 2006. In June 2006, a note holder of $50,000 in principal agreed to extend the maturity date of its convertible note until August 31, 2006 and fix the conversion price of the note at $2.55 per share. In connection with the amendment of the $50,000 convertible note in June 2006, the Company recorded a BCF of $50,000 as a result of fixing the conversion price at a per share amount that was below the estimated fair value of the Company's common stock at the date of amendment. The BCF has been recorded as a discount from the face amount of the convertible note and will be amortized using the effective interest method through maturity of such instrument. During the six months ended June 30, 2006, amortization of the debt discount was insignificant.

        On August 4, 2006, the Company repaid the remaining $950,000 of outstanding principal on the 2005 Notes, including accrued and unpaid interest of $59,010 (unaudited) (see Note 16). As a result of the repayment, the Company will not be required to record any further beneficial conversion charge.

        As of December 31, 2005, maturities of convertible notes payable were as follows (in thousands):

Years Ending
December 31,

   
2006   $ 1,000
2007     1,750
   
    $ 2,750
   

F-24


NOTE 8—INCOME TAXES

        The Company's income tax provision (benefit) consists of the following (in thousands):

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 
Current:                                
  Federal   $ 1,974   $ (499 ) $ (232 ) $ (533 ) $ 1,240  
  State     688     (59 )   2     2     116  
   
 
 
 
 
 
    Total current     2,662     (558 )   (230 )   (531 )   1,356  
   
 
 
 
 
 
Deferred:                                
  Federal     (111 )   225     (319 )   96     (462 )
  State     (234 )   (7 )   (363 )   (260 )   (82 )
   
 
 
 
 
 
    Total deferred     (345 )   218     (682 )   (164 )   (544 )
   
 
 
 
 
 
Income tax provision (benefit)   $ 2,317   $ (340 ) $ (912 ) $ (695 ) $ 812  
   
 
 
 
 
 

        Deferred tax assets and liabilities are classified as current or noncurrent according to the classification of the related asset or liability. Significant components of the Company's deferred tax assets and liabilities are as follows at December 31 and June 30 (in thousands):

 
  December 31,
   
 
 
  June 30,
2006

 
 
  2004
  2005
 
 
   
   
  (unaudited)

 
Deferred tax assets:                    
  Reserves and allowances   $ 784   $ 1,046   $ 1,425  
  Other accruals     57     73     287  
  Compensatory stock options and rights     481     503     409  
  Tax credit carryforwards     132     249     342  
  Deferred gain         241     221  
  NOL carryforward     162     289     136  
   
 
 
 
    Total deferred tax assets     1,616     2,401     2,820  
   
 
 
 
Deferred tax liabilities:                    
  State taxes, net of federal income tax benefit     (154 )   (278 )   (283 )
  Depreciation and amortization     (409 )   (304 )   (260 )
  Prepaid expenses     (74 )   (158 )   (72 )
   
 
 
 
    Total deferred tax liabilities     (637 )   (740 )   (615 )
   
 
 
 
    $ 979   $ 1,661   $ 2,205  
   
 
 
 

        The Company generated federal net operating losses ("NOL") of approximately $763,000 and $1,071,000 for the years ended December 31, 2005 and 2004, respectively. The federal NOL generated for December 31, 2005 will be carried back, and the federal NOL generated for December 31, 2004 has been carried back, to December 31, 2003 and fully utilized. In addition, the Company carried back approximately $125,000 of federal credits generated for the year ended

F-25



December 31, 2004 to the year ended December 31, 2003. At December 31, 2005, the Company had state net operating loss carryforwards of $3,854,000 which will begin to expire in 2013. In addition, the Company will carryforward approximately $249,000 of state credits. At June 30, 2006, the Company had state net operating loss carryforwards of $1,600,000 which will begin to expire in 2013. In addition, the Company will carryforward approximately $342,000 of state credits.

        A reconciliation of income taxes computed by applying the statutory U.S. income tax rate to the Company's income before income taxes to the income tax provision (benefit) is as follows:

 
  Years Ended December 31,
  Six Months Ended
June 30,

 
 
  2003
  2004
  2005
  2005
  2006
 
 
   
   
   
  (unaudited)

 
U.S. federal statutory tax   (35 )% (35 )% (35 )% (35 )% 35 %
State taxes, net of federal effect   2   (4 ) (7 ) (7 ) 1  
Research and development credits   (1 ) (10 )      
Benefit of lower tax rate   1   1   1   1   (1 )
Stock-based compensation   49   7       2  
Loss from foreign subsidiary     14   11   13   1  
Other   1   1   3      
   
 
 
 
 
 
Income tax provision (benefit)   17 % (26 )% (27 )% (28 )% 38 %
   
 
 
 
 
 

NOTE 9—COMMITMENTS AND CONTINGENCIES

Leases

        The Company leases certain of its facilities under non-cancelable operating leases through November 2010. Rental expense for the years ended December 31, 2003, 2004 and 2005 and for the six months ended June 30, 2005 and 2006 totaled $145,000, $207,000, $343,000, $172,000 (unaudited) and $213,000 (unaudited), respectively. The Company also has capital leases for certain equipment.

        In December 2005, the Company sold the building containing its manufacturing facility and the related land in Irvine, California to an unrelated third party for gross proceeds of $1,900,000. Concurrent with the sale, the Company entered into an agreement to lease the property back at an initial monthly rent of $10,000, subject to annual rent increases of 3% through lease expiration in November 2010. The Company is accounting for the lease as an operating lease. In connection with the sale, the Company recognized a gain of $580,000 which was deferred and is being amortized into income ratably over the lease term. During the six months ended June 30, 2006, the Company amortized $59,000 (unaudited) of the gain which is recorded as a reduction of rent expense in the accompanying statement of operations.

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        A summary of future minimum lease commitments as of December 31, 2005 is as follows (in thousands):

Years Ending
December 31,

  Capital Leases
  Operating Leases
2006   $ 544   $ 216
2007     534     173
2008     308     128
2009     96     132
2010     33     124
   
 
Total minimum lease payments   $ 1,515   $ 773
         
Less amount representing interest     (230 )    
   
     
Present value of future minimum lease payments (see Note 6)   $ 1,285      
   
     

Litigation

        The Company is subject to litigation in the ordinary course of business. The Company is not currently party to any pending litigation matters.

Other Contingent Obligations

        During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company's customers and licensees in connection with the use, sales and/or license of Company products; (ii) indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware; and (v) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company's use of the applicable premises. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments the Company could be obligated to make. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets.

        In February 2006, the Company's former Vice President of Finance (the "Former Officer") submitted his resignation. In order to secure the services of the Former Officer through an orderly transition of his responsibilities and in exchange for standard mutual releases of obligations, the Company entered into a severance agreement with the Former Officer. The agreement calls for the continuation of the Former Officer's salary through December 31, 2006. The Company will also reimburse the Former Officer for the cost of maintaining his prior medical insurance benefits

F-27



through the earlier of December 31, 2006 or the date on which he obtains medical coverage through a new employer. The total cost of the salary continuation and medical benefits to be provided under the agreement is approximately $149,000. Under terms of the agreement, the Former Officer is obligated to provide a specified minimum number of hours of service to the Company each month through the end of 2006. During the six months ended June 30, 2006, the Company paid $80,000 (unaudited) to the Former Officer in connection with the severance agreement.

NOTE 10—RELATED PARTY TRANSACTIONS

Loans to Employees for Stock

        In November 2000, the Company loaned $398,000 to two employees in connection with their purchases of shares of restricted stock. The original principal amount of each of these loans was $199,000, and both accrued interest at a rate of 7% annually. On December 31, 2003, the Company forgave the entire outstanding amount of $492,000, including both principal and accrued interest due. In addition, the Company granted each employee a cash bonus of $165,100, the amount equal to the anticipated tax liability incurred by both individuals as a result of the forgiveness of the respective loans.

        In February 2003, the Company loaned an employee $19,900 to exercise a portion of his then-vested common stock options. This full recourse note bears interest at a rate of 7% payable annually, and is due on February 17, 2008. As of December 31, 2005 and June 30, 2006 (unaudited), the amount of outstanding principal and accrued and unpaid interest on this note was approximately $23,000, and has been recorded as a reduction of stockholders' equity in the consolidated balance sheets.

        Interest income related to these loans amounted to approximately $34,000, $1,000, $1,000, $500 (unaudited) and $500 (unaudited) during the years ended December 31, 2003, 2004 and 2005 and the six months ended June 30, 2005 and 2006, respectively.

Loans From Employees

        In 2002, the Company entered into loan agreements with the majority stockholder and another employee to finance working capital needs. The loan from the majority stockholder accrued interest at a rate of 7% per annum, and the other employee note accrued interest at 15% per annum with all principal due in 2004. In December 2003, the Company repaid $100,000 due to the employee and offset the then outstanding balance of $168,000 due to the majority stockholder against outstanding balances advanced to the stockholder, as discussed below.

        Interest expense related to these notes amounted to $12,000 during the year ended December 31, 2003.

Advances to Employees

        The Company made advances in 2001 and 2002 to four employee stockholders, including the majority stockholder. These advances accrued interest at a rate of 7% per annum and were due on demand. In December 2003, the Company offset $168,000 of the advances to its majority stockholder against the two notes payable owed to him, as described above, reducing the net

F-28



amounts of his advances to $6,000. Subsequently, the Company forgave the entire remaining outstanding amounts of the advances to all four employees, totaling $203,000, and also granted the employees cash bonuses aggregating $162,000, which represent the anticipated tax liabilities to be incurred by each of these individuals in connection with the forgiveness of each of their advances.

        Interest income related to advances to employees amounted to $25,000 during the year ended December 31, 2003.

Guarantees by Executive Officers

        The Company's President, CEO and Chairman of the Board has personally guarantied the repayment of $1,750,000 in aggregate principal amount of outstanding convertible notes payable of the Company. In addition, the Company's President, CEO and Chairman of the Board, Vice President of Sales and Vice President of Engineering have each pesonally guarantied the repayment up to $1,000,000 of borrowings under the Credit Agreement. The guaranties of bank debt will terminate upon the completion of an initial public offering.

NOTE 11—STOCKHOLDERS' EQUITY

Sale of Restricted Stock

        During 2000, the Company sold 2,000,000 shares of common stock to two employees for $400,000, of which $398,000 of the purchase price was financed by the Company in the form of notes receivable, bearing interest at 7% per annum and due in 2005 but prepayable by the employees. The related shares issued were restricted and subject to repurchase by the Company at the purchase price until vested. The notes were deemed to be non-recourse for accounting purposes and the Company recognized compensation expense over the vesting period using variable accounting as prescribed under FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, as if the awards were stock options without a specific exercise price. As a result, related stock-based compensation expense fluctuated with changes in the fair market value of the Company's common stock. In December 2003, the notes receivable from the employees were forgiven and all shares were fully vested, at which time all remaining deferred compensation was expensed. In connection with these shares, the Company recognized stock-based compensation expense of $19,278,000 during fiscal 2003 based on the estimated fair market value of the Company's common stock on the date of forgiveness of $10.21, in addition to a charge of $492,000 related to the forgiveness of principal and interest on the notes (see Note 10).

Issuance of Common Stock for Option Exercises

        In 2003, options to purchase 100,000 shares of common stock were exercised for cash in the amount of $100 and a full recourse note receivable in the amount of $19,900, bearing interest at 7% per annum, with interest payable annually and principal due in 2008.

        In January 2004, options to purchase 20,000 shares of common stock were exercised by forgiving $4,000 of a $100,000 note due others (see Note 6) in lieu of cash payment for the exercise price. In addition, 1,667 common stock options were exercised for $333 in cash.

        In May 2005, options to purchase 1,667 shares of common stock were exercised for $3,251 cash.

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        In March and April 2006, certain warrant holders exercised warrants to purchase 550,000 shares of common stock for $110,000 cash (unaudited).

Series A Convertible Preferred Stock ("Series A")

        The Series A stockholders are entitled to noncumulative dividends at the rate of $0.16 per share per annum, when, as and if declared by the Board of Directors, prior and in preference to the payment of any dividends on common stock. Shares of Series A are convertible, at the option of the holder, into shares of common stock, on a 1:1 basis. The conversion may occur at any time after issuance and is automatically adjusted for stock splits such that the value of the converted shares remains unchanged. Conversion is automatic immediately prior to the closing of a public offering of the Company's common stock, or at the election of the holders of a majority of the shares of Series A preferred stock. Holders of Series A are entitled to a liquidation preference, as defined, of $2.00 per share, plus any declared and unpaid dividends, prior to any distribution of assets to holders of common stock. Holders of Series A have full voting rights on an as-converted basis.

NOTE 12—STOCK OPTIONS AND WARRANTS

Common Stock Options

        In November 2000, the Company adopted the 2000 Equity Incentive Plan (the "2000 Plan"), under which direct stock awards or options to acquire shares of the Company's common stock may be granted to employees and nonemployees of the Company. The 2000 Plan is administered by the Board of Directors and permits the issuance of up to 5,500,000 shares of the Company's common stock. Options granted under the 2000 Plan vest over a rate of at least 20% per year over five years and expire 10 years from the date of grant. Shares of restricted common stock are issued upon exercise of vested options and are subject to repurchase by the Company, at its sole discretion, upon termination of service. If the termination is due to resignation or due to cause, the repurchase price will be the original exercise price of the option. If the termination is for any other reason, the repurchase price will be the estimated fair market value of a share of common stock at the date of the termination. Such restrictions and repurchase rights lapse upon a public offering of the Company's common stock. If an employee wishes to sell shares acquired through the exercise of stock options, the employee must first offer to sell the shares back to the Company at a price determined by the employee. The Company then has thirty days to accept the offer. Should the Company not accept the offer, the employee may sell the shares to a third party on terms no more favorable than offered to the Company. As of December 31, 2005, options to purchase 1,185,867 common shares were available for future grant under the 2000 Plan.

Warrants

        From time to time, the Company issues warrants to non-employees for services rendered or to be rendered in the future. Such warrants are issued outside of the 2000 Plan. As of December 31, 2005, there were warrants to purchase 910,000 shares of common stock outstanding which are fully vested and exercisable. The weighted-average exercise price of these warrants was $0.53 per share at December 31, 2005.

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        A summary of changes in outstanding common stock options and warrants during the period from January 1, 2003 to December 31, 2005 is presented below (shares in thousands):

 
  Total
Shares

  Weighted Average
Exercise Price

Outstanding—January 1, 2003   1,834   $ 0.20
  Granted   1,076   $ 1.48
  Exercised   (100 ) $ 0.20
  Canceled   (60 ) $ 0.20
   
     

Outstanding—December 31, 2003

 

2,750

 

$

0.70
  Granted      
  Exercised   (22 ) $ 0.20
  Canceled   (279 ) $ 1.72
   
     

Outstanding—December 31, 2004

 

2,449

 

$

0.58
  Granted   866   $ 2.55
  Exercised   (2 ) $ 1.95
  Canceled   (213 ) $ 1.98
   
     

Outstanding—December 31, 2005

 

3,100

 

$

1.04
   
     

        The following table summarizes information about stock options and warrants outstanding and exercisable at December 31, 2005 (shares in thousands):

 
  Options/Warrants Outstanding
  Options/Warrants Exercisable
 
   
  Weighted-
Average
Remaining
Life (Years)

   
Exercise
Price

  Number of
Shares

  Weighted-
Average
Price

  Number
of Shares

  Weighted-
Average
Price

$0.20   1,629   4   $ 0.20   1,625   $ 0.20
$1.00   300   2   $ 1.00   300   $ 1.00
$1.25   230   7   $ 1.25   146   $ 1.25
$1.95   139   8   $ 1.95   70   $ 1.95
$2.55   802   9   $ 2.55   27   $ 2.55
   
           
     
    3,100             2,168      
   
           
     

        During fiscal 2002, the Company issued options to purchase 1,035,000 shares of common stock to employees. Due to the difference between the exercise price and estimated fair value of common stock, $7,000 of deferred compensation expense was recorded that will be amortized to expense over the vesting period. The Company recognized compensation expense of $2,067, $400 and $400 during fiscal 2003, 2004 and 2005, respectively, related to these grants.

        During fiscal 2003, the Company issued options to purchase 696,500 shares of common stock to employees. Due to the difference between the exercise price and the estimated fair value of common stock, $2,931,000 of deferred compensation expense was recorded that will be amortized

F-31



to expense over the vesting period. During fiscal 2003, 2004 and 2005, the Company recognized compensation expense (net of forfeitures) of $349,000, $250,000 and ($64,000), related to these grants.

        During fiscal 2005, the Company issued options to purchase 831,000 shares of the Company's common stock to employees and directors. The options were granted at exercise prices which were equal to the estimated fair value of the common stock on the date of grant. Therefore, no stock-based compensation expense was recorded in the accompanying consolidated statement of operations.

        The Company has also granted stock options and warrants to non-employees for services. Options or warrants to purchase 380,000 shares of common stock were granted to non-employees in 2003. Stock-based compensation expense related to stock options granted to non-employees was recognized as services were rendered. As of December 31, 2003, all of such options and warrants were fully vested and no future services were required. In connection with the grant of stock options and warrants to non-employees, the Company recognized stock-based compensation expense of $1,044,000 during fiscal 2003.

        During 2005, the Company issued options to purchase 35,000 shares of the Company's common stock to non-employee consultants for services to be performed over a four year period. During the year ended December 31, 2005 and the six months ended June 30, 2006, the Company recognized consulting expense of $3,000 and $7,000 (unaudited), respectively, which is included in selling, general and administrative expenses.

        During the six months ended June 30, 2006, the Company granted warrants to purchase 22,500 shares of the Company's common stock to a consulting firm for services. The estimated fair value of the warrants at the date of issuance using the Black-Scholes pricing model was determined to be $11,700 and will be amortized to consulting expense over a four year vesting period. Consulting expense related to these warrants was $2,000 (unaudited) during the six months ended June 30, 2006 and is included in selling, general and administrative expenses.

        The weighted-average fair value of common stock options and warrants granted during the years ended December 31, 2003 and 2005 was $3.82 and $0.17, respectively. No common stock options or warrants were granted during 2004.

NOTE 13—401(k) PLAN

        The Company sponsors a 401(k) defined contribution plan. Employees are eligible to participate in this plan provided they are employed full-time and have reached 21 years of age. Participants may make pre-tax contributions to the plan subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions on the contributions and investment earnings. The Company may make matching contributions on the contributions of a participant on a discretionary basis. There were no Company contributions made during the three years in the period ended December 31, 2005 or the six months ended June 30, 2005 and 2006 (unaudited).

F-32



NOTE 14—MAJOR CUSTOMERS AND SUPPLIERS

        The Company's product sales have historically been concentrated in a small number of customers. The following table sets forth sales to customers comprising 10% or more of the Company's total revenues as follows:

 
  Years Ended December 31,
 
 
  2003
  2004
  2005
 
Customer:              
  A   70 % 71 % 35 %
  B       13 %
  C     2 % 20 %
 
  Six Months Ended June 30,
 
 
  2005
  2006
 
 
  (unaudited)

 
Customer:          
  A   46 % 33 %
  B   1 % 2 %
  C   22 % 46 %

        The Company's accounts receivable are concentrated with three customers at December 31, 2004, representing 53%, 24% and 14%; and two customers at December 31, 2005, representing 39% and 17%; and one customer at June 30, 2006, representing 65% (unaudited) of aggregate gross receivables. A significant reduction in sales to, or the inability to collect receivables from, a significant customer could have a material adverse impact on the Company.

        The Company's purchases have historically been concentrated in a small number of suppliers. The following table sets forth purchases from suppliers comprising 10% or more of the Company's total purchases as follows:

 
  Years Ended December 31,
 
 
  2003
  2004
  2005
 
Supplier:              
  A   54 % 33 % 37 %
  B   18 % 21 % 19 %
  C     13 % 11 %

F-33


 
  Six Months Ended June 30,
 
 
  2005
  2006
 
 
  (unaudited)

 
Supplier:          
  A   8 % 21 %
  B   10 % 15 %
  C   43 % 11 %
  D     10 %

        While the Company believes alternative suppliers could be utilized, any inability to obtain components or products in the amounts needed on a timely basis or at commercially reasonable prices could result in delays in product introductions, interruption in product shipments or increases in product costs, which could have a material adverse effect on the Company.

NOTE 15—SEGMENT AND GEOGRAPHIC INFORMATION

        The Company operates in one reportable segment: the design and manufacture of high-performance memory subsystems for the server, high-performance computing and communications markets. The Company evaluates financial performance on a Company-wide basis. All the Company's international sales relate to shipments of products to its U.S. customers' international manufacturing sites or third-party hubs and are denominated in U.S. dollars.

        As of December 31, 2005 and June 30, 2006 (unaudited), all long-lived assets are located in the United States.

NOTE 16—SUBSEQUENT EVENTS (UNAUDITED)

        Effective July 28, 2006, the Company executed the Fifth Amendment to Amended and Restated Credit and Security Agreement (the "Fifth Amendment"). The Fifth Amendment provides for, among other things, an increase in the maximum borrowings under the line of credit facility up to $25 million ($3 million of which may be in the form of letters of credit), limited to 85% of eligible accounts receivable, plus the least of (i) a percentage of eligible inventory determined from time to time by the Company's bank, (ii) 80% of the orderly liquidation value, as defined, of eligible inventories, and (iii) $7 million. Interest is payable monthly, at the Company's option, either at prime rate plus 0.50% or LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. The line of credit facility, as amended, matures on July 31, 2008.

        The Fifth Amendment also provides for a $2 million term loan to be funded in two advances as follows: (i) $1 million on the first business day following the effective date of the Fifth Amendment, and (ii) $1 million if, and only if, the Company's year to date net income at August 31, 2006 equals or exceeds $1,208,000. The term loan principal will be payable in equal monthly installments of $83,350 commencing on September 1, 2006. In addition, the Company will be required to make a principal reduction payment on the term loan in an amount equal to the lesser of (i) 10% of the Company's excess cash flow, as defined, for its year ending December 31, 2006, or (ii) $500,000. Interest will be payable monthly, at the Company's option, either at the prime rate plus 0.50% or

F-34



LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. The term loan, including all accrued and unpaid interest is due and payable on the earlier of (i) the closing of an initial public offering by the Company, or (ii) July 31, 2008.

        The Fifth Amendment also provides for equipment advances up to $2 million. Interest on the equipment advances is payable monthly, at the Company's option, either at the prime rate plus 0.50% or LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. Interest only payments are required on the equipment advances through January 31, 2007. Commencing February 1, 2007, the Company is required to repay the equipment advances in 42 equal monthly installments. The equipment advances, including all accrued and unpaid interest, are due on July 31, 2008.

        On August 4, 2006, the Company repaid outstanding principal of $950,000 on certain of the 2005 Notes, including accrued and unpaid interest of $59,010. The repayment was funded by proceeds from an advance on the $2 million term loan (see above).

        In August 2006, the compensation committee of the Company's board of directors granted options to purchase 885,000 shares of common stock to certain of the Company's officers. Each of these options has an exercise price of $7.00 per share. The options granted to two officers vest quarterly over four years. The options granted to the other three officers vest upon the termination of the two-year lock-up period included in agreements that they entered into with the Company in August 2006. In addition, the Company issued warrants to purchase 15,000 shares of the Company's common stock to a consulting firm for services. The warrants have an exercise price of $7.00 per share and vest at various rates over a four-year period. The warrants expire in ten years from date of issuance.

        In August 2006, the Company granted options to purchase 25,000 shares of the Company's common stock to an employee. The options have an exercise price of $7.00 per share and vest over a four-year period. The options expire in ten years from date of grant.

F-35


GRAPHIC

LOGO

             Shares
Common Stock

Thomas Weisel Partners LLC

Needham & Company, LLC

WR Hambrecht + Co


Neither we nor any of the underwriters have authorized anyone to provide information different from that contained in this prospectus. When you make a decision about whether to invest in our common stock, you should not rely upon any information other than the information in this prospectus. Neither the delivery of this prospectus nor the sale of our common stock means that information contained in this prospectus is correct after the date of this prospectus. This prospectus is not an offer to sell or solicitation of an offer to buy these shares of common stock in any circumstances in which the offer or solicitation is unlawful.

Through and including                           , 2006 (the 25 th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligations to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.



PART II

INFORMATION NOT REQUIRED IN THE PROSPECTUS

Item 13.    Other Expenses of Issuance and Distribution

        Expenses of the Registrant in connection with the issuance and distribution of the securities being registered, other than the underwriting discount and commissions, are estimated as follows:

Securities and Exchange Commission Registration Fee   $ 6,152.50
National Association of Securities Dealers Fees   $ 6,250.00
*Nasdaq Global Market Listing Fees      
*Printing and Engraving Expenses      
*Legal Fees and Expenses      
*Accountant's Fees and Expenses      
*Expenses of Qualification Under State Securities Laws, including Attorneys' Fees      
*Transfer Agent and Registrar's Fees      
*Miscellaneous Costs      
  *Total      

*
To be provided by amendment.


