NETLIST INC, 10-K filed on 3/18/2014
Annual Report
Document And Entity Information (USD $)
In Millions, except Share data, unless otherwise specified
12 Months Ended
Dec. 28, 2013
Feb. 28, 2014
Jun. 28, 2013
Document And Entity Information [Abstract]
 
 
 
Document Type
10-K 
 
 
Amendment Flag
false 
 
 
Document Period End Date
Dec. 28, 2013 
 
 
Document Fiscal Year Focus
2013 
 
 
Document Fiscal Period Focus
FY 
 
 
Entity Registrant Name
NETLIST INC 
 
 
Entity Central Index Key
0001282631 
 
 
Current Fiscal Year End Date
--12-28 
 
 
Entity Filer Category
Smaller Reporting Company 
 
 
Entity Well-known Seasoned Issuer
No 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Voluntary Filers
No 
 
 
Entity Public Float
 
 
$ 21.4 
Entity Common Stock, Shares Outstanding
 
41,456,286 
 
Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Dec. 28, 2013
Dec. 29, 2012
ASSETS
 
 
Cash and cash equivalents
$ 6,701 
$ 7,755 
Restricted cash
1,100 
 
Investment in marketable securities
 
415 
Accounts receivable, net of allowance for doubtful accounts of $72 (2013) and $47 (2012)
4,866 
3,434 
Inventories
2,620 
7,380 
Prepaid expenses and other current assets
823 
723 
Total current assets
16,110 
19,707 
Property and equipment, net
1,143 
2,560 
Other assets
422 
130 
Total assets
17,675 
22,397 