Item 14.    Indemnification of Directors and Officers

        Netlist, Inc. is incorporated under the laws of the State of Delaware. Section 145 of the Delaware General Corporation Law provides that a corporation may indemnify any persons who were, are or are threatened to be made, parties to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was an officer, director, employee or agent of such corporation, or is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise. The indemnity may include expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such person acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to, the corporation's best interests and, with respect to any criminal action or proceeding, had no reasonable cause to believe that his or her conduct was unlawful.

        Section 145 of the Delaware General Corporation Law further authorizes a corporation to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or enterprise, against any liability asserted against him or her and incurred by him or her in any such capacity, arising out of his or her status as such, whether or not the corporation would otherwise have the power to indemnify him or her under Section 145 of the Delaware Corporation Law.

        Netlist, Inc.'s current certificate of incorporation, as amended, eliminates the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liabilities arising (a) from any breach of the director's duty of loyalty to the corporation or its stockholders; (b) from acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (c) under Section 174 of the Delaware General Corporation Law; or (d) from any transaction from which the director derived an improper personal benefit. Our amended and restated certificate of incorporation, which we intend to file

II-1



prior to the completion of this offering, will provide for the same elimination of personal liability. In addition, the amended and restated bylaws we intend to adopt prior to the completion of this offering will provide for indemnification of directors, officers, employees and agents to the fullest extent permitted by Delaware law and authorize us to purchase and maintain insurance to protect itself and any director, officer, employee or agent of our company or another business entity against any expense, liability, or loss, regardless of whether we would have the power to indemnify such person under our bylaws or Delaware law.

        We have entered into indemnification agreements with each of our current directors and executive officers. These agreements will require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to us, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. We also intend to enter into indemnification agreements with our future directors and executive officers.


Item 15.    Recent Sales of Unregistered Securities

        We have issued and sold the following unregistered securities since the beginning of fiscal year 2003:

        Between December 30, 2002 and June 30, 2006, we granted options to purchase 1,840,000 shares of our common stock at exercise prices ranging from $1.25 to $2.55 per share to employees, directors, consultants and advisors under our 2000 Equity Incentive Plan. In August 2006, we granted options to purchase 910,000 shares of our common stock to members of our management, and 50,000 shares of our common stock to non-employee directors, each at an exercise price of $7.00 per share under our 2000 Equity Incentive Plan.

        In April 2001, we issued and sold two promissory notes convertible into shares of our common stock, each in the original principal amount of $625,000, to Serim Paper Manufacturing Co., Ltd. and HeungHwa Industries Co., Ltd. In October 2002 and April 2004, we exchanged these two notes (or the applicable successor notes) for new notes of like tenor. In October 2005, we exchanged the applicable successor notes for new notes of like tenor with an extended maturity date and a change in conversion price from $2.50 to $1.67. In April 2001 we issued warrants for the purchase of an aggregate of 550,000 shares of our common stock, each at a strike price of $0.20 per share, to seven individuals related to Serim Paper and HeungHwa. All of these warrants were exercised in full in 2006.

        In January 2003, we issued a warrant to purchase 60,000 shares of our common stock at an exercise price of $1.25 per share to Logic One Sales, Inc., as partial compensation for services provided to us by Logic One as one of our manufacturer's representatives. This warrant expires in January 2013.

        In February 2003, we issued a promissory note convertible into shares of our common stock to Serim Paper in the original principal amount of $500,000. In August 2004, we exchanged this note for a new note of like tenor. In February 2006, we exchanged the applicable successor note for new notes of like tenor with an extended maturity date and a change in conversion price from $2.50 to $1.67. In February 2003, we issued warrants for the purchase of an aggregate of 300,000 shares of our common stock, each at a strike price of $1.00 per share, to three individuals related to Serim Paper.

        In December 2005, we issued promissory notes convertible into shares of our common stock to six accredited investors in the aggregate principal amount of $1,000,000. In August 2006, we used $1 million in proceeds of our term loan to repay $950,000 in principal amount, and unpaid interest, on these convertible promissory notes.

II-2



        In May 2006, we issued a warrant to purchase 22,500 shares of our common stock at an exercise price of $2.55 per share to Tatum, LLC, as partial consideration for services provided to us by Tatum, LLC in connection with the hiring of our Vice President and Chief Financial Officer, Lee Kim. This warrant has a 10-year term. The warrant becomes exercisable with respect to 5,625 of the underlying shares on May 3, 2007, and an additional 468 of the underlying shares become available for exercise on each month thereafter, such that on May 3, 2010, all 22,500 shares underlying this warrant will be available for exercise.

        In August 2006, we issued a warrant to purchase 15,000 shares of our common stock at an exercise price of $7.00 per share to Tatum, LLC in connection with a grant of options to Lee Kim pursuant to an agreement between Tatum, LLC and us. This warrant has a 10-year term and vests in equal quarterly installments such that in August 2010 this warrant will be exercisable for all 15,000 underlying shares.

        The issuances of the securities in the transactions described above were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering, where the purchasers represented their intention to acquire the securities for investment only and not with a view to public distribution and received or had access to adequate information about us, or were deemed to be exempt from registration under the Securities Act under Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan or a written contract relating to compensation.

        Appropriate legends were affixed to the stock certificates and warrants issued in the above transactions. Similar legends were imposed in connection with any subsequent exercises, as applicable, of any of the securities described above. No underwriters were employed in any of the transactions described above.


Item 16.    Exhibits and Financial Statement Schedules

    (a)
    Exhibits

1.1   Underwriting Agreement, dated as of                      , 2006, among Netlist, Inc. and                          .*
3.1   Restated Certificate of Incorporation of Netlist, Inc. (to be adopted and filed in connection with the offering contemplated by this registration statement).*
3.2   Amended and Restated Bylaws of Netlist, Inc. (to be adopted in connection with the offering contemplated by this registration statement).*
5.1   Opinion of Bingham McCutchen LLP.*
10.1   Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, among Netlist, Inc., Netlist Technology Texas, L.P. ("Netlist Texas"), and Wells Fargo Business Credit, Inc. ("Wells Fargo").
10.2   First Amendment to Amended and Restated Credit and Security Agreement, dated as of June 30, 2004, among Netlist, Inc., Netlist Texas and Wells Fargo.
10.3   Second Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of December 20, 2005, among Netlist, Inc., Netlist Texas and Wells Fargo.
10.4   Third Amendment to Amended and Restated Credit and Security Agreement, dated as of February 14, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
10.5   Fourth Amendment to Amended and Restated Credit and Security Agreement and Waiver of Defaults, dated as of April 18, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
     

II-3


10.6   Fifth Amendment to Amended and Restated Credit and Security Agreement, dated as of July 28, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
10.7   Amended and Restated 2000 Equity Incentive Plan of Netlist, Inc.*
10.8   Letter agreement regarding employment, dated January 11, 2006, between Netlist, Inc. and Lee Kim.
10.9   Full-time Permanent Engagement Resources Agreement, dated as of January 10, 2006, between Netlist, Inc. and Tatum, LLC.
10.10   Master Sales and Supply Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.
10.11   Management Fee Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.
10.12   Form of Indemnity Agreement for officers and directors.
14.1   Code of Ethics (to be adopted in connection with the offering contemplated by this registration statement).*
16.1   Letter regarding change in certifying accountant.
21.1   Subsidiaries of Netlist, Inc.
23.1   Consent of Corbin & Company, LLP.
23.2   Consent of Deloitte & Touche LLP.
23.3   Consent of Bingham McCutchen LLP (included in Exhibit 5.1).*
24.1   Power of Attorney of Netlist, Inc. (included on the signature page in Part II hereof).

*
To be filed by amendment.

(b)
Financial Statement Schedules

        The following financial statement schedule is included in this registration statement:

Reports of Independent Registered Public Accounting Firm on Financial Statement Schedule   S-1

Schedule II - Valuation and Qualifying Accounts

 

S-3

        All other schedules for which provision is made in the applicable accounting regulations of the Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the consolidated financial statements, and therefore have been omitted.


Item 17.    Undertakings.

        Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, and controlling persons of the Registrant pursuant to the foregoing provisions described in Item 14 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate

II-4



jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

        The undersigned registrant hereby undertakes:

            (1)   To provide to the Underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser.

            (2)   For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4), or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.

            (3)   For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

II-5


        Pursuant to the requirements of the Securities Act of 1933, as amended, Netlist, Inc. has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on this 18th day of August, 2006.

    NETLIST, INC.

 

 

By:

/s/  
CHUN K. HONG       
Chun K. Hong
President, Chief Executive Officer and
Chairman of the Board


POWER OF ATTORNEY

        Each person whose signature appears below constitutes and appoints Chun K. Hong and Lee Kim, jointly and severally, each in his own capacity, his true and lawful attorneys-in-fact, with full power of substitution, for him and his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such said attorneys-in-fact and agents with full power and authority to do so and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated:

Signature
  Title
  Date

 

 

 

 

 
/s/   CHUN K. HONG       
Chun K. Hong
  President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)   August 18, 2006

/s/  
LEE KIM       
Lee Kim

 

Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

 

August 18, 2006

/s/  
NAM KI HONG       
Nam Ki Hong

 

Director

 

August 18, 2006

/s/  
THOMAS F. LAGATTA       
Thomas F. Lagatta

 

Director

 

August 18, 2006

/s/  
ALAN H. PORTNOY       
Alan H. Portnoy

 

Director

 

August 18, 2006

/s/  
DAVID M. RICKEY       
David M. Rickey

 

Director

 

August 18, 2006

/s/  
PRESTON ROMM       
Preston Romm

 

Director

 

August 18, 2006

II-6



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
of Netlist, Inc.

        We have audited the consolidated financial statements of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2005, and for the year then ended, and have issued our report thereon dated May 11, 2006 (appearing in the prospectus, which is part of this registration statement). Our audit also included the consolidated financial statement schedule listed in Item 16(b) of the accompanying index of this registration statement. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/   CORBIN & COMPANY, LLP      
Irvine, California
May 11, 2006

S-1



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Netlist, Inc.:

        We have audited the consolidated financial statements of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2004, and for each of the two years in the period ended December 31, 2004, and have issued our report thereon dated March 1, 2006 (appearing in the prospectus, which is part of this registration statement). Our audits also included the consolidated financial statement schedule listed in Item 16(b) of this registration statement. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/   DELOITTE & TOUCHE LLP     
Costa Mesa, California
March 1, 2006

S-2



Netlist, Inc.

Schedule II Valuation and Qualifying Accounts (in thousands)

 
  Balance At
Beginning of
Period

  Charged to
Cost and
Expenses

  (Deductions)
  Balance at
End of
Period

Allowance for sales returns and doubtful accounts:                        
Year Ended December 31, 2003   $ 61   $ 452   $ (377 ) $ 136
Year Ended December 31, 2004     136     200     (104 )   232
Year Ended December 31, 2005   $ 232   $ 19   $ (142 ) $ 109

S-3




QuickLinks

TABLE OF CONTENTS
PROSPECTUS SUMMARY
Netlist, Inc.
The Offering
Summary Consolidated Financial Data
RISK FACTORS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
USE OF PROCEEDS
DIVIDEND POLICY
CAPITALIZATION
DILUTION
SELECTED CONSOLIDATED FINANCIAL DATA
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
MANAGEMENT
Summary Compensation Table
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PRINCIPAL AND SELLING STOCKHOLDERS
DESCRIPTION OF CAPITAL STOCK
SHARES ELIGIBLE FOR FUTURE SALE
MATERIAL UNITED STATES FEDERAL TAX CONSIDERATIONS FOR NON-UNITED STATES HOLDERS
UNDERWRITING
LEGAL MATTERS
EXPERTS
WHERE YOU CAN FIND ADDITIONAL INFORMATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
NETLIST, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except per share amounts)
NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Operations (in thousands, except per share amounts)
NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (in thousands)
NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands)
NETLIST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS
POWER OF ATTORNEY
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Netlist, Inc. Schedule II Valuation and Qualifying Accounts (in thousands)

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Exhibit 10.1

EXECUTION COPY



  

AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT

AMONG

NETLIST, INC.

AND

NETLIST TECHNOLOGY TEXAS LP, AS BORROWERS

AND

WELLS FARGO BUSINESS CREDIT, INC.

AS LENDER

as of

December 27, 2003





TABLE OF CONTENTS

 
 
   
  Page
ARTICLE I    DEFINITIONS   1
  Section 1.1   Definitions   1
  Section 1.2   Other Definitional Terms; Rules of Interpretation   11
ARTICLE II    AMOUNT AND TERMS OF THE CREDIT FACILITY   11
  Section 2.1   Revolving Advances   11
  Section 2.2   Procedures for Requesting Advances   11
  Section 2.3   Intentionally Omitted   12
  Section 2.4   Capital Adequacy; Funding Exceptions   12
  Section 2.5   Letters of Credit   13
  Section 2.6   Special Account   13
  Section 2.7   Payment of Amounts Drawn Under Letters of Credit; Obligation of Reimbursement   13
  Section 2.8   Obligations Absolute   14
  Section 2.9   Intentionally Omitted   14
  Section 2.10   Inventory Appraisals   14
  Section 2.11   Intentionally Omitted   15
  Section 2.12   Interest; Applicable Margin; Minimum Interest Charge; Default Interest; Participations; Clearance Days; Usury   15
  Section 2.13   Fees   16
  Section 2.14   Time for Interest Payments; Payment on Non-Banking Days; Computation of Interest and Fees   18
  Section 2.15   Lockbox; Collateral Account; Application of Payments   18
  Section 2.16   Voluntary Prepayment; Termination of the Credit Facility by the Borrowers   18
  Section 2.17   Mandatory Prepayment   19
  Section 2.18   Revolving Advances to Pay Obligations   19
  Section 2.19   Use of Proceeds   19
  Section 2.20   Liability Records   19
ARTICLE III    SECURITY INTEREST; OCCUPANCY; SETOFF   19
  Section 3.1   Grant of Security Interest   19
  Section 3.2   Notification of Account Debtors and Other Obligors   19
  Section 3.3   Assignment of Insurance   19
  Section 3.4   Occupancy   20
  Section 3.5   License   20
  Section 3.6   Financing Statement   20
  Section 3.7   Setoff   21
  Section 3.8   Power of Attorney   21
ARTICLE IV    CONDITIONS OF LENDING   22
  Section 4.1   Conditions Precedent to the Initial Advances and Letter of Credit   22
  Section 4.2   Conditions Precedent to All Advances and Letters of Credit   23
ARTICLE V    REPRESENTATIONS AND WARRANTIES   23
  Section 5.1   Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number   23
  Section 5.2   Capitalization   24
  Section 5.3   Authorization of Borrowing; No Conflict as to Law or Agreements   24
  Section 5.4   Legal Agreements   24
  Section 5.5   Subsidiaries   24
           

i


  Section 5.6   Financial Condition; No Adverse Change   24
  Section 5.7   Litigation   25
  Section 5.8   Regulation U   25
  Section 5.9   Taxes   25
  Section 5.10   Titles and Liens   25
  Section 5.11   Intellectual Property Rights   25
  Section 5.12   Plans   26
  Section 5.13   Default   26
  Section 5.14   Environmental Matters   26
  Section 5.15   Submissions to Lender   27
  Section 5.16   Financing Statements   27
  Section 5.17   Rights to Payment   27
  Section 5.18   Eligible Accounts; Eligible Foreign Accounts   27
  Section 5.19   Eligible Inventory   27
  Section 5.20   Equipment   27
  Section 5.21   Fraudulent Transfer   27
ARTICLE VI    COVENANTS   28
  Section 6.1   Reporting Requirements   28
  Section 6.2   Financial Covenants   31
  Section 6.3   Permitted Liens; Financing Statements   31
  Section 6.4   Indebtedness   32
  Section 6.5   Guaranties   32
  Section 6.6   Investments and Subsidiaries   32
  Section 6.7   Dividends and Distributions   33
  Section 6.8   Salaries   33
  Section 6.9   Intentionally Omitted   33
  Section 6.10   Books and Records; Inspection and Examination   33
  Section 6.11   Account Verification   33
  Section 6.12   Compliance with Laws   33
  Section 6.13   Payment of Taxes and Other Claims   33
  Section 6.14   Maintenance of Properties   34
  Section 6.15   Insurance   34
  Section 6.16   Preservation of Existence   34
  Section 6.17   Delivery of Instruments, etc   34
  Section 6.18   Sale or Transfer of Assets; Suspension of Business Operations   34
  Section 6.19   Consolidation and Merger; Asset Acquisitions   35
  Section 6.20   Sale and Leaseback   35
  Section 6.21   Restrictions on Nature of Business   35
  Section 6.22   Accounting   35
  Section 6.23   Discounts, etc   35
  Section 6.24   Plans   35
  Section 6.25   Place of Business   35
  Section 6.26   Change in Name, Trade Name, Trade Style or FEIN   35
  Section 6.27   Transactions With Affiliates   35
  Section 6.28   Performance by the Lender   35
ARTICLE VII    EVENTS OF DEFAULT, RIGHTS AND REMEDIES   36
  Section 7.1   Events of Default   36
  Section 7.2   Rights and Remedies   39
  Section 7.3   Disclaimer of Warranties   40
  Section 7.4   Compliance With Laws   41
           

ii


  Section 7.5   No Marshalling   41
  Section 7.6   Borrowers to Cooperate   41
  Section 7.7   Application of Proceeds   41
  Section 7.8   Remedies Cumulative   41
  Section 7.9   Lender Not Liable For The Collateral   41
ARTICLE VIII    MISCELLANEOUS   41
  Section 8.1   No Waiver   41
  Section 8.2   Amendments, Etc   41
  Section 8.3   Addresses for Notices; Requests for Accounting   42
  Section 8.4   Intentionally Omitted   42
  Section 8.5   Further Documents   42
  Section 8.6   Costs and Expenses   42
  Section 8.7   Indemnity   42
  Section 8.8   Participants   43
  Section 8.9   Advertising and Promotion   43
  Section 8.10   Execution in Counterparts; Telefacsimile Execution   43
  Section 8.11   Retention of Borrowers' Records   43
  Section 8.12   Binding Effect; Assignment; Complete Agreement; Exchanging Information   43
  Section 8.13   Severability of Provisions   44
  Section 8.14   Revival and Reinstatement of Obligations   44
  Section 8.15   Headings   44
  Section 8.16   Governing Law; Jurisdiction, Venue; Waiver of Jury Trial   44
ARTICLE IX    JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT   44
  Section 9.1   Joint and Several Liability   44
  Section 9.2   Primary Obligation; Waiver of Marshalling   45
  Section 9.3   Financial Condition of Borrowers   45
  Section 9.4   Continuing Liability   45
  Section 9.5   Additional Waivers   45
  Section 9.6   Settlement or Releases   47
  Section 9.7   No Election   48
  Section 9.8   Indefeasible Payment   48
  Section 9.9   Single Loan Account   48
  Section 9.10   Apportionment of Proceeds of Advances   48
  Section 9.11   Lender Held Harmless   49
  Section 9.12   Borrowers' Integrated Operations   49

iii



AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT

Dated as of December 27, 2003

        NETLIST, INC., a Delaware corporation ("Netlist"), NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP"), and WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), are entering into this Agreement with reference to the following facts:

        WHEREAS, Netlist and the Lender previously entered into that certain Credit and Security Agreement, dated as of July 2, 2003, as amended by that certain First Amendment to Credit and Security Agreement, dated as of October 30, 2003, and a second amendment which is also entitled the First Amendment to Credit and Security Agreement, dated as of December 5, 2003 (as so amended, the "Prior Agreement").

        WHEREAS, Netlist has requested that its Subsidiary, NTTLP, be a co-borrower and the Lender has agreed with such request, subject to the terms and conditions of this Agreement.

        WHEREAS, the parties hereto hereby agree to enter into this Agreement in order to amend and restate in its entirety, and continue the Obligations incurred under, the Prior Agreement.

        NOW THEREFORE, the parties hereto hereby agree as follows:


ARTICLE I

DEFINITIONS

        Section 1.1     Definitions.     For all purposes of this Agreement, except as otherwise expressly provided, the following terms shall have the meanings assigned to them in this Section or in the Section referenced after such term:

        "Account Debtor" means any Person who is or who may become obligated under, with respect to, or on account of, an Account, chattel paper, or a General Intangible.

        "Accounts" means all of each Borrower's now owned or hereafter acquired right, title, and interest with respect to "accounts" (as that term is defined in the UCC), and any and all supporting obligations in respect thereof.

        "Advance" means a Revolving Advance.

        "Affiliate" means, as applied to any Person, any other Person who, directly or indirectly, controls, is controlled by, or is under common control with, such Person. For purposes of this definition, "control" means the possession, directly or indirectly, of the power to direct the management and policies of a Person, whether through the ownership of stock, by contract, or otherwise; provided , however , that, in any event: (a) any Person which owns directly or indirectly 10% or more of the securities having ordinary voting power for the election of directors or other members of the governing body of a Person or 10% or more of the partnership or other ownership interests of a Person (other than as a limited partner of such Person) shall be deemed to control such Person, (b) each director (or comparable manager) of a Person shall be deemed to be an Affiliate of such Person, and (c) each partnership or joint venture in which a Person is a partner or joint venturer shall be deemed to be an Affiliate of such Person.

        "Agreement" means this Amended and Restated Credit and Security Agreement.

        "Applicable Margin" means fifty (50) basis points; provided that (1) if the condition(s) described in the table below are fulfilled to the satisfaction of the Lender, and (2) if no Default Period is then

1



continuing, then the Applicable Margin shall mean the margin set forth in the table below opposite the applicable condition, effective the first day of the month following the fulfillment of such condition:

Condition

  Applicable Margin

Receipt of Netlist's 12/31/03 audited financial statements evidencing Net Income during such fiscal year of not less than $2,500,000   Twenty-five (25) basis points
Receipt of Netlist's 12/31/04 audited and consolidated financial statements evidencing Net Income during such fiscal year of not less than $2,500,000   Zero (0) basis points

        "Approved Buyer" means an Account Debtor under an Eligible Foreign Account that is (i) not located in a country that is unacceptable to the Lender in its sole discretion, and (ii) otherwise acceptable to the Lender in its sole discretion. Unacceptable countries are determined by the Lender from time to time, in its sole discretion. As of September 30, 2003, the unacceptable countries are listed on Schedule 1 attached hereto.

        "Availability" means the difference of (i) the Borrowing Base and (ii) the sum of (A) the outstanding principal balance of the Revolving Note and (B) the L/C Amount.

        "Banking Day" means a day on which the Federal Reserve Bank of New York is open for Business.

        "Bankruptcy Code" means the United States Bankruptcy Code, as in effect from time to time.

        "Base Rate" means the rate of interest publicly announced from time to time by Wells Fargo Bank National Association at its principal office in San Francisco as its "prime rate", with the understanding that the "prime rate" is one of Wells Fargo's base rates (not necessarily the lowest of such rates) and serves as the basis upon which effective rates of interest are calculated for loans making reference thereto.

        "Book Net Worth" means the aggregate of the common and preferred stockholders' equity in the Borrowers, prepared on a consolidating and consolidated basis including any Subsidiaries, determined in accordance with GAAP.

        "Borrowers" means Netlist and NTTLP (each, a "Borrower").

        "Borrowing Base" means at any time the lesser of:

2


        Notwithstanding the foregoing, the Lender may reduce the advance rates or create additional reserves against the Eligible Accounts, the Eligible Foreign Accounts and/or the Eligible Inventory, in its sole and absolute discretion, without declaring an Event of Default if it reasonably determines that there has occurred a Material Adverse Effect.

        "Capital Expenditures" means for a period, any expenditure of money during such period for the purchase or construction of assets, or for improvements or additions thereto, which are capitalized on the Borrowers' balance sheet.

        "Change of Control" means the occurrence of any of the following events:

        "Collateral" means all of each Borrower's Accounts, chattel paper, deposit accounts, documents, Equipment, General Intangibles, goods, instruments, Inventory, Investment Property, letter-of-credit rights, letters of credit, all sums on deposit in any Collateral Account, and any items in any Lockbox; together with (i) all substitutions and replacements for and products of any of the foregoing; (ii) in the case of all goods, all accessions; (iii) all accessories, attachments, parts, equipment and repairs now or hereafter attached or affixed to or used in connection with any goods; (iv) all warehouse receipts, bills of lading and other documents of title now or hereafter covering such goods; (v) all collateral subject to the Lien of any Security Document; (vi) any money, or other assets of either Borrower that now or hereafter come into the possession, custody, or control of the Lender; (vii) all sums on deposit in the Special Account; and (viii) proceeds of any and all of the foregoing.

        "Collateral Account" means the "Lender Account" as defined in the Lockbox and Collection Account Agreement.

        "Commitment" means the Lender's commitment to make Advances to, and to cause the Issuer to issue Letters of Credit for the account of, the Borrowers pursuant to Article II.

        "Constituent Documents" means with respect to any Person, as applicable, such Person's certificate of incorporation, articles of incorporation, by-laws, certificate of formation, articles of organization, limited liability company agreement, management agreement, operating agreement, shareholder agreement, partnership agreement or similar document or agreement governing such Person's existence, organization or management or concerning disposition of ownership interests of such Person or voting rights among such Person's owners.

        "Credit Facility" means the credit facility being made available to the Borrowers by the Lender under Article II.

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        "Daily Balance" means, with respect to each day during the term of this Agreement, the amount of an Obligation owed at the end of such day.

        "Default" means an event that, with giving of notice or passage of time or both, would constitute an Event of Default.

        "Default Period" means any period of time beginning on the day a Default or Event of Default occurs and ending on the date the Lender notifies the Borrower in writing that such Default or Event of Default has been cured or waived.

        "Default Rate" means an annual interest rate equal to three percent (3%) over the initial Floating Rate, which interest rate shall change when and as the Base Rate changes.

        "Dilution" means, as of any date of determination, a percentage, based upon the experience of the calendar year-to-date period ending on the date of determination, that is the result of dividing the Dollar amount of (a) bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts during such period, by (b) Borrower's sales during such period (excluding extraordinary items) plus the Dollar amount of clause (a).

        "Dilution Reserve" means, as of any date of determination, an amount sufficient to reduce the advance rate against Eligible Accounts and/or the Eligible Foreign Accounts by one percentage point for each percentage point by which Dilution is in excess of 4%.

        "Director" means a director if the Borrower is a corporation, a manager if the Borrower is a limited liability company, or a general partner if the Borrower is a partnership.

        "Dollars" or "$" means lawful currency of the United States of America.

        "ERISA" means the Employee Retirement Income Security Act of 1974.

        "ERISA Affiliate" means any trade or business (whether or not incorporated) that is a member of a group which includes the Borrowers and which is treated as a single employer under Section 414 of the IRC.

        "Eligible Accounts" means those Accounts created by either Borrower in the ordinary course of its business, that arise out of such Borrower's sale of goods or rendition of services, that comply with each of the representations and warranties respecting Eligible Accounts made by the Borrowers in the Loan Documents, and that are not excluded as ineligible by virtue of one or more of the criteria set forth below; provided , however , that such criteria may be fixed and revised from time to time by the Lender in the Lender's sole and absolute discretion to address the results of any audit performed by the Lender from time to time after the Closing Date. In determining the amount to be included, Eligible Accounts shall be calculated net of customer deposits and unapplied cash remitted to the Borrower. Eligible Accounts shall not include the following:

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        "Eligible Foreign Account" means an Account that would be an Eligible Account except that the Account Debtor either (i) does not maintain its chief executive office in the United States, or (ii) is not organized under the laws of the United States or any state thereof, or (iii) is the government of any foreign country or sovereign state, or of any state, province, municipality, or other political subdivision thereof, or of any department, agency, public corporation, or other instrumentality thereof, but excluding any Accounts having the following characteristics:

        "Eligible Inventory" means Inventory consisting of raw chips and first quality finished goods consisting of custom memory products held for sale in the ordinary course of either Borrower's business, that complies with each of the representations and warranties respecting Eligible Inventory made by the Borrowers in this Agreement and the Loan Documents, and that is not excluded as ineligible by virtue of the one or more of the criteria set forth below; provided , however , that such criteria may be fixed and revised from time to time by the Lender in the Lender's sole and absolute discretion to address the results of any audit or appraisal performed by the Lender from time to time after the Closing Date. In determining the amount to be so included, Inventory shall be valued at the lower of cost or market on a basis consistent with the Borrowers' historical accounting practices. The following shall not be included in Eligible Inventory:

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        "Environmental Law" means any federal, state, local or other governmental statute, regulation, law or ordinance dealing with the protection of human health and the environment.

        "Equipment" means all of each Borrower's equipment, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all present and future machinery, vehicles, furniture, fixtures, manufacturing equipment, shop equipment, office and recordkeeping equipment, parts, tools, supplies, and including specifically the goods described in any equipment schedule or list herewith or hereafter furnished to the Lender by either Borrower.

        "Event of Default" has the meaning specified in Section 7.1.

        "FEIN" means Federal Employer Identification Number.

        "Financial Covenants" means the covenants set forth in Section 6.2.

        "Floating Rate" means an annual interest rate equal to the sum of the Base Rate plus the Applicable Margin, which interest rate shall, in each case, change when and as the Base Rate changes.

        "FREP Activation Notice" means a written notice from the Borrowers to the Lender of the Borrowers' request to obtain Advances against Eligible Foreign Accounts pursuant to the terms and conditions of this Agreement.

        "Funding Date" has the meaning given in Section 2.1.

        "GAAP" means generally accepted accounting principles, applied on a basis consistent with the accounting practices applied in the financial statements described in Section 5.6.

        "General Intangibles" means all of each Borrower's general intangibles, as such term is defined in the UCC, whether now owned or hereafter acquired, including all present and future Intellectual Property Rights, customer or supplier lists and contracts, manuals, operating instructions, permits, franchises, the right to use such Borrower's name, and the goodwill of such Borrower's business.

        "General Partner" means Netlist Holdings GP, Inc., a Texas corporation.

        "Governmental Authority" means any federal, state, local, or other governmental or administrative body, instrumentality, department, or agency or any court, tribunal, administrative hearing body, arbitration panel, commission, or other similar dispute-resolving panel or body.

        "Guarantor(s)" means Chun K. Hong, Christopher Lopes, Jayesh Bhakta, the General Partner and the Limited Partner and any other Person now or hereafter guarantying the Obligations.

        "Guaranty" means each certain Continuing Guaranty by a Guarantor in favor of the Lender.

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        "Hazardous Substances" means pollutants, contaminants, hazardous substances, hazardous wastes, petroleum and fractions thereof, and all other chemicals, wastes, substances and materials listed in, regulated by or identified in any Environmental Law.

        "Indebtedness" means of a Person as of a given date, all items of indebtedness or liability which in accordance with GAAP would be included in determining total liabilities as shown on the liabilities side of a balance sheet for such Person and shall also include the aggregate payments required to be made by such Person at any time under any lease that is considered a capitalized lease under GAAP.

        "IRC" means the Internal Revenue Code of 1986.

        "Infringe" means when used with respect to Intellectual Property Rights means any infringement or other violation of Intellectual Property Rights.

        "Insolvency Proceeding" means any proceeding commenced by or against any Person under any provision of the Bankruptcy Code or under any other state or federal bankruptcy or insolvency law, assignments for the benefit of creditors, formal or informal moratoria, compositions, extensions generally with creditors, or proceedings seeking reorganization, arrangement, or other similar relief.

        "Intellectual Property Rights" means all actual or prospective rights arising in connection with any intellectual property or other proprietary rights, including all rights arising in connection with copyrights, patents, service marks, trade dress, trade secrets, trademarks, trade names or mask works.

        "Inventory" means all of each Borrower's inventory, as such term is defined in the UCC, whether now owned or hereafter acquired, whether consisting of whole goods, spare parts or components, supplies or materials, whether acquired, held or furnished for sale, for lease or under service contracts or for manufacture or processing, and wherever located.

        "Inventory Advance Rate" means the lesser of (i) seventy percent (70%) of the appraised orderly liquidation recovery rate for Inventory or (ii) forty percent (40%).

        "Investment Property" means all of each Borrower's investment property, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all securities, security entitlements, securities accounts, commodity contracts, commodity accounts, stocks, bonds, mutual fund shares, money market shares and U.S. Government securities.

        "Issuer" means the issuer of any Letter of Credit.

        "L/C Amount" means the sum of (i) the aggregate face amount of any issued and outstanding Letters of Credit and (ii) the unpaid amount of the Obligation of Reimbursement.

        "L/C Application" means an application and agreement for letters of credit in a form acceptable to the Issuer and the Lender.

        "Letter of Credit" has the meaning specified in Section 2.5.

        "Licensed Intellectual Property" has the meaning given in Section 5.11(c).

        "Lien" means any security interest, mortgage, deed of trust, pledge, lien, charge, encumbrance, title retention agreement or analogous instrument or device, including the interest of each lessor under any capitalized lease and the interest of any bondsman under any payment or performance bond, in, of or on any assets or properties of a Person, whether now owned or hereafter acquired and whether arising by agreement or operation of law.

        "Limited Partner" means Netlist Holdings LP, Inc., a Delaware corporation.

        "Loan Account" has the meaning given in Section 9.9.

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        "Loan Documents" means this Agreement, the Note, each Guaranty, the Security Documents, the Subordination Agreements and any L/C Application.

        "Lockbox" means as defined in the Lockbox and Collection Account Agreement.

        "Lockbox and Collection Account Agreement" means each Lockbox and Collection Account Agreement by and among Borrowers, Wells Fargo Bank, N.A., and the Lender.

        "Material Adverse Effect" means any of the following:

        "Maturity Date" means July 2, 2006.

        "Maximum Line" means $15,000,000, unless reduced pursuant to Section 2.16, in which case it means such lesser amount.

        "Minimum Interest Charge" has the meaning given in Section 2.12(c).

        "Multiemployer Plan" means a multiemployer plan (as defined in Section 4001(a)(3) of ERISA) to which the Borrower or any ERISA Affiliate contributes or is obligated to contribute.

        "Net Income" and "Net Loss" mean fiscal year-to-date after-tax net income, or loss, as applicable, prepared on a consolidating and consolidated basis to include any Subsidiaries, from continuing operations as determined in accordance with GAAP.

        "Note" means the Revolving Note.

        "Obligation of Reimbursement" has the meaning given in Section 2.7(a).

        "Obligations" means the Note, the Obligation of Reimbursement and each and every other debt, liability and obligation of every type and description which either Borrower may now or at any time hereafter owe to the Lender, whether such debt, liability or obligation now exists or is hereafter created or incurred, whether it arises in a transaction involving the Lender alone or in a transaction involving other creditors of the Borrower, and whether it is direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or sole, joint, several or joint and several, and including all indebtedness of either Borrower arising under any Credit Document or guaranty between either Borrower and the Lender, whether now in effect or hereafter entered into.

        "Officer" means with respect to either Borrower, an officer if such Borrower is a corporation, or a partner if such Borrower is a partnership.

        "Owned Intellectual Property" has the meaning given in Section 5.11(a).

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        "Owner" means with respect to each Borrower, each Person having legal or beneficial title to an ownership interest in such Borrower or a right to acquire such an interest.

        "Pension Plan" means a pension plan (as defined in Section 3(2) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate and covered by Title IV of ERISA.

        "Permitted Lien" has the meaning given in Section 6.3(a).

        "Person" means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof.

        "Plan" means an employee benefit plan (as defined in Section 3(3) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate.

        "Premises" means all premises where the Borrower conducts its business and has any rights of possession, including the premises legally described in Exhibit D attached hereto.

        "Reportable Event" means a reportable event (as defined in Section 4043 of ERISA), other than an event for which the 30-day notice requirement under ERISA has been waived in regulations issued by the Pension Benefit Guaranty Corporation.

        "Revolving Advance" has the meaning given in Section 2.1.

        "Revolving Note" means the Borrowers' second replacement revolving promissory note, payable to the order of the Lender in substantially the form of Exhibit A hereto.

        "Security Agreements" means (i) the Security Agreement, dated as of the date hereof, executed by the General Partner in the Lender's favor, (ii) the Security Agreement, dated as of the date hereof, executed by the Limited Partner in the Lender's favor, and (iii) any other security agreement accepted by the Lender from time to time.

        "Security Documents" means this Agreement, the Lockbox and Collection Account Agreement, the Security Agreements and any other document delivered to the Lender from time to time to secure the Obligations.

        "Security Interest" has the meaning given in Section 3.1.

        "Solvent" means, with respect to any Person on a particular date, that such Person is not insolvent (as such term is defined in the Uniform Fraudulent Transfer Act).

        "Special Account" means a specified cash collateral account maintained by a financial institution acceptable to the Lender in connection with Letters of Credit, as contemplated by Section 2.6.

        "Subordinated Indebtedness" has the meaning given to such term in either Subordination Agreement.

        "Subordination Agreements" means (i) the Subordination Agreement, dated as of July 2, 2003, executed by Serim Paper Manufacturing Co., Ltd. in the Lender's favor and acknowledged by Netlist, (ii) the Subordination Agreement, dated as of July 2, 2003, executed by HeungHwa Industry Co. Ltd. in the Lender's favor and acknowledged by Netlist, and (iii) any other subordination agreement accepted by the Lender from time to time.

        "Subsidiary" means any corporation of which more than 50% of the outstanding shares of capital stock having general voting power under ordinary circumstances to elect a majority of the board of Directors of such corporation, irrespective of whether or not at the time stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency, is at the time directly or indirectly owned by the Borrower, by the Borrower and one or more other Subsidiaries, or by one or more other Subsidiaries.

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        "Termination Date" means the earliest of (i) the Maturity Date, (ii) the date the Borrowers terminate the Credit Facility, or (iii) the date the Lender demands payment of the Obligations after an Event of Default pursuant to Section 7.2.

        "UCC" means the Uniform Commercial Code as in effect in the state designated in Section 8.15 as the state whose laws shall govern this Agreement, or in any other state whose laws are held to govern this Agreement or any portion hereof.

        Section 1.2     Other Definitional Terms; Rules of Interpretation.     The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. All accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. All terms defined in the UCC and not otherwise defined herein have the meanings assigned to them in the UCC. References to Articles, Sections, subsections, Exhibits, Schedules and the like, are to Articles, Sections and subsections of, or Exhibits or Schedules attached to, this Agreement unless otherwise expressly provided. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". Unless the context in which used herein otherwise clearly requires, "or" has the inclusive meaning represented by the phrase "and/or". Defined terms include in the singular number the plural and in the plural number the singular. Reference to any agreement (including the Loan Documents), document or instrument means such agreement, document or instrument as amended or modified and in effect from time to time in accordance with the terms thereof (and, if applicable, in accordance with the terms hereof and the other Loan Documents), except where otherwise explicitly provided, and reference to any promissory note includes any promissory note which is an extension or renewal thereof or a substitute or replacement therefor. Reference to any law, rule, regulation, order, decree, requirement, policy, guideline, directive or interpretation means as amended, modified, codified, replaced or reenacted, in whole or in part, and in effect on the determination date, including rules and regulations promulgated thereunder.

ARTICLE II

AMOUNT AND TERMS OF THE CREDIT FACILITY

        Section 2.1     Revolving Advances.     The Lender agrees, on the terms and subject to the conditions herein set forth, to make advances to the Borrowers from time to time from the date all of the conditions set forth in Section 4.1 are satisfied (the "Funding Date") to the Termination Date (the "Revolving Advances"). The Lender shall have no obligation to make a Revolving Advance to the extent the amount of the requested Revolving Advance exceeds Availability. The Borrowers' obligation to pay the Revolving Advances shall be evidenced by the Revolving Note and shall be secured by the Collateral. Within the limits set forth in this Section 2.1, the Borrowers may borrow, prepay pursuant to Section 2.16 and reborrow.

        Section 2.2     Procedures for Requesting Advances.     The Borrowers shall comply with the following procedures in requesting Revolving Advances:

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        Section 2.3     Intentionally Omitted.     

        Section 2.4     Capital Adequacy; Funding Exceptions.     

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        Section 2.5     Letters of Credit.     

        Section 2.6     Special Account.     If the Credit Facility is terminated for any reason while any Letter of Credit is outstanding, the Borrowers shall thereupon pay the Lender in immediately available funds for deposit in the Special Account an amount equal to the L/C Amount. The Special Account shall be an interest bearing account maintained for the Lender by any financial institution acceptable to the Lender. Any interest earned on amounts deposited in the Special Account shall be credited to the Special Account. The Lender may apply amounts on deposit in the Special Account at any time or from time to time to the Obligations in the Lender's sole discretion. The Borrowers may not withdraw any amounts on deposit in the Special Account as long as the Lender maintains a security interest therein. The Lender agrees to transfer any balance in the Special Account to the Borrowers when the Lender is required to release its security interest in the Special Account under applicable law.

        Section 2.7     Payment of Amounts Drawn Under Letters of Credit; Obligation of Reimbursement.     Each Borrower acknowledges that the Lender, as co-applicant, will be liable to the Issuer for reimbursement of any and all draws under Letters of Credit and for all other amounts required to be paid under the applicable L/C Application. Accordingly, the Borrowers shall pay to the Lender any and all amounts required to be paid under the applicable L/C Application, when and as required to be paid thereby, and the amounts designated below, when and as designated:

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        Section 2.8     Obligations Absolute.     The Borrowers' obligations arising under Section 2.7 shall be absolute, unconditional and irrevocable, and shall be paid strictly in accordance with the terms of Section 2.7, under all circumstances whatsoever, including (without limitation) the following circumstances:

        Section 2.9     Intentionally Omitted.     

        Section 2.10     Inventory Appraisals.     The Lender may from time to time (and will, no less than four times each year) obtain at the Borrowers' expense an appraisal of Inventory by an appraiser acceptable to the Lender in its sole discretion.

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        Section 2.11     Intentionally Omitted.     

        Section 2.12     Interest; Applicable Margin; Minimum Interest Charge; Default Interest; Participations; Clearance Days; Usury.     

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        Section 2.13     Fees.     

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        Section 2.14     Time for Interest Payments; Payment on Non-Banking Days; Computation of Interest and Fees.     

        Section 2.15     Lockbox; Collateral Account; Application of Payments.     

        Section 2.16     Voluntary Prepayment; Termination of the Credit Facility by the Borrowers.     Except as otherwise provided herein, the Borrowers may prepay the Advances in whole at any time or from time to time in part. The Borrowers may terminate the Credit Facility at any time if it (i) gives the Lender at least 30 days' prior written notice and (ii) pays the Lender termination and prepayment fees in accordance with Section 2.13(e). Subject to termination of the Credit Facility and payment and

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performance of all Obligations, the Lender shall, at the Borrowers' expense, release or terminate the Security Interest and the Security Documents to which the Borrowers are entitled by law.

        Section 2.17     Mandatory Prepayment.     Without notice or demand, if the sum of the outstanding principal balance of the Revolving Advances plus the L/C Amount shall at any time exceed the Borrowing Base, the Borrowers shall (i) first, immediately prepay the Revolving Advances to the extent necessary to eliminate such excess; and (ii) if prepayment in full of the Revolving Advances is insufficient to eliminate such excess, pay to the Lender in immediately available funds for deposit in the Special Account an amount equal to the remaining excess. Any payment received by the Lender under this Section 2.17 or under Section 2.16 may be applied to the Obligations, in such order and in such amounts as the Lender, in its discretion, may from time to time determine.

        Section 2.18     Revolving Advances to Pay Obligations.     Notwithstanding anything in Section 2.1, the Lender may, in its discretion at any time or from time to time, without the Borrowers' request and even if the conditions set forth in Section 4.2 would not be satisfied, make a Revolving Advance in an amount equal to the portion of the Obligations from time to time due and payable.

        Section 2.19     Use of Proceeds.     The Borrowers shall use the proceeds of Advances and each Letter of Credit for ordinary working capital purposes.

        Section 2.20     Liability Records.     The Lender may maintain from time to time, at its discretion, records as to the Obligations. All entries made on any such record shall be presumed correct until the Borrowers establish the contrary. Upon the Lender's demand, the Borrowers will admit and certify in writing the exact principal balance of the Obligations that the Borrowers then assert to be outstanding. Any billing statement or accounting rendered by the Lender shall be conclusive and fully binding on the Borrowers unless the Borrowers give the Lender specific written notice of exception within 30 days after receipt.

ARTICLE III

SECURITY INTEREST; OCCUPANCY; SETOFF

        Section 3.1     Grant of Security Interest.     Each Borrower hereby pledges, assigns and grants to the Lender a lien and security interest (collectively referred to as the "Security Interest") in the Collateral, as security for the payment and performance of the Obligations. Upon request by the Lender, each Borrower will grant the Lender a security interest in all commercial tort claims it may have against any Person.

        Section 3.2     Notification of Account Debtors and Other Obligors.     The Lender may at any time (whether or not a Default Period then exists) notify any Account Debtor or other person obligated to pay the amount due that such right to payment has been assigned or transferred to the Lender for security and shall be paid directly to the Lender. The Borrowers will join in giving such notice if the Lender so requests. At any time after the Borrowers or the Lender gives such notice to an Account Debtor or other obligor, the Lender may, but need not, in the Lender's name or in the Borrowers' name, demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such right to payment, or grant any extension to, make any compromise or settlement with or otherwise agree to waive, modify, amend or change the obligations (including collateral obligations) of any such Account Debtor or other obligor.

        Section 3.3     Assignment of Insurance.     As additional security for the payment and performance of the Obligations, each Borrower hereby assigns to the Lender any and all monies (including proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of such Borrower with respect to, any and all policies of insurance now or at any time hereafter covering the Collateral or any evidence thereof or any business records or valuable papers pertaining thereto,

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and each Borrower hereby directs the issuer of any such policy to pay all such monies directly to the Lender. At any time, whether or not a Default Period then exists, the Lender may (but need not), in the Lender's name or in the Borrowers' name, execute and deliver proof of claim, receive all such monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy.

        Section 3.4     Occupancy.     

        Section 3.5     License.     Without limiting the generality of any other Security Document, each Borrower hereby grants to the Lender a non-exclusive, worldwide and royalty-free license to use or otherwise exploit all Intellectual Property Rights of such Borrower for the purpose of: (a) completing the manufacture of any in-process materials during any Default Period so that such materials become saleable Inventory, all in accordance with the same quality standards previously adopted by such Borrower for its own manufacturing and subject to such Borrower's reasonable exercise of quality control; and (b) selling, leasing or otherwise disposing of any or all Collateral during any Default Period.

        Section 3.6     Financing Statement.     Each Borrower authorizes the Lender to file from time to time where permitted by law, such financing statements against collateral described as "all personal property" or describing specific items of collateral including commercial tort claims as the Lender deems necessary or useful to perfect the Security Interest. A carbon, photographic or other reproduction of this Agreement or of any financing statements signed by either Borrower is sufficient

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as a financing statement and may be filed as a financing statement in any state to perfect the security interests granted hereby. For this purpose, the following information is set forth:

        Section 3.7     Setoff.     The Lender may at any time or from time to time, at its sole discretion and without demand and without notice to anyone, setoff any liability owed to the Borrowers by the Lender, whether or not due, against any Obligation, whether or not due. In addition, each other Person holding a participating interest in any Obligations shall have the right to appropriate or setoff any deposit or other liability then owed by such Person to the Borrowers, whether or not due, and apply the same to the payment of said participating interest, as fully as if such Person had lent directly to the Borrowers the amount of such participating interest.

        Section 3.8     Power of Attorney.     Each Borrower hereby irrevocably makes, constitutes, and appoints the Lender (and any of the Lender's officers, employees, or agents designated by the Lender) as such Borrower's true and lawful attorney, with power to (a) if the Borrower refuses to, or fails timely to execute and deliver any of the documents required to be described in Section 8.5, sign the name of the Borrower on any of the documents described in Section 8.5, (b) at any time that an Event of Default has occurred and is continuing, sign the Borrower's name on any invoice or bill of lading relating to the Collateral, drafts against Account Debtors, or notices to Account Debtors, (c) send requests for verification of Accounts, (d) endorse the Borrower's name on any collection item that may come into the Lender's possession, (e) at any time that an Event of Default has occurred and is continuing, make, settle, and adjust all claims under Borrower's policies of insurance and make all determinations and decisions with respect to such policies of insurance, (f) at any time that an Event of Default has occurred and is continuing, settle and adjust disputes and claims respecting the Accounts, chattel paper, or General Intangibles directly with Account Debtors, for amounts and upon terms that the Lender determines to be reasonable, and the Lender may cause to be executed and delivered any documents and releases that the Lender determines to be necessary, and (g) notify the United States Postal Service to change the address for delivery of the Borrower's mail to any address designated by the Lender, otherwise intercept the Borrower's mail, and receive, open and dispose of the Borrower's mail, applying all Collateral as permitted under this Agreement and holding all other mail for the Borrower's account or forwarding such mail to the Borrower's last known address. The appointment of the Lender as each Borrower's attorney, and each and every one of its rights and powers, being coupled with an interest, is irrevocable until all of the Obligations have been fully and finally repaid and performed and the Lender's obligations to extend credit hereunder are terminated.

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ARTICLE IV

CONDITIONS OF LENDING

        Section 4.1     Conditions Precedent to the Initial Advances and Letter of Credit.     The Lender's obligation to make the initial Advances or to cause any Letters of Credit to be issued shall be subject to the condition precedent that the Lender shall have received all of the following, each in form and substance satisfactory to the Lender:

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        Section 4.2     Conditions Precedent to All Advances and Letters of Credit.     The Lender's obligation to make each Advance and to cause each Letter of Credit to be issued shall be subject to the further conditions precedent that:

ARTICLE V

REPRESENTATIONS AND WARRANTIES

        Each Borrower represents and warrants to the Lender as follows:

        Section 5.1     Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number.     

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        Section 5.2     Capitalization.     Schedule 5.2 constitutes a correct and complete list of all ownership interests of the Borrower and rights to acquire ownership interests including the record holder, number of interests and percentage interests on a fully diluted basis, and an organizational chart showing the ownership structure of all Subsidiaries of the Borrower.

        Section 5.3     Authorization of Borrowing; No Conflict as to Law or Agreements.     The execution, delivery and performance by the Borrower of the Loan Documents and the borrowings from time to time hereunder have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of the Borrower's Owners; (ii) require any authorization, consent or approval by, or registration, declaration or filing with, or notice to, any Governmental Authority, or any third Person, except such authorization, consent, approval, registration, declaration, filing or notice as has been obtained, accomplished or given prior to the date hereof; (iii) violate any provision of any law, rule or regulation (including Regulation X of the Board of Governors of the Federal Reserve System) or of any order, writ, injunction or decree presently in effect having applicability to the Borrower or of the Borrower's Constituent Documents; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected; or (v) result in, or require, the creation or imposition of any Lien (other than the Security Interest) upon or with respect to any of the properties now owned or hereafter acquired by the Borrower.

        Section 5.4     Legal Agreements.     This Agreement constitutes and, upon due execution by the Borrower, the other Loan Documents will constitute the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms, except as enforcement may be limited by equitable principles or by bankruptcy, insolvency, reorganization, moratorium, or similar laws relating to or limiting creditors' rights generally.

        Section 5.5     Subsidiaries.     Except as set forth in Schedule 5.5 hereto, the Borrower has no Subsidiaries.

        Section 5.6     Financial Condition; No Adverse Change.     Netlist has furnished to the Lender its audited financial statements for its fiscal year ended December 31, 2001 and unaudited financial statements for the fiscal-year-to-date period ended May 31, 2003, and those statements fairly present Netlist's financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with generally accepted accounting principles. Since the date of the most recent financial statements, there has been no material adverse change in

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Netlist's business, properties or condition (financial or otherwise) which has had a Material Adverse Effect.

        Section 5.7     Litigation.     There are no actions, suits or proceedings pending or, to the Borrower's knowledge, threatened against or affecting the Borrower or any of its Affiliates or the properties of the Borrower or any of its Affiliates before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which, if determined adversely to the Borrower or any of its Affiliates, would have a Material Adverse Effect.

        Section 5.8     Regulation U.     The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock.

        Section 5.9     Taxes.     The Borrower and its Affiliates have paid or caused to be paid to the proper authorities when due all federal, state and local taxes required to be withheld by each of them. The Borrower and its Affiliates have filed all federal, state and local tax returns which to the knowledge of the Officers of the Borrower or any Affiliate, as the case may be, are required to be filed, and the Borrower and its Affiliates have paid or caused to be paid to the respective taxing authorities all taxes as shown on said returns or on any assessment received by any of them to the extent such taxes have become due.

        Section 5.10     Titles and Liens.     The Borrower has good and absolute title to all Collateral free and clear of all Liens other than Permitted Liens. No financing statement naming the Borrower as debtor is on file in any office except to perfect only Permitted Liens.

        Section 5.11     Intellectual Property Rights.     

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        Section 5.12     Plans.     Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate (i) maintains or has maintained any Pension Plan, (ii) contributes or has contributed to any Multiemployer Plan or (iii) provides or has provided post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required under Section 601 of ERISA, Section 4980B of the IRC or applicable state law). Neither the Borrower nor any ERISA Affiliate has received any notice or has any knowledge to the effect that it is not in full compliance with any of the requirements of ERISA, the IRC or applicable state law with respect to any Plan. No Reportable Event exists in connection with any Pension Plan. Each Plan which is intended to qualify under the IRC is so qualified, and no fact or circumstance exists which may have an adverse effect on the Plan's tax-qualified status. Neither the Borrower nor any ERISA Affiliate has (i) any accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the IRC) under any Plan, whether or not waived, (ii) any liability under Section 4201 or 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan or (iii) any liability or knowledge of any facts or circumstances which could result in any liability to the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Labor or any participant in connection with any Plan (other than routine claims for benefits under the Plan).

        Section 5.13     Default.     The Borrower is in compliance with all provisions of all agreements, instruments, decrees and orders to which it is a party or by which it or its property is bound or affected, the breach or default of which could have a Material Adverse Effect.

        Section 5.14     Environmental Matters.     

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        Section 5.15     Submissions to Lender.     All financial and other information provided to the Lender by or on behalf of the Borrower in connection with the Borrower's request for the credit facilities contemplated hereby is (i) true and correct in all material respects, (ii) does not omit any material fact necessary to make such information not misleading and, (iii) as to projections, valuations or proforma financial statements, present a good faith opinion as to such projections, valuations and proforma condition and results.

        Section 5.16     Financing Statements.     The Borrower has authorized the filing of financing statements sufficient when filed to perfect the Security Interest and the other security interests created by the Security Documents. When such financing statements are filed in the offices noted therein, the Lender will have a valid and perfected security interest in all Collateral which is capable of being perfected by filing financing statements. None of the Collateral is or will become a fixture on real estate, unless a sufficient fixture filing is in effect with respect thereto.

        Section 5.17     Rights to Payment.     Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral is (or, in the case of all future Collateral, will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, setoff or counterclaim, of the Account Debtor or other obligor named therein or in the Borrower's records pertaining thereto as being obligated to pay such obligation.

        Section 5.18     Eligible Accounts; Eligible Foreign Accounts.     Each Account included in the Borrowing Base is an "Eligible Account" or an "Eligible Foreign Account" as defined herein, and conforms to the definitions thereof.

        Section 5.19     Eligible Inventory.     All Inventory included in the Borrowing Base is "Eligible Inventory," as defined herein, and conforms to the definition thereof.

        Section 5.20     Equipment.     All of the Equipment is used or held for use in the Borrower's business and is fit for such purposes.

        Section 5.21     Fraudulent Transfer.     The Borrower is Solvent. No transfer of property is being made by the Borrower and no obligation is being incurred by the Borrower in connection with the

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transactions contemplated by this Agreement or the other Loan Documents with the intent to hinder, delay, or defraud either present or future creditors of the Borrower.

ARTICLE VI

COVENANTS

        So long as the Obligations shall remain unpaid, or the Credit Facility shall remain outstanding, each Borrower will comply with the following requirements, unless the Lender shall otherwise consent in writing:

        Section 6.1     Reporting Requirements.     The Borrower will deliver, or cause to be delivered, to the Lender each of the following, which shall be in form and detail acceptable to the Lender:

     

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Daily

 

(a)    a report of cash collections, sales assignments, credit memos/adjustments and deposits, copies of all invoices over $100,000, and a calculation of the Borrowing Base as of such date, and

 

 

(b)    notice of all returns, disputes, or claims.

Weekly

 

(c)    A copy of Dell Computers rolling 16 week forecast needs.

Monthly (not later than the 15th day of each month)

 

(d)    a detailed calculation of the Borrowing Base (including detail regarding those Accounts that are not Eligible Accounts or Eligible Foreign Accounts, and Inventory that is not Eligible Inventory),

 

 

(e)    a certified detailed listing and aging, by total, of the Accounts, together with a reconciliation to the detailed calculation of the Borrowing Base previously provided to Lender,

 

 

(f)    a summary aging, by vendor, of Borrower's accounts payable and any book overdraft, together with a reconciliation to the Borrower's general ledger and monthly financial statements delivered pursuant to Section 6.1(b),

 

 

(g)    an Inventory stock status report, by type and by location,

 

 

(h)    an Inventory slow moving report, and

 

 

(i)    an Inventory certification and perpetual report by location, including Inventory turnover by item number, together with a reconciliation to the Borrower's general ledger and monthly financial statements delivered pursuant to Section 6.1(b).

Semi-Annually

 

(j)    a detailed list of Borrower's customers

Upon request by Lender

 

(k)    copies of invoices in connection with the Accounts, credit memos, remittance advices, deposit slips, shipping and delivery documents in connection with the Accounts and, for Inventory and Equipment acquired by Borrower, purchase orders and invoices, and

 

 

(l)    such other reports as to the Collateral, or the financial condition of Borrower, as Lender may request.

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        Section 6.2     Financial Covenants.     

Test Date

  Minimum Book Net Worth Plus
Subordinated Indebtedness

12/31/03 and each month end thereafter   $ 5,583,000
Year to Date Period Ending

  Minimum Year to Date
Consolidated Net Income

12/31/03   $ 3,833,000

        Section 6.3     Permitted Liens; Financing Statements.     

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        Section 6.4     Indebtedness.     The Borrower will not incur, create, assume or permit to exist any Indebtedness or liability on account of deposits or advances or any Indebtedness for borrowed money or letters of credit issued on the Borrower's behalf, or any other Indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:

        Section 6.5     Guaranties.     The Borrower will not assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any obligations of any other Person, except:

        Section 6.6     Investments and Subsidiaries.     The Borrower will not purchase or hold beneficially any stock or other securities or evidences of indebtedness of, make or permit to exist any loans or advances to, or make any investment or acquire any interest whatsoever in, any other Person, including any partnership or joint venture, except:

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        Section 6.7     Dividends and Distributions.     The Borrower will not declare or pay any dividends (other than dividends payable solely in stock of the Borrower) or distributions on any class of its stock or partnership interests, as the case may be, or make any payment on account of the purchase, redemption or other retirement of any shares of such stock or such partnership interests or make any distribution in respect thereof, either directly or indirectly.

        Section 6.8     Salaries.     The Borrower will not pay excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation; or increase the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families.

        Section 6.9     Intentionally Omitted.     

        Section 6.10     Books and Records; Inspection and Examination.     The Borrower will keep accurate books of record and account for itself pertaining to the Collateral and pertaining to the Borrower's business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender's request, will permit any officer, employee, attorney or accountant for the Lender to audit, review, make extracts from or copy any and all company and financial books and records of the Borrower at all times during ordinary business hours, to send and discuss with Account Debtors and other obligors requests for verification of amounts owed to the Borrower, and to discuss the Borrower's affairs with any of its Directors, Officers, employees or agents. The Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to Lender, at the Borrower's expense, all financial information, books and records, work papers, management reports and other information in their possession regarding the Borrower. The Borrower will permit the Lender, or its employees, accountants, attorneys or agents, to examine and inspect any Collateral or any other property of the Borrower at any time during ordinary business hours.

        Section 6.11     Account Verification.     The Lender may at any time and from time to time send or require the Borrower to send requests for verification of accounts or notices of assignment to Account Debtors and other obligors. The Lender may also at any time and from time to time telephone Account Debtors and other obligors to verify accounts.

        Section 6.12     Compliance with Laws.     

        Section 6.13     Payment of Taxes and Other Claims.     The Borrower will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a Lien upon any properties of the Borrower; provided, that the Borrower shall not be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made.

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        Section 6.14     Maintenance of Properties.     

        Section 6.15     Insurance.     The Borrower will obtain and at all times maintain insurance with insurers believed by the Borrower to be responsible and reputable, in such amounts and against such risks as may from time to time be required by the Lender, but in all events in such amounts and against such risks as is usually carried by companies engaged in similar business and owning similar properties in the same general areas in which the Borrower operates. Without limiting the generality of the foregoing, the Borrower will at all times keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (for Collateral consisting of motor vehicles) and such other risks and in such amounts as the Lender may reasonably request, with any loss payable to the Lender to the extent of its interest, and all policies of such insurance shall contain a lender's loss payable endorsement for the Lender's benefit. All policies of liability insurance required hereunder shall name the Lender as an additional insured.

        Section 6.16     Preservation of Existence.     The Borrower will preserve and maintain its existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business and shall conduct its business in an orderly, efficient and regular manner.

        Section 6.17     Delivery of Instruments, etc.     Upon request by the Lender, the Borrower will promptly deliver to the Lender in pledge all instruments, documents and chattel paper constituting Collateral, duly endorsed or assigned by the Borrower.

        Section 6.18     Sale or Transfer of Assets; Suspension of Business Operations.     The Borrower will not sell, lease, assign, transfer or otherwise dispose of (i) the stock of any Subsidiary, (ii) all or a substantial part of its assets, or (iii) any Collateral or any interest therein (whether in one transaction or in a series of transactions) to any Person other than (x) another Borrower, (y) the sale of Inventory in the ordinary course of business, and (z) dispositions of obsolete, worn or nonfunctional equipment. The Borrower will not liquidate, dissolve or suspend business operations. The Borrower will not transfer any part of its ownership interest in any Intellectual Property Rights and will not permit any agreement under which it has licensed Licensed Intellectual Property to lapse, except that the Borrower may transfer such rights or permit such agreements to lapse if it shall have reasonably determined that the applicable Intellectual Property Rights are no longer useful in its business. If the Borrower transfers any Intellectual Property Rights for value, the Borrower will pay over the proceeds to the Lender for application to the Obligations. The Borrower will not license any other Person to use any of the Borrower's Intellectual Property Rights, except that the Borrower may grant licenses in the ordinary course of its business in connection with sales of Inventory or provision of services to its customers.

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        Section 6.19     Consolidation and Merger; Asset Acquisitions.     The Borrower will not consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person.

        Section 6.20     Sale and Leaseback.     The Borrower will not enter into any arrangement, directly or indirectly, with any other Person whereby the Borrower shall sell or transfer any real or personal property, whether now owned or hereafter acquired, and then or thereafter rent or lease as lessee such property or any part thereof or any other property which the Borrower intends to use for substantially the same purpose or purposes as the property being sold or transferred.

        Section 6.21     Restrictions on Nature of Business.     The Borrower will not engage in any line of business materially different from that presently engaged in by the Borrower and will not purchase, lease or otherwise acquire assets not related to its business.

        Section 6.22     Accounting.     The Borrower will not adopt any material change in accounting principles other than as required by GAAP. The Borrower will not adopt, permit or consent to any change in its fiscal year.

        Section 6.23     Discounts, etc.     After notice from the Lender, the Borrower will not grant any discount, credit or allowance to any customer of the Borrower or accept any return of goods sold. The Borrower will not at any time modify, amend, subordinate, cancel or terminate the obligation of any Account Debtor or other obligor of the Borrower.

        Section 6.24     Plans.     Unless disclosed to the Lender pursuant to Section 5.12, neither the Borrower nor any ERISA Affiliate will (i) adopt, create, assume or become a party to any Pension Plan, (ii) incur any obligation to contribute to any Multiemployer Plan, (iii) incur any obligation to provide post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required by law) or (iv) amend any Plan in a manner that would materially increase its funding obligations.

        Section 6.25     Place of Business.     The Borrower will not transfer its chief executive office or principal place of business, or move, relocate, close or sell any business location. The Borrower will not permit any tangible Collateral or any records pertaining to the Collateral to be located in any state or area in which, in the event of such location, a financing statement covering such Collateral would be required to be, but has not in fact been, filed in order to perfect the Security Interest. The Borrower will not change its jurisdiction of organization.

        Section 6.26     Change in Name, Trade Name, Trade Style or FEIN.     Borrower shall not change its legal name, trade names, trade styles or FEIN, or add any new trade names or trade styles from those listed on Schedule 5.1; provided, however , that Borrower may amend Schedule 5.1 so long as (i) such amendment occurs by written notice to Secured Party not less than 30 days prior to the date on which such new name, trade name, trade style or FEIN becomes effective, and (ii) at the time of such written notification, Borrower executes and delivers any financing statement amendments or fixture filing amendments necessary to continue perfected Lender security interest in the Collateral.

        Section 6.27     Transactions With Affiliates.     The Borrower will not directly or indirectly enter into or permit to exist any transaction with any Affiliate of the Borrower except for transactions that are in the ordinary course of the Borrower's business, upon fair and reasonable terms, that are fully disclosed to the Lender, and that are no less favorable to the Borrower than would be obtained in an arm's length transaction with a non-Affiliate.

        Section 6.28     Performance by the Lender.     If the Borrower at any time fails to perform or observe any of the foregoing covenants contained in this Article VI or elsewhere herein, and if such failure shall continue for a period of ten calendar days after the Lender gives the Borrower written notice

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thereof (or in the case of the agreements contained in Sections 6.13 and 6.15, immediately upon the occurrence of such failure, without notice or lapse of time), the Lender may, but need not, perform or observe such covenant on behalf and in the name, place and stead of the Borrower (or, at the Lender's option, in the Lender's name) and may, but need not, take any and all other actions which the Lender may reasonably deem necessary to cure or correct such failure (including the payment of taxes, the satisfaction of Liens, the performance of obligations owed to Account Debtors or other obligors, the procurement and maintenance of insurance, the execution of assignments, security agreements and financing statements, and the endorsement of instruments); and the Borrower shall thereupon pay to the Lender on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys' fees and legal expenses) incurred by the Lender in connection with or as a result of the performance or observance of such agreements or the taking of such action by the Lender, together with interest thereon from the date expended or incurred at the Default Rate. To facilitate the Lender's performance or observance of such covenants of the Borrower, the Borrower hereby irrevocably appoints the Lender, or the Lender's delegate, acting alone, as the Borrower's attorney in fact (which appointment is coupled with an interest) with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file in the name and on behalf of the Borrower any and all instruments, documents, assignments, security agreements, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by the Borrower under this Section 6.28.

ARTICLE VII

EVENTS OF DEFAULT, RIGHTS AND REMEDIES

        Section 7.1     Events of Default.     "Event of Default", wherever used herein, means any one of the following events:

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        Section 7.2     Rights and Remedies .    During any Default Period, the Lender may exercise any or all of the following rights and remedies, all of which each Borrower acknowledges and agrees are commercially reasonable:

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Notwithstanding the foregoing, upon the occurrence of an Event of Default described in subsections (e) or (f) of Section 7.1, the Obligations shall be immediately due and payable automatically without presentment, demand, protest or notice of any kind.

        Section 7.3     Disclaimer of Warranties .    The Lender may sell the Collateral without giving any warranties as to the Collateral. The Lender may specifically disclaim any warranties of title or the like. This procedure will not be considered to adversely affect the commercial reasonableness of any sale of the Collateral.

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        Section 7.4     Compliance With Laws .    The Lender may comply with any applicable state or federal law requirements in connection with a disposition of the Collateral, and the Lender's compliance therewith will not be considered to adversely affect the commercial reasonableness of any sale of the Collateral.

        Section 7.5     No Marshalling .    The Lender shall be under no obligation to marshal any assets in favor of the Borrowers, or against or in payment of the Obligations or any other obligation owned to the Lender by the Borrowers or any other Person.

        Section 7.6     Borrowers to Cooperate .    Upon the exercise by the Lender of any power, right, privilege, or remedy pursuant to this Agreement which requires any consent, approval, registration, qualification, or authorization of any Governmental Authority, each Borrower agrees to execute and deliver, or will cause the execution and delivery of, all applications, certificates, instruments, assignments, and other documents and papers that the Lender or any purchaser of the Collateral may be required to obtain for such governmental consent, approval, registration, qualification, or authorization.

        Section 7.7     Application of Proceeds .    All proceeds realized as the result of any sale of the Collateral shall be applied by the Lender:

        Section 7.8     Remedies Cumulative .    The rights and remedies of the Lender under this Agreement, the other Loan Documents, and all other agreements contemplated hereby and thereby shall be cumulative. The Lender shall have all other rights and remedies not inconsistent herewith as provided under the UCC, by law, or in equity. No exercise by the Lender of any one right or remedy shall be deemed an election of remedies, and no waiver by the Lender of any default on the Borrowers' part shall be deemed a continuing waiver of any further defaults.

        Section 7.9     Lender Not Liable For The Collateral .    So long as the Lender complies with the obligations, if any, imposed by the UCC, the Lender shall not otherwise be liable or responsible in any way or manner for: (a) the safekeeping of the Collateral; (b) any loss or damage thereto occurring or arising in any manner or fashion or from any cause; (c) any diminution in the value thereof; or (d) any act or default of any carrier, warehouseman, bailee, forwarding agency, or other person whomsoever. The Borrowers bear the risk of loss or damage of the Collateral.

ARTICLE VIII

MISCELLANEOUS

        Section 8.1     No Waiver .    No failure or delay by the Lender in exercising any right, power or remedy under the Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any such right, power or remedy preclude any other or further exercise thereof or the exercise of any other right, power or remedy under the Loan Documents.

        Section 8.2     Amendments, Etc .    No amendment, modification, termination or waiver of any provision of any Loan Document or consent to any departure by the Borrowers therefrom or any release of a Security Interest shall be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the

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specific purpose for which given. No notice to or demand on the Borrowers in any case shall entitle the Borrowers to any other or further notice or demand in similar or other circumstances.

        Section 8.3     Addresses for Notices; Requests for Accounting .    Except as otherwise expressly provided herein, all notices, requests, demands and other communications provided for under the Loan Documents shall be in writing and shall be (a) personally delivered, (b) sent by first class United States mail, (c) sent by overnight courier of national reputation, or (d) transmitted by telecopy, in each case addressed or telecopied to the party to whom notice is being given at its address or telecopier number as set forth below next to its signature or, as to each party, at such other address or telecopier number as may hereafter be designated by such party in a written notice to the other party complying as to delivery with the terms of this Section. All such notices, requests, demands and other communications shall be deemed to have been given on (a) the date received if personally delivered, (b) when deposited in the mail if delivered by mail, (c) the date sent if sent by overnight courier, or (d) the date of transmission if delivered by telecopy, except that notices or requests to the Lender pursuant to any of the provisions of Article II shall not be effective until received by the Lender. All requests under Section 9210 of the UCC (i) shall be made in a writing signed by a person authorized under Section 2.2(b), (ii) shall be personally delivered, sent by registered or certified mail, return receipt requested, or by overnight courier of national reputation (iii) shall be deemed to be sent when received by the Lender and (iv) shall otherwise comply with the requirements of Section 9210. Each Borrower requests that the Lender respond to all such requests which on their face appear to come from an authorized individual and releases the Lender from any liability for so responding. The Borrowers shall pay Lender the maximum amount allowed by law for responding to such requests.

        Section 8.4     Intentionally Omitted .    

        Section 8.5     Further Documents .    The Borrowers will from time to time execute and deliver or endorse any and all instruments, documents, conveyances, assignments, security agreements, financing statements, control agreements and other agreements and writings that the Lender may reasonably request in order to secure, protect, perfect or enforce the Security Interest or the Lender's rights under the Loan Documents (but any failure to request or assure that the Borrowers execute, deliver or endorse any such item shall not affect or impair the validity, sufficiency or enforceability of the Loan Documents and the Security Interest, regardless of whether any such item was or was not executed, delivered or endorsed in a similar context or on a prior occasion).

        Section 8.6     Costs and Expenses .    The Borrowers shall pay on demand all costs and expenses, including reasonable attorneys' fees, incurred by the Lender in connection with the Obligations, this Agreement, the Loan Documents, any Letter of Credit and any other document or agreement related hereto or thereto, and the transactions contemplated hereby, including all such costs, expenses and fees incurred in connection with the negotiation, preparation, execution, amendment, administration, performance, collection and enforcement of the Obligations and all such documents and agreements and the creation, perfection, protection, satisfaction, foreclosure or enforcement of the Security Interest.

        Section 8.7     Indemnity .    In addition to the payment of expenses pursuant to Section 8.6, each Borrower shall indemnify, defend and hold harmless the Lender, and any of its participants, parent corporations, subsidiary corporations, affiliated corporations, successor corporations, and all present and future officers, directors, employees, attorneys and agents of the foregoing (the "Indemnitees") from and against any of the following (collectively, "Indemnified Liabilities"):

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        If any investigative, judicial or administrative proceeding arising from any of the foregoing is brought against any Indemnitee, upon such Indemnitee's request, the Borrowers, or counsel designated by the Borrowers and satisfactory to the Indemnitee, will resist and defend such action, suit or proceeding to the extent and in the manner directed by the Indemnitee, at the Borrowers' sole costs and expense. Each Indemnitee will use its best efforts to cooperate in the defense of any such action, suit or proceeding. If the foregoing undertaking to indemnify, defend and hold harmless may be held to be unenforceable because it violates any law or public policy, the Borrowers shall nevertheless make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The Borrowers' obligation under this Section 8.7 shall survive the termination of this Agreement and the discharge of the Borrowers' other obligations hereunder.

        Section 8.8     Participants .    Each Borrower hereby authorizes the Lender to disclose to any assignee or any participant (either, a "Transferee") and any prospective Transferee any and all financial information in the Lender's possession concerning such Borrower which has been delivered to the Lender by the Borrower pursuant to this Agreement or which has been delivered to the Lender by the Borrower in connection with the Lender's credit evaluation prior to entering into this Agreement. The Lender and its participants, if any, are not partners or joint venturers, and the Lender shall not have any liability or responsibility for any obligation, act or omission of any of its participants. All rights and powers specifically conferred upon the Lender may be transferred or delegated to any of the Lender's participants, successors or assigns.

        Section 8.9     Advertising and Promotion .    Each Borrower agrees that the Lender may use such Borrower's name(s) in advertising and promotional materials, and in conjunction therewith, the Lender may disclose the amount of the Commitment and the purpose thereof.

        Section 8.10     Execution in Counterparts; Telefacsimile Execution .    This Agreement and other Loan Documents may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same instrument. Delivery of an executed counterpart of this Agreement by telefacsimile shall be equally as effective as delivery of an original executed counterpart of this Agreement. Any party delivering an executed counterpart of this Agreement by telefacsimile also shall deliver an original executed counterpart of this Agreement but the failure to deliver an original executed counterpart shall not affect the validity, enforceability, and binding effect of this Agreement.

        Section 8.11     Retention of Borrowers' Records .    The Lender shall have no obligation to maintain any electronic records or any documents, schedules, invoices, agings, or other papers delivered to the Lender by the Borrowers or in connection with the Loan Documents for more than four months after receipt by the Lender.

        Section 8.12     Binding Effect; Assignment; Complete Agreement; Exchanging Information .    The Loan Documents shall be binding upon and inure to the benefit of the Borrowers and the Lender and their respective successors and assigns, except that the Borrowers shall not have the right to assign their

43



rights thereunder or any interest therein without the Lender's prior written consent. To the extent permitted by law, each Borrower waives and will not assert against any assignee any claims, defenses or set-offs which such Borrower could assert against the Lender. This Agreement shall also bind all Persons who become a party to this Agreement as a borrower. This Agreement, together with the Loan Documents, comprises the complete and integrated agreement of the parties on the subject matter hereof and supersedes all prior agreements, written or oral, on the subject matter hereof. Without limiting the Lender's right to share information regarding the Borrowers and their Affiliates with the Lender's participants, accountants, lawyers and other advisors, the Lender, Wells Fargo & Company, and all direct and indirect subsidiaries of Wells Fargo & Company, may exchange any and all information they may have in their possession regarding the Borrowers and their Affiliates, and each Borrower waives any right of confidentiality it may have with respect to such exchange of such information.

        Section 8.13     Severability of Provisions .    Any provision of this Agreement which is prohibited or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof.

        Section 8.14     Revival and Reinstatement of Obligations .    If the incurrence or payment of the Obligations by either Borrower or any Guarantor or the transfer to the Lender of any property should for any reason subsequently be declared to be void or voidable under any state or federal law relating to creditors' rights, including provisions of the Bankruptcy Code relating to fraudulent conveyances, preferences, or other voidable or recoverable payments of money or transfers of property (collectively, a "Voidable Transfer"), and if the Lender is required to repay or restore, in whole or in part, any such Voidable Transfer, or elects to do so upon the reasonable advice of its counsel, then, as to any such Voidable Transfer, or the amount thereof that the Lender is required or elects to repay or restore, and as to all reasonable costs, expenses, and attorneys fees of the Lender related thereto, the liability of such Borrower or any Guarantor automatically shall be revived, reinstated, and restored and shall exist as though such Voidable Transfer had never been made.

        Section 8.15     Headings .    Article, Section and subsection headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose.

        Section 8.16     Governing Law; Jurisdiction, Venue; Waiver of Jury Trial .    The Loan Documents shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of California. The parties hereto hereby (i) consent to the personal jurisdiction of the state and federal courts located in the State of California in connection with any controversy related to this Agreement; (ii) waive any argument that venue in any such forum is not convenient, (iii) agree that any litigation initiated by the Lender or the Borrowers in connection with this Agreement or the other Loan Documents may be venued in either the State or Federal courts located in Los Angeles County, State of California; and (iv) agree that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law.

THE PARTIES WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED ON OR PERTAINING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT.

ARTICLE IX

JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT

        Section 9.1     Joint and Several Liability .    Each Borrower agrees that it is jointly and severally, directly and primarily liable to Lender for payment, performance and satisfaction in full of the Obligations and that such liability is independent of the duties, obligations, and liabilities of the other

44


Borrower. Lender may bring a separate action or actions on each, any, or all of the Obligations against any Borrower, whether action is brought against the other Borrower or whether the other Borrower is joined in such action. In the event that any Borrower fails to make any payment of any obligation on or before the due date thereof, the other Borrower immediately shall cause such payment to be made or each of such obligations to be made or each of such Obligations to be performed, kept, observed, or fulfilled.

        Section 9.2     Primary Obligation; Waiver of Marshalling .    This Agreement and the Loan Documents to which Borrowers are a party are a primary and original obligation of each Borrower, are not the creation of a surety relationship, and are an absolute, unconditional, and continuing promise of payment and performance which shall remain in full force and effect without respect to future changes in conditions, including any change of law or any invalidity or irregularity with respect to this Agreement or the Loan Documents to which Borrowers are a party. Each Borrower agrees that its liability under this Agreement and the Loan Documents which Borrowers are a party shall be immediate and shall not be contingent upon the exercise or enforcement by Lender of whatever remedies they may have against the other Borrower, or the enforcement of any lien or realization upon any security Lender may at any time possess. Each Borrower consents and agrees that Lender shall be under no obligation to marshal any assets of any Borrower against or in payment of any or all of the Obligations.

        Section 9.3     Financial Condition of Borrowers .    Each Borrower acknowledges that it is presently informed as to the financial condition of the other Borrower and of all other circumstances which a diligent inquiry would reveal and which bear upon the risk of nonpayment of the Obligations. Each Borrower hereby covenants that it will continue to keep informed as to the financial condition of the other Borrower, the status of the other Borrower and of all circumstances which bear upon the risk of nonpayment. Absent a written request from any Borrower to Lender for information, each Borrower hereby waives any and all rights it may have to require Lender to disclose to such Borrower any information which Lender may now or hereafter acquire concerning the condition or circumstances of the other Borrower.

        Section 9.4     Continuing Liability .    The liability of each Borrower under this Agreement and the Loan Documents to which Borrowers are a party includes Obligations arising under successive transactions continuing, compromising, extending, increasing, modifying, releasing, or renewing the Obligations, changing the interest rate, payment terms, or other terms and conditions thereof, or creating new or additional Obligations after prior Obligations have been satisfied in whole or in part. To the maximum extent permitted by law, each Borrower hereby waives any right to revoke its liability under this Agreement and Loan Documents as to future indebtedness, and in connection therewith, each Borrower hereby waives any rights it may have under Section 2815 of the California Civil Code.

        Section 9.5     Additional Waivers .    Each Borrower absolutely, unconditionally, knowingly, and expressly waives:

45


46


        Section 9.6     Settlement or Releases .    Each Borrower consents and agrees that without notice to or by such Borrower, and without affecting or impairing the liability of such Borrower hereunder, Lender may, by action or inaction:

47


        Section 9.7     No Election .    Lender shall have the right to seek recourse against each Borrower to the fullest extent provided for herein, and no election by Lender to proceed in one form of action or proceeding, or against any party, or on any obligation, shall constitute a waiver of Lender's right to proceed in any other form of action or proceeding or against other parties unless Lender has expressly waived such right in writing. Specifically, but without limiting the generality of the foregoing, no action or proceeding by Lender under this Agreement and the Loan Documents shall serve to diminish the liability of any Borrower under this Agreement and the Loan Documents to which Borrowers are a party except to the extent that Lender finally and unconditionally shall have realized indefeasible payment by such action or proceeding.

        Section 9.8     Indefeasible Payment .    The Obligations shall not be considered indefeasibly paid unless and until all payments to Lender are no longer subject to any right on the part of any Person, including any Borrower, any Borrower as a debtor in possession, or any trustee (whether appointed pursuant to the Bankruptcy Code, or otherwise) of any of Borrower's assets to invalidate or set aside such payments or to seek to recoup the amount of such payments or any portion thereof, or to declare same to be fraudulent or preferential. Upon such full and final performance and indefeasible payment of the Obligations, Lender shall have no obligation whatsoever to transfer or assign its interest in this Agreement and the Loan Documents to any Borrower. In the event that, for any reason, any portion of such payments to Lender is set aside or restored, whether voluntarily or involuntarily, after the making thereof, then the obligation intended to be satisfied thereby shall be revived and continued in full force and effect as if said payment or payments had not been made, and any Borrower shall be liable for the full amount Lender is required to repay plus any and all costs and expenses (including attorneys' fees and attorneys' fees incurred in proceedings brought under the Bankruptcy Code) paid by Lender in connection therewith.

        Section 9.9     Single Loan Account .    At the request of Borrowers to facilitate and expedite the administration and accounting processes and procedures of the Credit Facility, Lender has agreed, in lieu of maintaining separate loan accounts on Lender's books in the name of each of the Borrowers, that Lender may maintain a single loan account under the name of both Borrowers (the "Loan Account"). All Advances or any other borrowings under the Credit Facility shall be made jointly and severally to Borrowers and shall be charged to the Loan Account, together with all interest and other charges as permitted under and pursuant to this Agreement. The Loan Account shall be credited with all repayments of Obligations received by Lender, on behalf of Borrowers, from either Borrower pursuant to the terms of this Agreement.

        Section 9.10     Apportionment of Proceeds of Advances .    Each Borrower expressly agrees and acknowledges that Lender shall have no responsibility to inquire into the correctness of the apportionment or allocation of or any disposition by any of Borrowers of (a) the Advances or any borrowings under the Credit Facility, or (b) any of the expenses and other items charged to the Loan Account pursuant to this Agreement. The Advances and all such borrowings and such expenses and other item shall be made for the collective, joint, and several account of Borrowers and shall be charged to the Loan Account.

48



        Section 9.11     Lender Held Harmless .    Each Borrower agrees and acknowledges that the administration of this Agreement on a combined basis, as set forth herein, is being done as an accommodation to Borrowers and at their request, and that Lender shall incur no liability to Borrowers as a result thereof. To induce Lender to do so, and in consideration thereof, each Borrower hereby agrees to indemnify and hold Lender harmless from and against any and all liability, expense, loss, damage, claim of damage, or injury, made against Lender by Borrowers or by any other person or entity, arising from or incurred by reason of such administration of the Agreement.

        Section 9.12     Borrowers' Integrated Operations .    Each Borrower represents and warrants to Lender that the collective administration of the Credit Facility is being undertaken by Lender pursuant to this Agreement because Borrowers are integrated in their operation and administration and require financing on a basis permitting the availability of credit from time to time to Borrowers. Each Borrower will derive benefit, directly and indirectly, from such collective administration and credit availability because the successful operation of each Borrower is enhanced by the continued successful performance of the integrated group.

* * *

[remainder of this page intentionally left blank]
* * *

49


        IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized as of the date first above written.

Netlist, Inc.   NETLIST, INC.

3 Goddard

 

 

 
Irvine, California 92618   By:  
Telecopier: (949) 435-0031    
Attention: Dan Skaggs
e-mail: dskaggs@netlistinc.com
    Name: Chun K. Hong
Its: President

Netlist Technology Texas, L.P.
9430 Research Blvd. Echelon IV, Suite 400

 

NETLIST TECHNOLOGY TEXAS L.P.
By: Netlist Holdings GP, Inc., its general partner
Austin, Texas 78759
Attention: Dan Skaggs
     
e-mail: dskaggs@netlistinc.com   By:  
     
Name: Chun K. Hong
Its: President

Wells Fargo Business Credit, Inc.

 

WELLS FARGO BUSINESS CREDIT, INC.
245 S. Los Robles Avenue, Suite 700
Pasadena, California 91101
     
Telecopier: (626) 844-9063   By:  
Attention: Hank Kaminski    
e-mail: kaminhm@wellsfargo.com     Name: Hank Kaminski
Its: Vice President

S-1



Table of Exhibits and Schedules

Exhibit A   Form of Replacement Revolving Note

Exhibit C

 

Compliance Certificate

Exhibit D

 

Premises

Schedule 1

 

Unacceptable Countries

Schedule 5.1

 

Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral

Schedule 5.2

 

Capitalization and Organizational Chart

Schedule 5.5

 

Subsidiaries

Schedule 5.11

 

Intellectual Property Disclosures

Schedule 6.3

 

Permitted Liens

Schedule 6.4

 

Permitted Indebtedness and Guaranties

Schedule E

 

Eligible Equipment


Exhibit A to Credit and Security Agreement

SECOND REPLACEMENT REVOLVING NOTE

$15,000,000   Irvine, California

December 27, 2003

 

 

        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promises to pay on the Termination Date under the Credit Agreement (defined below), to the order of WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), at its main office in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Fifteen Million Dollars ($15,000,000) or, if less, the aggregate unpaid principal amount of all Revolving Advances made by the Lender to the Borrowers under the Credit Agreement (defined below) together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Note is fully paid at the rate from time to time in effect under the Amended and Restated Credit and Security Agreement of even date herewith (the "Credit Agreement") by and between the Lender and the Borrowers. The principal hereof and interest accruing thereon shall be due and payable as provided in the Credit Agreement. This Note may be prepaid only in accordance with the Credit Agreement.

        This Note is issued pursuant, and is subject, to the Credit Agreement, which provides, among other things, for acceleration hereof. This Note is the Revolving Note referred to in the Credit Agreement. This Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

        The Borrowers shall pay all costs of collection, including reasonable attorneys' fees and legal expenses if this Note is not paid when due, whether or not legal proceedings are commenced.

        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

    NETLIST, INC.

 

 

By

 
     
Its President

 

 

NETLIST TECHNOLOGY TEXAS L.P.

 

 

By:

Netlist Holdings GP, Inc., its general partner

 

 

By

 
     
Its President


Exhibit C to Credit and Security Agreement

Compliance Certificate

To:
Hank Kaminski
Wells Fargo Business Credit, Inc.

Date:                        , 200    

Subject:    Netlist, Inc. and Netlist Technology Texas LP

        In accordance with our Amended and Restated Credit and Security Agreement dated as of December 27, 2003 ("Credit Agreement"), attached are the consolidated financial statements of Netlist, Inc. ("Netlist") and Netlist Technology Texas LP (collectively with Netlist, the "Borrowers" and, individually, the "Borrower") as of and for                        , 20    (the "Reporting Date") and the year-to-date period then ended (the "Current Financials"). All terms used in this certificate have the meanings given in the Credit Agreement.

        The undersigned certifies that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present Netlist's financial condition as of the date thereof.

Events of Default.     (Check one):

Financial Covenants.     Each of the undersigned further hereby certify as follows:

Test Date

  Minimum Book Net Worth Plus Subordinated Indebtedness
12/27/03 and each month end thereafter   $ 5,583,000
Year to Date Period Ending

  Minimum Year to Date Net Income
12/27/03   $ 3,833,000

Exhibit C
1


        Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

    NETLIST, INC.

 

 

By

 
     
Its Chief Financial Officer

 

 

NETLIST TECHNOLOGY TEXAS LP

 

 

By:

Netlist Holdings GP, Inc.,
its general partner

 

 

By

 
     
Its Chief Financial Officer

Exhibit C
2



Exhibit D to Credit and Security Agreement

Premises

        The Premises referred to in the Credit and Security Agreement are legally described as follows:

Irvine, CA Location

PARCEL 7 OF PARCEL MAP NO 99-125, IN THE CITY OF IRVINE, COUNTY OF ORANGE, STATE OF CALIFORNIA, AS PER MAP FILED IN BOOK 312, PAGES 33 THROUGH 37 OF PARCEL MAPS, IN THE OFFICE OF THE COUNTY RECORDER OF SAID COUNTY.

PROPERTY ADDRESS Known as: 3 Goddard, Building 7, Irvine, CA

And,

PM 302-38, PAR 6 AND IRVINE SU/B BLK 171 LOT 311 POR OF LOT AND BLK 171 POR OF B, IN THE CITY OF IRVINE, COUNTY OF ORANGE, STATE OF CALIFORNIA
PROPERTY ADDRESS Known as: 475 Goddard, Suite 100, Irvine, CA

Texas Location

9430 Research Boulevard Echelon IV
Suite 400
Austin, Texas 78759

Exhibit D
1



Schedule 1 to Credit and Security Agreement
Unacceptable Countries

Afghanistan   Haiti   Romania
Albania   Iran   Russia
Algeria   Iraq   Serbia
Argentina   Kampuchea    
Armenia   Kazakhstan   Slovenia
Azerbaijan   Kyrgystan   Sudan
Belarus   Laos   Syria
Bosnia-Herzeqovina   Latvia   Turkmenistan
Bulgaria   Lebanon   Tadjikistan
Chad   Liberia   Ukraine
Croatia   Libya   United States
Cuba   Lithuania   Uzbekistan
Estonia   Myanma   Venezuela
Georgia   North Korea    

Schedule 1



Schedule E to Credit and Security Agreement
Eligible Equipment

None

Schedule E




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TABLE OF CONTENTS
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
ARTICLE I DEFINITIONS
Table of Exhibits and Schedules
Exhibit A to Credit and Security Agreement SECOND REPLACEMENT REVOLVING NOTE
Exhibit C to Credit and Security Agreement Compliance Certificate
Exhibit D to Credit and Security Agreement Premises
Schedule 1 to Credit and Security Agreement Unacceptable Countries
Schedule E to Credit and Security Agreement Eligible Equipment

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EXHIBIT 10.2


FIRST AMENDMENT TO AMENDED AND RESTATED
CREDIT AND SECURITY AGREEMENT

        This First Amendment to Amended and Restated Credit Agreement (this "Amendment"), dated as of June    , 2004, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), on the other hand.

Recitals

        The Borrowers and the Lender are parties to that certain Amended and Restated Credit and Security Agreement dated as of December 27, 2003 (as amended from time to time, the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.

        The Borrowers have requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.

        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:

        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.

        2.     Amendment.     Subsection (x) of the definition of Eligible Accounts set forth in Section 1.1 of the Credit Agreement is amended in its entirety to read as follows:

        3.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.

        4.     Conditions Precedent.     This Amendment shall be effective when the Lender shall have received: (a) an executed original hereof, together with the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor, each in substance and form acceptable to the Lender in its sole discretion; and (b) an accommodation fee of $2,500.

        5.     Representations and Warranties.     The Borrowers hereby represent and warrant to the Lender as follows:

1


        6.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.

        7.     Costs and Expenses.     The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses.

        8.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.

2



        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

    WELLS FARGO BUSINESS CREDIT, INC.

 

 

By:

 

 
       
Name: Hank Kaminski
Its:
Vice President

 

 

NETLIST, INC.

 

 

By:

 

 
       
        Name:  
         
        Its: President

 

 

NETLIST TECHNOLOGY TEXAS, L.P.

 

 

By:

 

 
       
        Name:  
         
        Its: President

3



ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS

        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

   
CHUN K. HONG, an individual

 

 


CHRISTOPHER LOPES, an individual

 

 


JAYESH BHAKTA, an individual

 

 

NETLIST HOLDINGS GP, INC.

 

 

By:

 

 

 
       
        Name:  
         
        Its:  
         

 

 

NETLIST HOLDINGS LP, INC.

 

 

By:

 

 

 
       
        Name:  
         
        Its:  
         

4



ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

    HEUNGHWA INDUSTRY CO., LTD

 

 

By:

 

 

 
       
        Name:  
         
        Its:  
         

 

 

SERIM PAPER MANUFACTURING CO., LTD

 

 

By:

 

 

 
       
        Name:  
         
        Its:  
         

5




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FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

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EXHIBIT 10.3


SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT
AND WAIVER OF DEFAULTS

        THIS AMENDMENT, dated as of December    , 2005, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.

RECITALS

        The Borrower and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to a Credit and Security Agreement dated as of December 23, 2003 as amended by a First Amendment to Credit and Security Agreement dated as of June 30, 2004 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.

        WFBCI has merged with and into Lender and Lender is the surviving corporation.

        The Borrower has requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.

        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:

        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein. In addition, Section 1.1 of the Credit Agreement is amended by adding or amending, as the case may be, the following definitions:

        "Accounts Advance Rate" means up to eighty-five percent (85%), or such lesser rate as the Lender in its sole discretion may deem appropriate from time to time ; provided that, as of any date of determination, the Accounts Advance Rate shall be reduced by one (1) percentage point for each percentage by which Dilution is in excess of 5%.

        "Applicable Margin" means, in the case of Advances against Eligible Foreign Accounts, 4.75 percentage points (475 basis points), and in the case of all other Advances, 3.50 percentage points (350 basis points).

        "Bridge Loan" means certain Subordinated Indebtedness to be obtained by the Borrowers in the amount of $1,000,000 in or about December, 2005, upon terms and conditions satisfactory to the Lender.

        "Borrowing Base" means at any time the lesser of:


        "Borrowing Base Reserve" means, as of any date of determination, such amounts (expressed as either a specified amount or as a percentage of a specified category or item) as the Lender may from time to time establish and adjust in reducing Availability (a) to reflect events, conditions, contingencies or risks which, as determined by the Lender, do or may affect (i) the Collateral or its value, (ii) the assets, business or prospects of the Borrower, or (iii) the security interests and other rights of the Lender in the Collateral (including the enforceability, perfection and priority thereof), or (b) to reflect the Lender's judgment that any collateral report or financial information furnished by or on behalf of the Borrower to the Lender is or may have been incomplete, inaccurate or misleading in any material respect, or (c) in respect of any state of facts that the Lender determines constitutes a Default or an Event of Default.

        "Business Day" means a day on which the Federal Reserve Bank of New York is open for business.

        "Commercial Letter of Credit Agreement" means an agreement governing the issuance of documentary letters of credit by the Lender, entered into between the Borrower as applicant and the Lender as issuer.

        "Dilution" means, as of any date of determination, a percentage, based upon the experience of the trailing six (6) month period ending on the date of determination, which is the result of dividing (a) actual bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts as determined by Lender in its sole discretion during such period, by (b) Borrower's net sales during such period (excluding extraordinary items) plus the amount of clause (a).

        "Foreign Accounts Eligibility Period" means from date of the Lender's receipt of the FREP Activation Notice until November 30, 2006.

        "Inventory Advance Rate" means thirty-four percent (34%), or such other rate as the Lender in its sole discretion may deem appropriate from time to time.

        "L/C Application" means an application for the issuance of standby or documentary letters of credit pursuant to the terms of a Standby Letter of Credit Agreement or a Commercial Letter of Credit Agreement, in form acceptable to the Lender.

        "Loan Documents" means this Agreement, the Note, the Guaranties, the Subordination Agreements, any L/C Applications and the Security Documents, together with every other agreement, note, document, contract or instrument to which the Borrower now or in the future may be a party and which is required by the Lender.

        "Maturity Date" means July 31, 2007.

        "Net Cash Proceeds" means in connection with any asset sale, the cash proceeds (including any cash payments received by way of deferred payment whether pursuant to a note, installment receivable or otherwise, but only as and when actually received) from such asset sale, net of (i) attorneys' fees, accountants' fees, investment banking fees, brokerage commissions and amounts required to be applied to the repayment of any portion of the Debt secured by a Lien not prohibited hereunder on the asset which is the subject of such sale, and (ii) taxes paid or reasonably estimated to be payable as a result of such asset sale.

        "Net Orderly Liquidation Value" means a professional opinion of the estimated most probable Net Cash Proceeds which could typically be realized at a properly advertised and professionally managed liquidation sale, conducted under orderly sale conditions for an extended period of time (usually six to nine months), under the economic trends existing at the time of the appraisal.



        "Obligation of Reimbursement" means the obligation of the Borrower to reimburse the Lender pursuant to the terms of the Standby Letter of Credit Agreement or the Commercial Letter of Credit Agreement and any applicable L/C Application.

        "Obligations" means each Note, the Obligation of Reimbursement and each and every other debt, liability and obligation of every type and description which the Borrower may now or at any time hereafter owe to the Lender, whether such debt, liability or obligation now exists or is hereafter created or incurred, whether it arises in a transaction involving the Lender alone or in a transaction involving other creditors of the Borrower, and whether it is direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or sole, joint, several or joint and several, and including all indebtedness of the Borrower arising under any Loan Document or guaranty between the Borrower and the Lender, whether now in effect or subsequently entered into, and all Wells Fargo Affiliate Obligations.

        "Prime Rate" means at any time the rate of interest most recently announced by the Lender at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of the Lender's base rates, and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof in such internal publication or publications as the Lender may designate. Each change in the rate of interest shall become effective on the date each Prime Rate change is announced by the Lender.

        "Standby Letter of Credit Agreement" means an agreement governing the issuance of standby letters of credit by Lender entered into between the Borrower as applicant and Lender as issuer.

        "Subordinated Indebtedness" has the meaning given to such term in each Subordination Agreement.

        "Subordination Agreements" means (i) the Subordination Agreement, dated as of July 2, 2003, executed by Serim Paper Manufacturing Co., Ltd. in the Lender's favor and acknowledged by Netlist, (ii) the Subordination Agreement, dated as of July 2, 2003, executed by HeungHwa Industry Co. Ltd. in the Lender's favor and acknowledged by Netlist, (iii) the Subordination Agreement(s) in the Lender's favor executed by the lenders of the Bridge Loan in connection therewith and acknowledged by Netlist, and (iv) any other subordination agreement accepted by the Lender from time to time.

        "Wells Fargo Affiliate Obligations" means all obligations, liabilities, contingent reimbursement obligations, fees, and expenses owing by the Borrower or its Subsidiaries to any Person that is owned in material part by the Lender, and that relates to any service or facility extended to the Borrower or its Subsidiaries, including: (a) credit cards, (b) credit card processing services, (c) debit cards, and (d) purchase cards, as well as any other services or facilities from time to time specified by the Lender, whether direct or indirect, absolute or contingent, due or to become due, and whether existing now or in the future.

        2.     Rules of Interpretation.     Section 1.2 of the Credit Agreement is amended to read as follows:


        3.     Termination Fee.     Section 2.13(e) of the Credit Agreement is amended in its entirety as follows:

        4.     FREP Fee.     Section 2.13(j) of the Credit Agreement is amended in its entirety as follows:

        5.     Financing Statements.     Section 3.6 of the Credit Agreement is amended by adding the following new sentence before the first sentence of that Section:

        6.     Projections.     Section 6.1(d) of the Credit Agreement is amended in its entirety as follows:

        7.     Financial Covenants.     Section 6.2 of the Credit Agreement is amended in its entirety as follows:


Test Date

  Minimum Book Net Worth Plus Subordinated Indebtedness(1)
10/31/05   $ 5,300,000
11/30/05   $ 5,250,000
12/31/05   $ 5,150,000
1/31/06   $ 5,100,000
2/28/06 and each month end thereafter   $ 5,100,000

(1)
The covenant levels set forth in this table shall be increased as follows:

        1)    On the funding of the Bridge Loan, Dollar for Dollar by the amount of the Bridge Loan;

        2)    Upon the sale of the Premises located at 3 Goddard, Irvine, CA 92618, Dollar for Dollar to the nearest $10,000,000 of the gain on such sale, calculated in accordance with GAAP; and

        3)    Upon the closing of any equity or debt offering of the Borrowers, an amount equal to 75% of the total capital raised in the month of closing.

Year to Date Period Ending

  Minimum Year to Date
Consolidated Net Income
(Maximum Net Loss)

12/31/05   <$450,000>

        8.     Permitted Indebtedness.     Section 6.4 of the Credit Agreement is amended in its entirety as follows:


        9.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.

        10.     Waiver of Defaults.     The Borrower is in default of the following provisions of the Credit Agreement (collectively, the "Existing Defaults"):

Section/Covenant

  Required Performance
7.2(a)—Minimum Book Net Worth Plus Subordinated Indebtedness   $5,583,000 from March 31, 2005 through September 30, 2005

7.2(b)—Minimum Year to Date Consolidated Net Income

 

$3,833,000 from November 30, 2004 through September 30, 2005

6.1(a)—Annual Financial Statements

 

Annual Financial Statements for fiscal year 2004 due 12/31/05

        Upon the terms and subject to the conditions set forth in this Amendment, the Lender hereby waives the Existing Defaults. This waiver shall be effective only in this specific instance and for the specific purpose for which it is given, and this waiver shall not entitle the Borrower to any other or further waiver in any similar or other circumstances.

        11.     Amendment Fee.     The Borrower shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $25,000 in consideration of the Lender's execution and delivery of this Amendment.

        12.     Conditions Precedent.     This Amendment , and the waiver set forth in Paragraph 10 hereof, shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:

        (a)   A Standby Letter of Credit Agreement and a Commercial Letter of Credit Agreement, and L/C Application for each Letter of Credit that the Borrowers wish to have issued thereunder.

        (b)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.

        (c)   Payment of the fee described in Paragraph 11.

        (d)   Such other matters as the Lender may require.

        13.     Representations and Warranties.     The Borrower hereby represents and warrants to the Lender as follows:

        (a)   The Borrower has all requisite power and authority to execute this Amendment to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by the Borrower and constitutes the legal, valid and binding obligation of the Borrower, enforceable in accordance with its terms.

        (b)   The execution, delivery and performance by the Borrower of this Amendment have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to the Borrower, or the articles of incorporation or by-laws of the Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected.

        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.



        14.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.

        15.     Prime Rate.     Each reference in the Credit Agreement to "Base Rate" will be deleted and replaced with the newly defined term "Prime Rate" set forth in Paragraph 2 of this Amendment. Each reference in the Credit Agreement to "Banking Day" will be deleted and replaced with the newly defined term "Business Day" set forth in Paragraph 2 of this Amendment

        16.     No Other Waiver.     Except as set forth in Paragraph 10 hereof, the execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.

        17.     Release.     

        (a)   The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which the Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:

        (b)   The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, the Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause

        18.     Costs and Expenses.     The Borrower hereby reaffirms its agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrower specifically agrees to pay all fees and disbursements of counsel to the Lender for the services



performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrower hereby agrees that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrower, make a loan to the Borrower under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses and the fee required under paragraph 11 of this Amendment.

        19.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.

[remainder of this page intentionally left blank]


        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.


 

 

 

 

 

 

 

 

 
WELLS FARGO BANK, NATIONAL ASSOCIATION   NETLIST, INC.
Through its Wells Fargo Business Credit operating division            
        By:       
        Name: Chun K. Hong
Its: President

By

 



 

 

 

 

 

 
Name: Jeffrey Cristol
Its Vice President
           

 

 

 

 

NETLIST TECHNOLOGY TEXAS L.P.
        By:   Netlist Holdings GP, Inc., its general partner

 

 

 

 

 

 

By:

 


            Name: Chun K. Hong
Its: President

9



ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS

        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.


 

 


CHUN K. HONG, an individual

 

 


CHRISTOPHER LOPES, an individual

 

 

 

JAYESH BHAKTA, an individual

 

 

NETLIST HOLDINGS GP, INC.

 

 

By:

 

    

    Name:
Its:

10


ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.


 

 

HEUNGHWA INDUSTRY CO., LTD

 

 

By:

 

    

    Name:
Its:

 

 

SERIM PAPER MANUFACTURING CO., LTD

 

 

By:

 

    

    Name:
Its:

11




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SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT AND WAIVER OF DEFAULTS
ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS

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Exhibit 10.4


THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT

        THIS AMENDMENT, dated as of February 14, 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.


RECITALS

        The Borrower and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to a Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Credit and Security Agreement, dated as of June 30, 2004 and a Second Amendment to Credit and Security Agreement, dated as of December 20, 2005 (as so amended, the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.

        WFBCI has merged with and into Lender and Lender is the surviving corporation.

        The Borrower has requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.

        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:

        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.

        2.     Amendment to Eligible Accounts.     Clause (x) of the definition of "Eligible Accounts" set forth in Section 1.1 of the Credit Agreement is amended in its entirety as follows:

        3.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.

        4.     Conditions Precedent.     This amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:

        (a)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.

        (b)   Such other matters as the Lender may require.

1



        5.     Representations and Warranties.     The Borrower hereby represents and warrants to the Lender as follows:

        (a)   The Borrower has all requisite power and authority to execute this Amendment to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by the Borrower and constitutes the legal, valid and binding obligation of the Borrower, enforceable in accordance with its terms.

        (b)   The execution, delivery and performance by the Borrower of this Amendment have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to the Borrower, or the articles of incorporation or by-laws of the Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected.

        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.

        6.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.

        7.     No Waiver.     The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.

        8.     Costs and Expenses.     The Borrower hereby reaffirms its agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limited the generality of the foregoing, the Borrowers specifically agrees to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrower hereby agrees that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrower, make a loan to the Borrower under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses.

        12.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.

[remainder of this page is intentionally left blank]

2


        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

    WELLS FARGO BUSINESS CREDIT, INC.

 

 

By:

 
     
Name:
Its:

 

 

NETLIST, INC.

 

 

By:

 
     
Name:
Its:

 

 

NETLIST TECHNOLOGY TEXAS, L.P.

 

 

By:

 
     
Name:
Its:

Third Amendment to Amended and Restated
Credit and Security Agreement

S-1


ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS

        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.


 

 


CHUN K. HONG, an individual

 

 


CHRISTOPHER LOPES, an individual

 

 


JAYESH BHAKTA, an individual

 

 

NETLIST HOLDINGS GP, INC.

 

 

By:

 
     
Name:
Its:

 

 

NETLIST HOLDINGS LP, INC.

 

 

By:

 
     
Name:
Its:

2



ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

    HEUNGHWA INDUSTRY CO., LTD

 

 

By:

 
     
Name:
Its:

3



ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

    SERIM PAPER MANUFACTURING CO., LTD

 

 

By:

 
     
Name:
Its:

4




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THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT
RECITALS
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

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Exhibit 10.5


FOURTH AMENDMENT TO
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
AND WAIVER OF DEFAULTS

        THIS AMENDMENT, dated as of April    , 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.

RECITALS

        The Borrowers and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to an Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Credit and Security Agreement, dated as of June 30, 2004, a Second Amendment to Credit and Security Agreement, dated as of December 20, 2005, and a Third Amendment to Credit and Security Agreement, dated as of February 14, 2006 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.

        WFBCI has merged with and into Lender and Lender is the surviving corporation.

        The Borrowers are in default of the following provisions of the Credit Agreement for the dates indicated (collectively, the "Existing Defaults"):

Section/Covenant

  Required Performance

6.2(a)—Minimum Book Net Worth Plus Subordinated Indebtedness   $5,150,000 at 12/31/05
$5,100,00 at 1/31/06
$5,100,000 at 2/28/06

6.2(b)—Maximum Year to Date Consolidated Net Loss

 

<$450,000> at 12/31/05

6.2(d)—Stop Loss

 

The Borrowers will not suffer a Net Loss in excess of $200,000 during any of the months of October, November or December, 2005, or in excess of $150,000 during the months of January and February 2006

6.1(a)—Reporting Requirements

 

The Borrowers shall deliver their audited Financial Statements within 90 days after the end of the fiscal years ended 12/31/04 and 12/31/05

        The Borrowers have requested that the Lender waive the Existing Defaults and make certain amendments to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.

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        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:

        1.     Defined Terms .    

        (a)   Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.

        (b)   The following definitions set forth in Section 1.1 of the Credit Agreement are hereby amended in their entirety as follows:

        (c)   The following new definitions are hereby added to Section 1.1 of the Credit Agreement in appropriate alphabetical order:

        (d)   Clause (b)(iii) of the definition of "Borrowing Base" set forth in Section 1.1 of the Credit Agreement is hereby amended in its entirety as follows:

        (e)   Upon consummation of the Private Offering and the Lender's verification of Borrowers' receipt of the Minimum Net Proceeds, the definitions of "Applicable Margin" and "Inventory Advance Rate" set forth in Section 1.1 of the Credit Agreement shall be automatically amended in their entirety as follows without further action required:

        (f)    Upon consummation of the Private Offering and the Lender's verification of Borrowers' receipt of the Minimum Net Proceeds, clause (b)(iii) of the definition of "Borrowing Base" set forth in

2


Section 1.1 of the Credit Agreement shall be automatically amended in its entirety as follows without further action required:

        (g)   Clause (x) of the definition of "Eligible Accounts" set forth in Section 1.1 of the Credit Agreement is hereby amended in its entirety as follows:

        2.     Financial Covenants .    Section 6.2 of the Credit Agreement is hereby amended in its entirety as follows:

Test Date

  Minimum Book Net Worth Plus
Subordinated Indebtedness(1)

3/31/06   $5,350,000
4/30/06   $5,200,000
5/31/06   $5,050,000
6/30/06   $5,100,000
7/31/06   $4,900,000
8/31/06   $4,925,000
9/30/06   $5,300,000
10/31/06   $5,450,000
11/30/06   $5,750,000
12/31/06 and thereafter   $6,250,000

(1)
The covenant levels set forth in this table shall be increased (1) upon the closing of the Private Offering or any other equity or debt offering of the Borrowers or Acquiror, by an amount equal to 100% of the total capital raised in the month of closing, and (2) by the amount of any positive adjustments to the Book Net Worth set forth in the Borrowers' consolidated financial statements for the fiscal years ended 12/31/04 and 12/31/05 as a result of the finalization of the CPA audits of those financial statements.

3


Month Ending

  Minimum Consolidated
Net Income (Maximum
Net Loss) if Private
Offering has not been
consummated prior to
such measurement period

  Minimum Consolidated
Net Income (Maximum
Net Loss) if Private
Offering has been
consummated prior to
such measurement period

3/31/06   $150,000   <$275,000>
4/30/06   <$350,000>   <$325,000>
5/31/06   <$300,000>   <$300,000>
6/30/06   <$50,000>   <$100,000>

 

 

 

 

 
Fiscal Quarter Ending

   
   
9/30/06   $550,000   $300,000
12/31/06   $900,000   $700,000

        3.     Permitted Liens .    Section 6.3(a) of the Credit Agreement is hereby amended in its entirety as follows:

        4.      Merger.    Section 6.19 of the Credit Agreement is hereby amended in its entirety as follows:

4


        5.     Private Offering .    The following new Section 6.29 is hereby added to the Credit Agreement immediately following Section 6.28 thereof as follows:

        6.     Change of Control .    Section 7.1(c) of the Credit Agreement is hereby amended in its entirety as follows:

        7.     Waiver of Existing Defaults .    Upon the terms and subject to the conditions set forth in this Amendment, the Lender hereby waives the Existing Defaults; provided that the Borrowers shall deliver their audited Financial Statements for their fiscal year ended December 31, 2005 on or before May 1, 2006 and otherwise in compliance with Section 6.1(a) of the Credit Agreement. Failure by the Borrowers to comply with the proviso at the end of the prior sentence shall constitute a new and separate Event of Default. The waiver set forth in the first sentence of this Paragraph 7 shall be effective only in this specific instance and for the specific purpose for which it is given, and this waiver shall not entitle the Borrowers to any other or further waiver in any similar or other circumstances.

        8.     Amendment Fee .    The Borrowers shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $15,000 in consideration of the Lender's execution and delivery of this Amendment.

        9.     No Other Changes .    Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.

        10.     Conditions Precedent .    This Amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:

        11.     Representations and Warranties .    Each Borrower hereby represents and warrants to the Lender as follows:

5


        12.     References .    All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.

        13.     No Waiver .    The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement (except for the Existing Defaults) or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.

        14.     Release .    

        (a)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which such Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:

        (b)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, each Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause.

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        15.     Costs and Expenses .    The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses, and the Amendment Fee described in Paragraph 8 above.

        16.     Miscellaneous .    This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.

[remainder of this page intentionally left blank]

7


        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

WELLS FARGO BANK, NATIONAL ASSOCIATION
Through its Wells Fargo Business Credit operating division
  NETLIST, INC.

By:

 

 


 

By:

 

 

Name:   Jeffrey Cristol   Name:   Chun K. Hong
Its   Vice President   Its:   President

 

 

 

 

NETLIST TECHNOLOGY TEXAS L.P.
        By:   Netlist Holdings GP, Inc., its general partner

 

 

 

 

By:

 

 

        Name:   Chun K. Hong
        Its:   President

8


ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS

        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 14 thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.


 

 


CHUN K. HONG , an individual

 

 


CHRISTOPHER LOPES , an individual

 

 


JAYESH BHAKTA , an individual

 

 

NETLIST HOLDINGS GP, INC.

 

 

By:

 

    Name:
Its:
 

9


ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 14 thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

    HEUNGHWA INDUSTRY CO., LTD

 

 

By:

 

    Name:
Its:
 

 

 

SERIM PAPER MANUFACTURING CO., LTD

 

 

By:

 

    Name:
Its:
 

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FOURTH AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT AND WAIVER OF DEFAULTS

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Exhibit 10.6


FIFTH AMENDMENT TO
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT

        This Amendment, dated as of July 28, 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION (as more fully defined in Paragraph 1 of this Amendment, the "Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division, on the other hand.

RECITALS

        The Borrowers and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to an Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Amended and Restated Credit and Security Agreement, dated as of June 30, 2004, a Second Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of December 20, 2005, a Third Amendment to Credit and Security Agreement, dated as of February 14, 2006, and a Fourth Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of April 18, 2006 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.

        WFBCI has merged with and into Lender and Lender is the surviving corporation.

        The Borrowers have requested that the Lender make certain amendments to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.

        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:

        1.     Defined Terms .    

1


2


Test Date

  Applicable Period
9/30/06   Three months ending on the test date
12/31/06   Six months ending on the test date
3/31/07   Nine months ending on the test date
6/30/07 and each fiscal quarter end thereafter   Twelve months ending on the test date

3


4


LIBOR

  Base LIBOR
    100%—LIBOR Reserve Percentage

5


        2.     Amendments to Sections 2.2 and 2.3 .    Sections 2.2 and 2.3 of the Credit Agreement are hereby amended in their entirety as follows:

6


        3.     Amendment to Sections 2.5, 2.6, 2.7 and 2.8 .    Sections 2.5, 2.6, 2.7 and 2.8 of the Credit Agreement are hereby amended in their entirety as follows:

7


8


        4.     Amendments to Section 2.9, 2.10 and 2.11.     Sections 2.9, 2.10 and 2.11 of the Credit Agreement are hereby amended in their entirety as follows:

9


        5.     Amendment to Sections 2.12(a), (b) and (c).     Sections 2.12(a), (b) and (c) of the Credit Agreement are hereby amended in their entirety as follows:

10


 
  Margins
 
 
  Floating Rate Advances
  LIBOR Advances
 
Condition

  Revolving
Advances

  Term
Advance
and
Equipment
Advances

  Revolving
Advances

  Term
Advance
and
Equipment
Advances

 

(i) Upon the Lender's receipt of satisfactory evidence that the Borrowers have received not less than $15,000,000 Net Cash Proceeds from an IPO on terms and conditions satisfactory to the Lender, in its sole discretion; or

 

0.0

%

0.0

%

2.5

%

2.5

%

(ii) Annual Net Income is determined by the Lender to be greater than $2,500,000

 

 

 

 

 

 

 

 

 

        6.     Amendment to Section 2.13(e).     Section 2.13(e) of the Credit Agreement is hereby amended in its entirety as follows:

        7.     Contracted Funds Breakage Fees; Overadvance Fees.     New Sections 2.13(k) and (l) are hereby added to the Credit Agreement immediately following Section 2.13(j) thereof as follows:

11


        8.     Repayment of Bridge Loan.     Section 2.19 of the Credit Agreement is hereby amended in its entirety as follows:

        9.     Amendment to Section 3.1.     Section 3.1 of the Credit Agreement is hereby amended in its entirety as follows:

12


        10.     Amendment to Section 6.1(b).     Section 6.1(b) of the Credit Agreement is amended in its entirety as follows:

        11.     Projections.     Section 6.1(d) of the Credit Agreement is amended in its entirety as follows:

13


        12.     Financial Covenants.     Section 6.2 of the Credit Agreement is hereby amended in its entirety as follows:

Test Date

  Minimum Book Net Worth Plus
Subordinated Indebtedness(1)

7/31/06   $ 5,550,000
8/31/06   $ 5,550,000
9/30/06   $ 5,850,000
10/31/06   $ 6,000,000
11/30/06   $ 6,250,000
12/31/06 and each month end thereafter   $ 6,700,000

(1)
The covenant levels set forth in this table shall be increased upon the closing of the Private Offering or any IPO or debt offering of the Borrowers or Acquiror, by an amount equal to 100% of the total capital raised in the month of closing.
Fiscal Quarter Ending

  Minimum Net Income
9/30/06   $ 300,000
12/31/06   $ 700,000
3/31/07   $ 300,000

        13.     Amendment to Section 6.4.     Section 6.4 of the Credit Agreement is hereby amended in its entirety as follows:

14


        14.     Amendments to Section 6.6.     

        (a)   Section 6.6(e) of the Credit Agreement is hereby amended in its entirety as follows:

        (b)   A new clause (f) is hereby added to Section 6.6 of the Credit Agreement immediately following clause (e) thereof as follows:

        15.     Amendment to Section 6.10.     Section 6.10 of the Credit Agreement is hereby amended in its entirety as follows:

15


        16.     Amendment to Section 6.29.     Section 6.29 of the Credit Agreement is hereby amended in its entirety as follows:

        17.     Amendment to Section 7.1.     Section 7.1 of the Credit Agreement is hereby amended by adding a new clause (x) immediately following clause (w) thereof as follows:

        18.     Amendment Fee.     The Borrowers shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $30,000 in consideration of the Lender's execution and delivery of this Amendment.

        19.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.

16


        20.     Conditions Precedent.     This Amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:

        (a)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.

        (b)   The Term Note and the Equipment Note, each duly executed by the Borrowers.

        (c)   A Payoff Letter from ARC indicating the amount required to repay the Bridge Loan in full and obtain a termination or release of all of the Liens existing in favor of ARC in and to the assets of Borrowers, and otherwise in form and substance satisfactory to the Lender.

        (d)   An Authority to Pay Letter on the Lender's standard form duly executed by the Borrowers authorizing and directing the Lender to pay ARC the amounts demanded in the Payoff Letter described in clause (c) above.

        (e)   Payment of the Amendment Fee described in Paragraph 18 above.

        (f)    Such other matters as the Lender may require.

        21.     Conditions Subsequent.     The effectiveness of this Amendment is further subject to and contingent upon the receipt by the Lender, on or before 5:00 p.m., August 28, 2006, of a Certificate of the Secretary of each Borrower, in form and substance satisfactory to the Lender in its sole discretion, certifying as to (i) the resolutions of the board of directors of such Borrower ratifying and approving the execution and delivery of this Amendment, the Term Note and the Equipment Note, (ii) true, correct and complete copies of such Borrower's Constituent Documents, and (iii) that the officers and agents of such Borrower who have been certified to the Lender pursuant to a Certificate of Authority of such Borrower's secretary or assistant secretary, as being authorized to sign and to act on behalf of such Borrower continue to be so authorized or setting forth the sample signatures of each of the officers and agents of such Borrower authorized to execute and deliver this Amendment, the Term Note and the Equipment Note, and all other documents, agreements and certificates on behalf of such Borrower. In the event that the Borrowers shall fail to fulfill the condition subsequent set forth in this Paragraph 21 to the satisfaction of the Lender, in its sole discretion, on or before the date indicated, such failure shall constitute an Event of Default.

        22.     Representations and Warranties.     Each Borrower hereby represents and warrants to the Lender as follows:

        (a)   Such Borrower has all requisite power and authority to execute this Amendment, the Term Note and the Equipment Note, to perform all of its obligations hereunder and thereunder, and this Amendment, the Term Note and the Equipment Note have been duly executed and delivered by such Borrower and constitute the legal, valid and binding obligation of such Borrower, enforceable in accordance with their terms.

        (b)   The execution, delivery and performance by each Borrower of this Amendment, the Term Note and the Equipment Note have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to such Borrower, or the articles of incorporation or by-laws of such Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which such Borrower is a party or by which it or its properties may be bound or affected.

17



        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.

        23.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby. All references in the Credit Agreement to "Obligations" (prior to giving effect to this Amendment) shall be deemed to be a reference to the new term "Indebtedness" set forth in Paragraph 1 above.

        24.     No Waiver.     The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement (except for the Existing Defaults) or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.

        25.     Release.     

        (a)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which such Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:

        (b)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, each Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause.

18


        26.     Costs and Expenses.     The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses, and the Amendment Fee described in Paragraph 18 above.

        27.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.

[remainder of this page intentionally left blank]

19


        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

WELLS FARGO BANK, NATIONAL ASSOCIATION
Through its Wells Fargo Business Credit operating division
  NETLIST, INC.

By

 

 


 

By:

 

 

Name:   Jeffrey Cristol   Name:   Chun K. Hong
Its   Vice President   Its:   President

 

 

 

 

NETLIST TECHNOLOGY TEXAS L.P.
        By:   Netlist Holdings GP, Inc., its general partner

 

 

 

 

 

 

By:

 

 

            Name:   Chun K. Hong
            Its:   President

Signature page to
Fifth Amendment To
Amended And Restated Credit And Security Agreement

S-1



ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
AND AMENDMENT TO GUARANTY

        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Bank, National Association (the "Lender"), acting through its Wells Fargo Business Credit operating division, successor-by-merger to Wells Fargo Business Credit, Inc., pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 25 thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

        Section 4 of each Guaranty is hereby amended in its entirety as follows:

        A new Section 25 is hereby added to each Guaranty immediately following Section 24 thereof as follows:

         25.     Termination and Release of Guaranty.     The Lender agrees to terminate and release this Guaranty promptly upon the Lender's receipt of satisfactory evidence that Borrowers have received not less than $15,000,000 Net Cash Proceeds from an IPO on terms and conditions satisfactory to the Lender, in its sole discretion; provided that no Default Period then exists.

[remainder of this page intentionally left blank]


   
CHUN K. HONG, an individual

 

 


CHRISTOPHER LOPES, an individual

 

 


JAYESH BHAKTA, an individual

 

 

NETLIST HOLDINGS GP, INC.

 

 

By:

 
     
    Name:
Its:
Agreed:    

WELLS FARGO BANK, NATIONAL ASSOCIATION
Through its Wells Fargo Business Credit operating division

 

 

By

 

 

 
 
   
Name: Jeffrey Cristol
Its Vice President
   

Signature page to
Acknowledgment And Agreement Of Guarantors
And Amendment To Guaranty

S-1



ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS

        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Bank, National Association (the "Lender"), acting through its Wells Fargo Business Credit operating division, successor-by-merger to Wells Fargo Business Credit, Inc., pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 25 thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

    HEUNGHWA INDUSTRY CO., LTD

 

 

By:

 
     
    Name:
Its:

 

 

SERIM PAPER MANUFACTURING CO., LTD

 

 

By:

 
     
    Name:
Its:

Signature page to
Acknowledgment And Agreement Of Guarantors
And Amendment To Guaranty

S-1


Exhibit A
to
Fifth Amendment to Amended and Restated Credit and Security Agreement


TERM NOTE

  $2,000,000   July 28, 2006

        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promise to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Lender"), acting through its Wells Fargo Business Credit operating division, on the Termination Date set forth in the Amended and Restated Credit and Security Agreement dated as of December 27, 2003 that was entered into by the Lender and the Borrowers (as amended to date and as may be further amended from time to time, the "Credit Agreement"), at Lender's main office located at in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Two Million Dollars ($2,000,000) or the aggregate unpaid principal amount of the Term Advance made by the Lender to the Borrowers under the Credit Agreement together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Term Note is fully paid at the rate from time to time in effect under the Credit Agreement.

        This Term Note is the Term Note referred to in the Credit Agreement, and is subject to the terms of, the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Term Note may be prepaid only in accordance with the terms of the Credit Agreement. This Term Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

        The Borrowers hereby agree to pay all costs of collection, including attorneys' fees and legal expenses in the event this Term Note is not paid when due, whether or not legal proceedings are commenced.

        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

    NETLIST, INC.

 

 

By:

 

 

 

 
       
        Name: Chun K. Hong
        Its: President

 

 

NETLIST TECHNOLOGY TEXAS L.P.
By: Netlist Holdings GP, Inc., its general partner

 

 

 

 

By:

 

 
           
        Name: Chun K. Hong
        Its: President

Exhibit A



Exhibit B
to
Fifth Amendment to Amended and Restated Credit and Security Agreement

EQUIPMENT NOTE

$2,000,000   July 28, 2006

        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promise to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Lender"), acting through its Wells Fargo Business Credit operating division, on the Termination Date set forth in the Amended and Restated Credit and Security Agreement dated as of December 27, 2003 that was entered into by the Lender and the Borrowers (as amended to date and as may be further amended from time to time, the "Credit Agreement"), at Lender's main office located at in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Two Million Dollars ($2,000,000) or the aggregate unpaid principal amount of all Equipment Advances made by the Lender to the Borrowers under the Credit Agreement together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Term Note is fully paid at the rate from time to time in effect under the Credit Agreement.

        This Equipment Note is the Equipment Note referred to in the Credit Agreement, and is subject to the terms of, the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Term Note may be prepaid only in accordance with the terms of the Credit Agreement. This Term Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

        The Borrowers hereby agree to pay all costs of collection, including attorneys' fees and legal expenses in the event this Term Note is not paid when due, whether or not legal proceedings are commenced.

        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

    NETLIST, INC

 

 

By:

 

    

    Name:   Chun K. Hong
    Its:   President

 

 

NETLIST TECHNOLOGY TEXAS L.P.
By: Netlist Holdings GP, Inc., its general partner

 

 

 

 

By:

 

    

        Name:   Chun K. Hong
        Its:   President

1



Exhibit C
to
Fifth Amendment to Amended and Restated Credit and Security Agreement

Compliance Certificate

To:   Jeffrey Cristol
Wells Fargo Business Credit

Date:

 

                        , 200    

Subject:

 

Netlist, Inc. and Netlist Technology Texas LP

        In accordance with our Amended and Restated Credit and Security Agreement dated as of December 27, 2003 (as amended to date, the "Credit Agreement"), attached are the consolidated financial statements of Netlist, Inc. ("Netlist") and Netlist Technology Texas LP (collectively with Netlist, the "Borrowers" and, individually, the "Borrower") as of and for                        , 20    (the "Reporting Date") and the year-to-date period then ended (the "Current Financials"). All terms used in this certificate have the meanings given in the Credit Agreement.

        The undersigned certifies that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present Netlist's financial condition as of the date thereof.

Events of Default.     (Check one):

Financial Covenants.    Each of the undersigned further hereby certify as follows:


        Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

    NETLIST, INC.

 

 

By

 

 
       
Its Chief Financial Officer

 

 

NETLIST TECHNOLOGY TEXAS LP

 

 

By:

 

Netlist Holdings GP, Inc.,
its general partner
        By  
         
Its Chief Financial Officer



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FIFTH AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS AND AMENDMENT TO GUARANTY
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
TERM NOTE
Exhibit B to Fifth Amendment to Amended and Restated Credit and Security Agreement
EQUIPMENT NOTE
Exhibit C to Fifth Amendment to Amended and Restated Credit and Security Agreement Compliance Certificate

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Exhibit 10.8

         LOGO

January 11, 2006

Mr. Lee Kim
19172 Red Bluff Drive
Trabuco Canyon, CA 92679

Dear Lee:

        This letter will serve as the entire agreement between Netlist, Inc. (the "Company") and you, Lee Kim (the "Employee"), with respect to your employment with the Company.

        1.     Term     

        The Employee will work full-time for the Company, beginning on January 14, 2006 (the "Beginning Date"). As an employee of the Company, the Employee will serve as its Chief Financial Officer and perform such services as are customary for an individual having such title and holding such position. The Employee agrees to comply with the Company's rules, regulations and practices adopted from time to time, so long as they are uniformly applied to all employees of the Company. The Employee further agrees that during his employment with the Company he shall not, directly or indirectly, engage or participate in any activities which are in conflict with the best interests of the Company.

        2.     Salary     

        Initially, the Employee will be paid an annual salary (the "Salary") of $200,000. Salary for any portion of a month will be prorated based upon the number of normal workdays remaining in the month. The salary will be subject to increase by the Company from time to time. The salary will be processed through payroll and paid at the same time as other executive employees.

        3.     Incentive Bonus and Equity Participation     

        The Employee will be entitled to receive incentive cash bonuses and/or warrants or options for the purchase of the Company's stock as specified on the attached Schedule A . During the course of the Employee's engagement hereunder, the Employee will remain a partner of Tatum CFO Partners, LLP ("Tatum") or its successor organization. As a partner of Tatum, the Employee will share with Tatum a portion of his economic interest in any stock options or equity bonus that the Company may grant the Employee and may also share with Tatum (to the extent specified in the Resources Agreement referenced below) a portion of any cash bonus and severance paid to the Employee by the Company. The Company acknowledges and consents to such arrangement.

        4.     Tatum Resources     

        The Company acknowledges and agrees that the Employee is and will remain a partner of, and has and will retain an interest in, Tatum, which will benefit the Company in that the Employee will have access to certain Tatum resources pursuant to a certain Full-Time Permanent Engagement Resources Agreement between the Company and Tatum (the "Resources Agreement").

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        5.     Employee Benefits     

        The Employee will be eligible for vacation and holidays consistent with the Company's policy as it applies to executive management and no waiting period will apply.

        The Company will reimburse the Employee for all out-of-pocket business expenses promptly after they are incurred.

        The Company will reimburse the Employee for the cost of continuing professional education consistent with the currently effective continuing education requirements of the American Institute of Certified Public Accountants.

        The Employee may elect to participate in the Company's employee retirement plan and/or 401(k) plan, and the Employee will be exempt from any delay periods required for eligibility.

        In lieu of the Employee participating in the Company-sponsored employee medical, dental and vision insurance benefit, the Employee will remain on his or her current Tatum medical plan. The Company will reimburse the Employee for amounts paid by the Employee for such medical insurance for himself and his family of up to $750.00 per month. In accordance with the U.S. federal tax law, such amount will not be considered reportable W-2 income, but instead non-taxable benefits expense.

        If the Company has directors' and officers' liability insurance in effect, the Company will provide such insurance coverage for the Employee, along with written evidence to the Employee that the Employee is covered by such insurance.

        Furthermore, the Company will maintain such insurance coverage, if any, with respect to occurrences arising during the term of this agreement for at least three years following the termination or expiration of this agreement or will purchase a directors' and officers' extended reporting period, or "tail," policy to cover the Tatum Partner.

        The Company agrees to indemnify the Employee to the full extent permitted by law for any losses, costs, damages, and expenses, including reasonable attorneys' fees, as they are incurred, in connection with any cause of action, suit, or other proceeding arising in connection with Employee's employment with the Company. This indemnity will not apply to Employee's gross negligence or willful misconduct or to actions taken by the Employee in bad faith.

        6.     Non-competition, Non-recruitment and Non-solicitation by Employee.     

        The Employee agrees that, during his employment with the Company, the Employee will not engage in any activity competitive with or adverse to the Company's business or welfare, whether alone, as a partner, or as an officer, director, employee or shareholder, of any other corporation or business entity and shall not otherwise undertake planning for or the organization of any business activity competitive with the Company's business or combine or conspire with other employees or representatives of the Company for the purpose of organizing any such competitive business activity. This prohibition shall not include ownership of less than five percent (5%) of the outstanding stock by the Employee in a publicly traded corporation.

        During his employment with the Company and for a period of two (2) years following the termination of the Employment, the Employee shall not, directly or indirectly, induce, solicit or influence or attempt to induce, solicit or influence any person who is engaged or employed by the Company (whether part-time or full-time and whether as an officer, employee, consultant, agent or advisor), to terminate his or her employment or other engagement with the Company. The Employee further agrees that, during his employment with the Company and for two (2) years after termination of such employment, the Employee will not in any manner seek to engage or employ any individual who is employed or engaged by the Company, as an officer, employee, consultant, agent or advisor for any person or entity other than the Company.

2



        The Employee agrees that during his employment with the Company and for two (2) years after termination of such employment, the Employee shall not, directly or indirectly, personally, or on behalf of or in conjunction with any person or entity, divert or take away any client or customer of the Company.

        7.     Trade Secrets of the Company.     

        The Employee acknowledges and understands that during his employment with the Company, the Employee will have access to and will utilize and review information which constitutes valuable, important and confidential trade secrets, as that term is interpreted under the Uniform Trade Secrets Act (California Civil Code Section 3426 et seq.) and/or confidential and proprietary material and information of or relating to the business of the Company necessary for the successful conduct of the Company's business. This information includes, but is not limited to: (a) listings of and data regarding the clients (past and current) of the Company (collectively, the "Clients"); (b) information regarding potential customers and clients; (c) data relating to the identity of the Clients of the Company; (d) information regarding bidding, billing and pricing practices; (e) information regarding the nature and type of services rendered to the Clients; (f) other methodologies, computer programs, databases, processes, compilations of information, results of proposals, job notes, reports and records, and (g) information regarding the nature and type of software products sold to or under development with any Client (all of which information is sometimes referred to in this Agreement as the "Secrets"). The foregoing notwithstanding, the Secrets shall not include information or data which is (i) in the public domain, (ii) generally known in the information technology staffing services industry, (iii) already known to the Employee as of the date he began his employment with the Company, or (iv) rightfully disclosed to the Employee outside of the scope of his employment with the Company by a third party not under a duty of confidentiality to the Company. The Employee understands further that the Secrets have been and will be accumulated, by the Employee and other personnel at the Company at considerable expense to the Company (including but not limited to compensation paid to the Company personnel dealing with the Secrets and the Clients), and that the Company has and will continue to expend its resources in order to maintain actively and vigorously the confidentiality of the Secrets, as such information is extremely valuable to the Company, and well worth the expense of enforcement and preservation of such confidentiality. Accordingly, the Employee agrees as follows:

3


        8.     Confidential Information of Clients.     

        All ideas, concepts, information and written material disclosed to the Employee by the Company, or acquired from any of the Clients, and all financial, accounting, statistical, personnel, and business data and plans of the Clients, are and shall remain the sole and exclusive property and proprietary information of the Company, or said Client, and are disclosed in confidence by the Company or permitted to be acquired from the Clients in reliance on the Employee's agreement to maintain them in confidence and not to use or disclose them to any other person except in furtherance of the Company's business.

        9.     Return of Information.     

        At the time of the termination of his employment with the Company, or upon request, the Employee agrees to deliver promptly to the Company all notes, books, electronic data (regardless of storage media), correspondence and other written or graphical records (including all copies thereof) in the Employee's possession or under the Employee's control relating to any business, work, the Clients or any other aspect of the Company, whether or not they contain any Secrets, including but not limited to each original and all copies of all or any part thereof.

        10.     Cooperation.     

        The Employee agrees to cooperate in good faith with the Company in connection with any defense, prosecution, or investigation by the Company regarding any actual or potential litigation, administrative proceeding, or other such procedures, in which the Company may be involved as a party or non-party from time to time.

        11.     Termination; Severance Payments     

        The Company and the Employee may terminate this Agreement at any time with 30 days written notice. In the event this Agreement is terminated other than by the Employee voluntarily or by the Company for Cause (as defined below), or by reason of the Employee's death or permanent disability, the Employee shall be entitled to the following: If the termination of this agreement is within one year of the Beginning Date, the Employee will be entitled to receive a severance payment ("Severance Payment") equal to one month's Salary. After one year of employment, the Employee will be entitled to receive a Severance Payment equal to four months' Salary. After two years of employment, the Employee will be entitled to receive a Severance Payment equal to six months' Salary. For each additional period of six (6) months' employment, the Employee will receive an additional one (1) month's Salary as a Severance Payment, provided that the total Severance Payment will be limited to a maximum of twelve (12) months' Salary. If this agreement is terminated by the Company without cause or the required notice, or by the Employee for cause, the Employee will be entitled to receive the Severance Payments noted in this paragraph, plus one additional month's compensation for early termination, and all cash bonuses, equity, and other compensation covered by this agreement will vest immediately and become payable at the date of termination.

        If the Employee is terminated without Cause as a result of, and within six (6) months of, a merger, sale or other change of control event of the Company, the Employee will be entitled to receive a Severance Payment equal to twelve (12) months' Salary, regardless of length of service. If immediately following a sale, merger or other change of control event the Employee's title is not Chief Financial Officer or the Employee's duties do not reflect those duties normally associated with the duties of a chief financial officer, the Employee can self-terminate after ninety (90) days following the change of control event and be entitled to receive a Severance Payment of twelve (12) months' Salary, regardless of length of service.

        For purposes of this Agreement, the term "Cause" means (1) the Employee's violation of this Agreement; (2) conviction of a felony, misappropriation of any material funds or property of the

4



Company, commission of fraud or embezzlement with respect to the Company, or any act or acts of dishonesty relating to the Employee's employment by the Company resulting or intended to result in direct or indirect personal gain or enrichment at the expense of the Company; (3) failing to perform his obligations or carry out his duties to the Company competently due to use of alcohol or drugs that renders the Employee unable to perform the essential functions of his job; (4) committing any act or omission of a nature involving malfeasance or negligence in the performance of the Employee's duties to the Company that is likely to cause a material adverse effect on the business of the Company; or (5) materially deviating from the written policies or directives of the Company, as communicated by its Chief Executive Officer or Board of Directors, in such manner as would reasonably be expected to constitute grounds for termination of an employee in a position similar to the Employee; provided that, with respect to (4) or (5) above, the Company shall have first provided the Employee written notice stating with specificity the acts, duties or directives the Employee has failed to observe or perform, and the Employee shall not have, in the reasonable opinion of the Company, corrected the acts or omissions complained of within thirty (30) days following delivery of such notice.

        This agreement will terminate immediately upon the death or disability of the Employee. For purposes of this agreement, disability will be as defined by the applicable policy of disability insurance or, in the absence of such insurance, by the Company's Board of Directors acting in good faith.

        12.     Miscellaneous     

        This agreement contains the entire agreement between the parties, superseding any prior oral or written statements or agreements.

        Neither the Employee nor the Company will be deemed to have waived any rights or remedies accruing under this agreement unless such waiver is in writing and signed by the party electing to waive the right or remedy. This agreement binds and benefits the successors of the parties.

        The provisions of this agreement concerning the payment of salary and bonuses, directors' and officers' insurance and confidentiality will survive any termination or expiration of this agreement.

        The terms of this agreement are severable and may not be amended except in a writing signed by the parties. If any portion of this agreement is found to be unenforceable, the rest of this agreement will be enforceable except to the extent that the severed provision deprives either party of a substantial portion of its bargain.

        This agreement will be governed by and construed in all respects in accordance with the laws of the State of California, without giving effect to conflicts-of-laws principles.

        Each person signing below is authorized to sign on behalf of the party indicated, and in each case such signature is the only one necessary.

        Please sign below and return a signed copy of this letter to indicate your agreement with its terms and conditions.

Sincerely yours,

NETLIST, INC.

By:

/s/ Chun K. Hong

Signature

Name: Chun K. Hong

5



Title: President

Acknowledged and agreed by:

    EMPLOYEE
         
   
(Signature)
         
    Lee Kim
(Print name)
         
    Date:  

Netlist, Inc.
475 Goddard
Irvine, CA 92618
T. 949.435.0025
F. 949.435.0031

6



SCHEDULE A

Incentive Cash Bonus, Stock, or Warrants/Options

1.     Incentive Cash Bonus     

        The Employee shall be entitled to an annual performance based incentive cash bonus equal to 50% of Salary. Performance goals will be agreed upon with the Company's Chief Executive Officer no later than 45 days after the Beginning Date.

2.     Stock, Warrants, Stock Options or Other Equity-Based Incentive Compensation     

        The Employee shall be granted as of the Beginning Date options to purchase 150,000 shares of common stock of the Company. Such options will vest over a 4-year period as follows: a) 25% upon the one-year anniversary of Beginning Date; and b) monthly thereafter at the rate of 2.083% per month. All unvested shares shall immediately vest upon a change of control as defined by the Company's approved option plan.

7




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SCHEDULE A Incentive Cash Bonus, Stock, or Warrants/Options

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EXHIBIT 10.9


Tatum, LLC
Full-Time Permanent Engagement Resources Agreement

January 10, 2006

Mr. C. K. Hong
Chief Executive Officer
Netlist, Inc.
475 Goddard
Irvine, CA 92618

Dear Mr. Hong:

        Tatum, LLC ("Tatum") understands that Netlist, Inc. (the "Company") desires to hire Lee Kim, one of our partners, as an employee of the Company (the "Employee"). The Company acknowledges that the Employee is and will remain a partner in our firm so that he will have access to our firm's resources for use in his employment with the Company. This Full-Time Permanent Engagement Resources Agreement (the "Resources Agreement") sets forth the rights of the Company, through the Employee, to use such resources for the benefit of the Company and for the payment for such services.

        Since the Employee will be under the control and direct management of the Company, and not Tatum, Tatum's obligations to the Company are exclusively those set forth in this Resources Agreement. This document will serve as the entire agreement between the Company and Tatum.

Compensation

        The Company will pay directly to Tatum, as partial compensation for the resources provided, an amount equal to (i) 1.67% of monthly Salary of the Employee during the first and second 12 months of the term of the Resources Agreement, (ii) 1.00% of monthly Salary during the third 12 months, and (iii) $1,000 per month during the remainder of the term of this Resources Agreement.

        The Company will pay directly to Tatum a portion of any Severance Payments that the Company may make to Employee equal to the same percentage that applies above with respect to Salary, or $1,000 per month of Severance Payment after 36 months under this Resources Agreement.

        In addition, the Company will pay directly to Tatum 15% of any Cash Bonus otherwise payable to the Employee during the term of this Resources Agreement. With respect to 15% of any Equity Bonus otherwise to be granted to the Employee, after receiving appropriate representations from Tatum for securities law purposes, the Company agrees to issue such 15% portion directly to Tatum, in lieu of the Employee, in the form of one or more warrants containing terms and conditions substantially equivalent to those applicable to the portion of Equity Bonus retained by the Employee.

        For purposes hereof, (i) "Cash Bonus" means any contingent cash consideration (i.e., not yet realized in cash) that is paid, (ii) "Equity Bonus" means any stock, option, warrant, or similar right (i.e., not yet realized in cash) that is granted, in each case in connection with services rendered by the Employee, and (iii) "Salary" means all compensation, including severance, paid to Employee, except bonuses and benefits (including medical benefits subsidy paid to Employee). All compensation payable or deliverable to Tatum is referred to herein as the "Resource Fee."

        Payments to Tatum should be made by direct deposit through the Company's payroll system, or by an automated clearing house ("ACH") payment at the same time as payments are made to the Employee. If such payment method is not available and payments are made by check, Tatum will issue invoices to the Company, and the Company agrees to pay such invoices no later than ten (10) days after receipt of invoices.



Deposit

        Company agrees to pay Tatum and maintain a security deposit of $5,000 for the Company's future payment obligations to Tatum under this Resources Agreement (the "Deposit"). If the Company breaches this Resources Agreement and fails to cure such breach as provided herein, Tatum will be entitled to apply the Deposit to its damages resulting from such breach. Upon termination or expiration of this Resources Agreement, Tatum will return to the Company the balance of the Deposit remaining after application of any amounts to unfulfilled payment obligations of the Company to Tatum as provided for in this Resources Agreement.

Termination

        This Resources Agreement will terminate immediately upon the effective date of termination or expiration of the Employee's employment with the Company or upon the Employee ceasing to be a partner of Tatum.

        In the event that either party commits a breach of this Resources Agreement and fails to cure the same within seven (7) days following delivery by the non-breaching party of written notice specifying the nature of the breach, the non-breaching party will have the right to terminate this Resources Agreement immediately effective upon written notice of such termination.

Hiring Employee Outside of Resources Agreement

        The parties recognize and agree that Tatum is responsible for introducing the Employee to the Company. Therefore, if, at any time during the twelve (12)-month period following the termination or expiration of this Resources Agreement as a result of the termination of Employee's employment with the Company, the Company employs the Employee or engages the Employee as an independent contractor (other than in connection with another form of Tatum agreement) to render services of substantially the same nature as those for which Tatum is making the Employee available pursuant to this Resources Agreement, Tatum will be entitled to receive as a placement fee an amount equal to forty-five percent (45%) of the Employee's Annualized Compensation (as defined below). The amount will be due and payable to Tatum upon written demand to the Company. In addition, any equity previously granted to Tatum will continue to vest for as long as Employee or independent contractor, as the case may be, provides services for the Company. For this purpose, "Annualized Compensation" will mean the lesser of: a) the most recent annual Salary and the maximum amount of any bonus for which the Employee was eligible with respect to the then current bonus year; or b) if the Employee becomes an independent contractor, the amount of total fees paid or payable over the course of the 12 months following the first date that independent contractor provides services to the Company.

Insurance

        To the extent the Company has directors' and officers' liability insurance in effect, the Company will provide such insurance coverage for the Employee, along with written evidence to Tatum or the Employee that the Employee is covered by such insurance.

        Furthermore, the Company will maintain such insurance coverage, if any, with respect to occurrences arising during the term of this agreement for at least three years following the termination or expiration of this agreement or will purchase a directors' and officers' extended reporting period, or "tail," policy to cover the Employee.

Disclaimers, Limitations of Liability & Indemnity

        It is understood that Tatum does not have a contractual obligation to the Company other than to make its resources available to the Employee (by virtue of the Employee being a partner in Tatum) for the benefit of the Company under the terms and conditions of this Resources Agreement. The Resource Fee will be for the resources provided. Tatum assumes no responsibility or liability under this Resources Agreement other than to render the services called for hereunder and will not be



responsible for any action taken by the Company in following or declining to follow any of Tatum's advice or recommendations.

        Tatum represents to the Company that Tatum has conducted its standard screening and investigation procedures with respect to the Employee becoming a partner in Tatum, and the results of the same were satisfactory to Tatum. Tatum disclaims all other warranties, either express or implied. Without limiting the foregoing, Tatum makes no representation or warranty as to the accuracy or reliability of reports, projections, forecasts, or any other information derived from use of Tatum's resources, and Tatum will not be liable for any claims of reliance on such reports, projections, forecasts, or information. Tatum will not be liable for any non-compliance of reports, projections, forecasts, or information or services with federal, state, or local laws or regulations. Such reports, projections, forecasts, or information or services are for the sole benefit of the Company and not any unnamed third parties.

        In the event that any partner of Tatum (including without limitation the Employee to the extent not otherwise entitled in his or her capacity as an officer of the Company) is subpoenaed or otherwise required to appear as a witness or Tatum or such partner is required to provide evidence, in either case in connection with any action, suit, or other proceeding initiated by a third party or by the Company against a third party, then the Company shall reimburse Tatum for the costs and expenses (including reasonable attorneys' fees) actually incurred by Tatum or such partner and provide Tatum with compensation at Tatum's customary rate for the time incurred.

        The Company agrees that, with respect to any claims the Company may assert against Tatum in connection with this Resources Agreement or the relationship arising hereunder, Tatum's total liability will not exceed twelve (12) months of the then current monthly Resource Fee.

        As a condition for recovery of any liability, the Company must assert any claim against Tatum within three (3) months after discovery or ninety (90) days after the termination or expiration of this Resources Agreement, whichever is earlier.

        Tatum will not be liable in any event for incidental, consequential, punitive, or special damages, including without limitation, any interruption of business or loss of business, profit, or goodwill.

Arbitration

        If the parties are unable to resolve any dispute arising out of or in connection with this Resources Agreement, either party may refer the dispute to arbitration by a single arbitrator selected by the parties according to the rules of the American Arbitration Association ("AAA"), and the decision of the arbitrator will be final and binding on both parties. In the event that the parties fail to agree on the selection of the arbitrator within thirty (30) days after either party's request for arbitration under this paragraph, the arbitrator will be chosen by AAA. The arbitrator may in his discretion order documentary discovery but shall not allow depositions without a showing of compelling need. The arbitrator will render his decision within ninety (90) days after the call for arbitration. The arbitrator will have no authority to award punitive damages. Judgment on the award of the arbitrator may be entered in and enforced by any court of competent jurisdiction. The arbitrator will have no authority to award damages in excess or in contravention of this Resources Agreement and may not amend or disregard any provision herein. Notwithstanding the foregoing, no issue related to the ownership of intellectual property will be subject to arbitration but will instead be subject to determination by a court of competent jurisdiction, and either party may seek injunctive relief in any court of competent jurisdiction.

Miscellaneous

        Tatum will be entitled to receive all reasonable costs and expenses incidental to the collection of overdue amounts under this Resources Agreement, including but not limited to attorneys' fees actually incurred.



        Neither the Company nor Tatum will be deemed to have waived any rights or remedies accruing under this Resources Agreement unless such waiver is in writing and signed by the party electing to waive the right or remedy. This Resources Agreement binds and benefits the successors of Tatum and the Company.

        Neither party will be liable for any delay or failure to perform under this Resources Agreement (other than with respect to payment obligations) to the extent such delay or failure is a result of an act of God, war, earthquake, civil disobedience, court order, labor dispute, or other cause beyond such party's reasonable control.

        The terms of this Resources Agreement are severable and may not be amended except in a writing signed by Tatum and the Company. If any portion of this Resources Agreement is found to be unenforceable, the rest of the Resources Agreement will be enforceable except to the extent that the severed provision deprives either party of a substantial portion of its bargain.

        The provisions in this Resources Agreement concerning payment of compensation and reimbursement of costs and expenses, limitation of liability, directors' and officers' insurance, and arbitration will survive any termination or expiration of this Resources Agreement.

        This Resources Agreement will be governed by and construed in all respects in accordance with the laws of the State of Georgia, without giving effect to conflicts-of-laws principles.

        Nothing in this Resources Agreement shall confer any rights upon any person or entity other than the parties hereto and their respective successors and permitted assigns and the Employee.

        Each person signing below is authorized to sign on behalf of the party indicated, and in each case such signature is the only one necessary.

Bank Lockbox Mailing Address for Deposit and Resource Fee only:

Electronic Payment Instructions for Deposit and Resource Fee:

Bank Name:   Bank of America
Branch:   Atlanta
Routing Number:   For ACH Payments: 061 000 052
For Wires: 026 009 593
Account Name:   Tatum, LLC
Account Number:   003 279 247 763
Please reference Netlist, Inc. in the body of the wire.

        Please sign below and return a signed copy of this letter to indicate the Company's agreement with its terms and conditions.

We look forward to serving you.

Sincerely yours,

TATUM, LLC

/s/   KARL HARDESTY      
Signature

Karl Hardesty
Area Managing Partner



Acknowledged and agreed by:

    NETLIST, INC.

 

 

By:

/s/  
CHUN K. HONG       

 

 

Title:

President

 

 

Date:

January 11, 2006



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Tatum, LLC Full-Time Permanent Engagement Resources Agreement

Exhibit 10.10

MASTER SALES AND SUPPLY AGREEMENT

BY AND BETWEEN

NETLIST, INC.

AND

NETLIST TECHNOLOGY TEXAS LP

EFFECTIVE AS OF January 1, 2004


SALES AND SUPPLY AGREEMENT ("AGREEMENT")

        This AGREEMENT is entered into as of January 1, 2004 (the "Effective Date"), by and between Netlist, Inc. (the "Supplier"), a Delaware corporation, and Netlist Technology Texas LP (the "Purchaser"), a Texas limited partnership.

RECITALS

        1.     Supplier is engaged in the development and manufacture of board level products for the high performance computing market;

        2.     The Purchaser desires to engage Supplier as its exclusive source for the type of consumer products produced by Supplier;

        3.     Supplier desires to sell its line of products to Purchaser and provide the services stated above.

        Therefore, in consideration of the mutual covenants and conditions contained herein, and for other good and valuable consideration, the parties hereby agree as follows:

ARTICLE I

DEFINITIONS

        Affiliate or Affiliates.     "Affiliate" or "Affiliates" shall mean a Texas LP, firm, partnership or other entity that directly or indirectly owns, is owned by, or is under common ownership with a party to this Agreement to the extent of at least fifty percent (50%) of the equity having the power to vote on or direct the affairs of the entity and any person, firm, partnership, corporation or other entity actually controlled by, controlling, or under common control with a party to this Agreement.

        Effective Date.     "Effective Date" is as defined immediately prior to the Recitals at the beginning of this Agreement.

        Product.     "Product" shall mean the board level products that are necessary to Purchaser's operations and that Purchaser purchases from Supplier.

        Purchase Price.     "Purchase Price" shall mean the amount computed per Section 2.2 of this Agreement, or another price agreed upon by Purchaser and Supplier.

        Purchaser Inventory.     "Purchaser Inventory" shall mean inventory owned by Purchaser and made available to Purchaser for sales to each company's respective customers.

        Term.     "Term" shall have the meaning set forth in Section 5.1 of this Agreement.

        Third Party or Third Parties.     "Third Party" or "Third Parties" shall mean any entity other than a party to this Agreement or an Affiliate.

        Year.     "Year" shall mean the twelve (12) month period ending on the 31 st of December.

ARTICLE II

TERMS OF SALES

         Section 2.1.    Orders.     Purchaser shall order Product as it shall desire from Supplier, and Supplier shall supply such Product as Purchaser desires, pursuant to such procedures as Supplier periodically shall specify.

         Section 2.2.    Pricing.     The Purchase Price of Product and Services ordered by Purchaser shall be calculated according to the formula described in Appendix A. Periodic pricing adjustments or credits

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may be made by Supplier to ensure that Purchaser maintains such Gross Profit Margin after taking into account an offset to Purchases reflecting inventory Supplier uses to fulfill its own customer orders.

         Section 2.3.    Supplier Advice.     Supplier shall advise Purchaser of all shipments of Products on a monthly basis.

         Section 2.4.    Payment Terms.     Payment generally should be paid within 30 day(s) of the end of each month. Any requests for credit or deduction by Purchaser (e.g., due to shortage in shipment quantity, quality defects, damage in transit, or related matters), shall be communicated promptly to Supplier.

        The above payments are to be made in currency of the United States during business hours, on the day due, either (1) by check or wire transfer, or (2) by an adjustment to the intercompany payable and receivable accounts between Supplier and Purchaser.

         Section 2.5.    Delivery, Title, and Risk of Loss.     The parties agree that delivery and transfer of title of Product to Purchaser will occur at Supplier's warehouse. Delivery and transfer of title to Product that is purchased by Supplier as a finished good will occur as inventory is shipped to Purchaser's warehouse. As such, Purchaser shall own all inventory located in the Netlist Technology Warehouse (NTW) (known as Purchaser Inventory). Periodically, Supplier will be allowed to fulfill orders for its customers from Purchaser Inventory. Purchaser shall lease or license from Supplier, warehouse and distribution areas within the Supplier's facilities to facilitate such title transfer and store Purchaser Inventory.

         Section 2.6.    Sales.     Supplier shall maintain complete and accurate records of all Product supplied to Purchaser. Purchaser shall have the right, at its expense and on a reasonable basis with reasonable prior written notice to Supplier, to examine such records during regular business hours during the term of this Agreement and for twelve months after termination of this Agreement.

         Section 2.7.    Intellectual Property.     With respect to all Product, Supplier grants Purchaser a non-exclusive, limited use, sublicensable, royalty-free license to use the logos, trademarks, patents, and other marks inherent in the Product. In addition, Supplier grants Purchaser a non-exclusive, limited use, sublicensable, royalty-free license to use its customer lists.

ARTICLE III

WARRANTIES AND REPRESENTATIONS

         Section 3.1.    Of Supplier.     Supplier warrants that:

         Section 3.2.    Of Purchaser.     Purchaser warrants that:

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ARTICLE IV

INDEMNIFICATION

        Supplier shall save, hold harmless, and defend Purchaser from and against any loss, cost, or expense, including reasonable attorneys' fees, damages, or penalties of any kind, on account of or resulting from any claim or action for infringement of any existing or future patent, copyright, or trademark, or misappropriation of any trade secret or other intellectual property right with respect to Product. Supplier shall defend any such claim or action at its expense provided that Purchaser promptly notifies Supplier on learning of any such claim or action and cooperates with Supplier in defending any such claim or action.

ARTICLE V

TERM AND TERMINATION

         Section 5.1.    Term.     This Agreement shall remain in effect for a period of one year from the Effective Date and shall automatically renew at the end of such year, and each succeeding year, for an additional one year.

         Section 5.2.    Termination.     Either party shall have the right to terminate this Agreement at any time by giving written notice to the other party on the occurrence of any of the following events:

         Section 5.3.    Rights and Duties on Termination.     On termination of this Agreement:

ARTICLE VI

MISCELLANEOUS

         Section 6.1.    Notices.     Any and all notices, elections, offers, acceptances, and demands permitted or required to be made under this Agreement shall be in writing, signed by the person giving such notice, election, offer, acceptance, or demand and shall be delivered personally, or sent by registered or certified mail, to the party, at its address on file with the other party, or at such other address as may

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be supplied in writing. The date of personal delivery or the date of mailing, as the case may be, shall be the date of such notice, election, offer, acceptance, or demand.

         Section 6.2.    Force-Majeure.     If the performance of any part of this Agreement by either party, or of any obligation under this Agreement, is prevented, restricted, interfered with, or delayed by reason of any cause beyond the reasonable control of the party liable to perform, unless conclusive evidence to the contrary is provided, the party so affected shall, on giving written notice to the other party, be excused from such performance to the extent of such prevention, restrictions interference or delay, provided that the affected party shall use its reasonable best efforts to avoid or remove such causes of nonperformance and shall continue performance with the utmost dispatch whenever such causes are removed. When such circumstances arise, the parties shall discuss what, if any, modification of the terms of this Agreement may be required in order to arrive at an equitable solution.

         Section 6.3.    Successors and Assigns.     This Agreement shall be binding on and shall inure to the benefit of the parties, Affiliates, their respective successors, successors in title, and assigns, and each party agrees, on behalf of it, its Affiliates, successors, successors in title, and assigns, to execute any instruments that may be necessary or appropriate to carry out and execute the purpose and intentions of this Agreement and hereby authorizes and directs its Affiliates, successors, successors in title, and assigns to execute any and all such instruments. Each and every successor in interest to any party or Affiliate, whether such successor acquires such interest by way of gift, devise, assignment, purchase, conveyance, pledge, hypothecation, foreclosure, or by any other method, shall hold such interest subject to all of the terms and provisions of this Agreement. The rights of the parties, Affiliates, and their successors in interest, as among themselves and shall be governed by the terms of this Agreement, and the right of any party, affiliate or successor in interest to assign, sell, or otherwise transfer or deal with its interests under this Agreement shall be subject to the limitations and restrictions of this Agreement.

         Section 6.4.    Amendment.     No change, modification, or amendment of this Agreement shall be valid or binding on the parties unless such change or modification shall be in writing signed by the party or parties against whom the same is sought to be enforced.

         Section 6.5.    Remedies Cumulative.     The remedies of the parties under this Agreement are cumulative and shall not exclude any other remedies to which the party may be lawfully, entitled.

         Section 6.6.    Further Assurances.     Each party hereby covenants and agrees that it shall execute and deliver such deeds and other documents as may be required to implement any of the provisions of this Agreement.

         Section 6.7.    No Waiver.     The failure of any party to insist on strict performance of a covenant hereunder or of any obligation hereunder shall not be a waiver of such party's right to demand strict compliance therewith in the future, nor shall the same be construed as a novation of this Agreement.

         Section 6.8.    Integration.     This Agreement constitutes the full and complete agreement of the parties.

         Section 6.9.    Captions.     Titles or captions of articles and paragraphs contained in this Agreement are inserted only as a matter of convenience and for reference, and in no way define, limit, extend, or describe the scope of this Agreement or the intent of any provision hereof.

         Section 6.10.    Number and Gender.     Whenever required by the context, the singular number shall include the plural, the plural number shall include the singular, and the gender of any pronoun shall include all genders.

         Section 6.11.    Counterparts.     This Agreement may be executed in multiple copies, each of which shall for all purposes constitute an Agreement, binding on the parties, and each party hereby covenants and agrees to execute all duplicates or replacement counterparts of this Agreement as may be required.

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         Section 6.12.    Applicable Law.     This Agreement shall be governed by and construed in accordance with the laws of the State of California of the United States.

         Section 6.13.    Computation of Time.     Whenever the last day for the exercise of any privilege or the discharge of any duty hereunder shall fall on a Saturday, Sunday, or any public or legal holiday, whether local or national, the person having such privilege or duty shall have until 5:00 p.m. on the next succeeding business day to exercise such privilege, or to discharge such duty.

         Section 6.14.    Severability.     In the event any provision, clause, sentence, phrase, or word hereof, or the application thereof in any circumstances, is held to be invalid or unenforceable, such invalidity or unenforceability shall not affect the validity or enforceability of the remainder hereof, or of the application of any such provision, sentence, clause, phrase, or word in any other circumstances.

         Section 6.15.    Costs and Expenses.     Unless otherwise provided in this Agreement, each party shall bear all fees and expenses incurred in performing its obligations under this Agreement.

         Section 6.16.    Nature of Relationship.     The relationship established between Supplier and purchaser by this Agreement is that of supplier and buyer. Purchaser is an independent contractor. Nothing in this Agreement shall be deemed to establish or otherwise create a relationship of principal and agent, employer and employee, or otherwise between Supplier and Purchaser.

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         IN WITNESS WHEREOF , the parties have caused this Agreement to be executed on the date first written above by their authorized officers.

Netlist, Inc.. (Supplier)    

By:

 

 

 

 
   
   
Title:        
   
   

Netlist Technology Texas LP (Purchaser)

 

 

By:

 

 

 

 
   
   
Title:        
   
   

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APPENDIX A
PRODUCT PURCHASE PRICE

        Supplier will charge Purchaser an appropriate Product Purchase Price so that Purchaser covers its expected operating expenses and earns an arm's length operating profit. The arm's length Operating Profit Margin of Purchaser has been determined to be approximately    %. Since "Operating Profit Margin" is defined as gross profits minus operating expenses divided by net sales and since Purchaser expected operating expenses will be    % of sales, the Purchaser and Supplier have agreed to establish a Product Purchase Price that equals to the price received by the Purchaser from its customers minus a            % discount. This discount will be reviewed periodically to see if it is adequate to insure that the Purchaser can earn a            % Operating Profit Margin.

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Exhibit 10.11


MANAGEMENT FEE AGREEMENT BETWEEN
NETLIST, INC. AND NETLIST TECHNOLOGY TEXAS LP

        This Management Fee Agreement ("Agreement") made and entered into as of January 1, 2004, by and between Netlist, Inc. and Netlist Technology Texas LP has reference to the following facts and circumstances:

        (a)   Netlist, Inc. regularly provides the following services to its subsidiaries (collectively, the "Services"):

        (b)   Texas LP desires to avail itself of the Services and Netlist, Inc. is amenable to providing such, in each case, on the terms and conditions hereinafter set forth.

        Now, therefore, in consideration of the foregoing and the mutual covenants herein contained, the parties agree as follows:

        (1)     PROVISION OF SERVICES .    By its execution of this Agreement. Netlist, Inc. agrees to provide Services to Netlist Technology Texas LP to the extent and at the times requested by Netlist Technology Texas LP. In consideration of services rendered and/or available to be rendered to Netlist Technology Texas LP, Netlist Technology Texas LP agrees to pay to Netlist, Inc. a fee calculated by allocating actual expenses incurred by the relative headcount by entity or square footage used by entity.

        (2)     TERM .    The term of this Agreement shall be for one year commencing as of January 1, 2004 and shall automatically, without notice, be renewed for the same term at the expiration of each preceding term; provided, however, that either party may terminate this Agreement by giving written notice of termination to the other at its principal place of business at any time not less than 3 months prior to the expiration date of the current term.

        (3)     LAW .    This Agreement shall be governed by and construed in accordance with the internal law of the State of California, notwithstanding any choice of law principles.

NETLIST, INC.    

By:

 

    


 

 
Name:       
   
Title:       
   

NETLIST TECHNOLOGY TEXAS LP

 

 

By:

 

    


 

 
Name:       
   
Title:       
   



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MANAGEMENT FEE AGREEMENT BETWEEN NETLIST, INC. AND NETLIST TECHNOLOGY TEXAS LP

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Exhibit 10.12


FORM OF
INDEMNITY AGREEMENT

        THIS INDEMNITY AGREEMENT (this "Agreement"), dated as of                , 200  , is made by and between Netlist, Inc., a Delaware corporation (the "Company"), and                        (the "Indemnitee").

R E C I T A L S :

        A.    The Company recognizes that competent and experienced persons are increasingly reluctant to serve as directors and officers of corporations unless they are protected by comprehensive liability insurance or indemnification, or both, due to increased exposure to litigation costs and risks resulting from their service to such corporations, and due to the fact that the exposure frequently bears no reasonable relationship to the compensation of such directors and officers.

        B. The statutes and judicial decisions regarding the duties of directors and officers are often difficult to apply, ambiguous, or conflicting, and therefore fail to provide such directors with adequate, reliable knowledge of legal risks to which they are exposed or information regarding the proper course of action to take.

        C. The Company and the Indemnitee recognize that plaintiffs often seek damages in such large amounts, and the costs of litigation may be so substantial (whether or not the case is meritorious), that the defense and/or settlement of such litigation is often beyond the personal resources of directors and officers.

        D. The Company believes that it is unfair for its directors and officers to assume the risk of substantial judgments and other expenses which may occur in cases in which the director and/or officer, as the case may be, received no personal profit and in cases where such person acted in good faith.

        E. The Company is organized under the Delaware General Corporation Law (the "DGCL"), and Section 145 of the DGCL ("Section 145") empowers the Company to indemnify its directors and officers by agreement and to indemnify persons who serve, at the request of the Company, as the directors and officers of other corporations or enterprises, and expressly provides that the indemnification provided by Section 145 is not exclusive.

        F. The Board of Directors of the Company has determined that contractual indemnification as set forth herein is not only reasonable and prudent but necessary to promote the best interests of the Company and its stockholders.

        G. The Company desires and has requested the Indemnitee to serve or continue to serve as a director and/or officer of the Company.

        H. The Indemnitee only is willing to serve, or to continue to serve, as a director and/or officer of the Company if the Indemnitee is furnished the indemnity provided for herein by the Company.

A G R E E M E N T :

        NOW THEREFORE, in consideration of the mutual covenants and agreements set forth below, the parties hereto, intending to be legally bound, hereby agree as follows:

        1.     Definitions.     

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        2.     Agreement to Serve.     The Indemnitee agrees to serve and/or continue to serve as an agent of the Company, at the will of such corporation (or under separate agreement, if such agreement exists),

2


in the capacity the Indemnitee currently serves as an agent of such corporation, so long as the Indemnitee is duly appointed or elected and qualified in accordance with the applicable provisions of the Bylaws of such corporation or of any subsidiary thereof, or until such time as the Indemnitee tenders his resignation in writing; provided, however, that nothing contained in this Agreement is intended to create any right to continued employment of the Indemnitee in any capacity.

        3.     Indemnification.     

3


        7.     Notice and Other Indemnification Procedures.     

4


        8.     Assumption of Defense.     In the event the Company shall be obligated to pay the expenses of any proceeding against the Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such proceeding, with counsel reasonably acceptable to the Indemnitee, upon the delivery to the Indemnitee of written notice of its election to do so. After delivery of such notice, approval of such counsel by the Indemnitee and the retention of such counsel by the Company, the Company shall not be liable to the Indemnitee under this Agreement for any fees of counsel subsequently incurred by the Indemnitee with respect to the same proceeding, provided that (a) the Indemnitee shall have the right to employ his counsel in such proceeding at the Indemnitee's expense; and (b) if (i) the employment of counsel by the Indemnitee has been previously authorized in writing by the Company, (ii) the Indemnitee's counsel delivers a written notice to the Company stating that such counsel has reasonably concluded that there may be a conflict of interest between the Company and the Indemnitee in the conduct of any such defense or (iii) the Company shall not, in fact, have employed counsel to assume the defense of such proceeding within a reasonable time, then in any such event the fees and expenses of the Indemnitee's counsel shall be at the expense of the Company.

        9.     Liability Insurance.     

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        10.     Exceptions.     

        (b)     Claims Initiated by the Indemnitee.     Any provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement to indemnify or advance expenses to the Indemnitee with respect to proceedings or claims initiated or brought voluntarily by the Indemnitee and not by way of defense, except with respect to proceedings brought to establish or enforce a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145, but such indemnification or advancement of expenses may be provided by the Company in specific cases if the Board of Directors of the Company finds it to be appropriate.

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        13.     Interpretation of Agreement.     It is understood that the parties hereto intend this Agreement to be interpreted and enforced so as to provide indemnification to the Indemnitee to the fullest extent now or hereafter permitted by law.

        14.     Severability.     If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever, (a) the validity, legality and enforceability of the remaining provisions of the Agreement (including without limitation, all portions of any paragraphs of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby; and (b) to the fullest extent possible, the provisions of this Agreement (including, without limitation, all portions of any paragraph of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable and to give effect to Section 13 hereof.

        15.     Modification and Waiver.     No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. The indemnification rights afforded to the Indemnitee hereby are contract rights and may not be diminished, eliminated or otherwise affected by amendments to the Certificate of Incorporation or Bylaws of the Company or by other agreements.

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        16.     Successors and Assigns.     The terms of this Agreement shall bind, and shall inure to the benefit of, the successors and assigns of the parties hereto.

        17.     Notice.     Except as otherwise provided herein, any notice or demand which, by the provisions hereof, is required or which may be given to or served upon the parties hereto shall be in writing and, if by telegram, telecopy or telex, shall be deemed to have been validly served, given or delivered when sent, if by personal delivery, shall be deemed to have been validly served, given or delivered upon actual delivery and, if mailed, shall be deemed to have been validly served, given or delivered three business days after deposit in the United States mails, as registered or certified mail, with proper postage prepaid and addressed to the party or parties to be notified at the addresses set forth on the signature page of this Agreement (or such other address(es) as a party may designate for itself by like notice).

        18.     Governing Law.     This Agreement shall be governed exclusively by and construed according to the laws of the State of Delaware, as applied to contracts between Delaware residents entered into and to be performed entirely within Delaware.

        19.     Entire Agreement.     This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, understandings and negotiations, written and oral, between the parties with respect to the subject matter of this Agreement.

        20.     Survival of Rights.     The Company shall require any successor to the Company (whether direct or indirect, by purchase, merger, consolidation or otherwise) or to all, substantially all, or a substantial part of the business or assets of the Company, by written agreement in form and substance satisfactory to the Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.

        21.     Conflict With Other Laws.     Notwithstanding anything to the contrary in this Agreement, if any provision of this Agreement, including, but not limited to, the requirement to advance attorneys' fees to Indemnitee as provided herein, violates any provision of the Sarbanes-Oxley Act of 2002 or any rule or regulation promulgated thereunder, or any other law or rule, then the Company shall have no obligation to comply with such provision.

        22.     Counterparts; Facsimile Signatures.     This Agreement may be executed in one or more counterparts, each of which shall constitute an original, but all of which together shall constitute one instrument. Signatures transmitted via facsimile shall be deemed originals for purposes of this Agreement.

8



        IN WITNESS WHEREOF, the parties hereto have entered into this Agreement effective as of the date first above written.

    THE "COMPANY":


NETLIST, INC., A DELAWARE CORPORATION

 

 

By:



 

 

Title:


    Address: 475 Goddard
Irvine, CA 92618

 

 

THE "INDEMNITEE":

 

 


Signature of the Indemnitee

 

 


Print or Type Name of the Indemnitee

 

 

Address:



 

 

 


9




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FORM OF INDEMNITY AGREEMENT

Exhibit 16.1

August 18, 2006

Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-7561

Dear Sirs/Madams:

We have read the statements made by Netlist Inc. (copy attached), which we understand will be filed with the Commission pursuant to regulation S-K item 304 as part of the Company's Form S-1 Registration Statement dated August 18, 2006, and have the following comments:

Yours truly,

/s/ Deloitte & Touche LLP




EXHIBIT 21.1

SUBSIDIARIES

        Except as otherwise indicated, each of the following is a wholly owned direct subsidiary of Netlist, Inc.:

Entity Name

  Jurisdiction of Organization
Netlist Holdings GP, Inc.   Texas
Netlist Holdings LP, Inc.   Delaware
Netlist Technology Texas, L.P.(1)   Texas
Netlist International   Cayman Islands

(1)
Ownership interest is held ninety-nine percent by Netlist Holdings LP, Inc. and one percent by Netlist Holdings GP, Inc.



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EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

        We consent to the use in this Registration Statement on Form S-1 of our report dated May 11, 2006 relating to the consolidated financial statements of Netlist, Inc. and subsidiaries appearing in the Prospectus, which is part of this Registration Statement, and of our report dated May 11, 2006 relating to the consolidated financial statement schedule appearing elsewhere in this Registration Statement.

        We also consent to the reference to us under the heading "Experts" in such Prospectus.

/s/ Corbin & Company, LLP

Irvine, California
August 18, 2006




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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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EXHIBIT 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

        We consent to the use in this Registration Statement on Form S-1 of our report dated March 1, 2006 relating to the consolidated financial statements of Netlist, Inc. and subsidiaries appearing in the Prospectus, which is part of this Registration Statement, and of our report dated March 1, 2006 relating to the financial statement schedule appearing elsewhere in this Registration Statement.

        We also consent to the reference to us under the heading "Experts" in such Prospectus.

/s/ Deloitte & Touche LLP

Costa Mesa, California
August 18, 2006




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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM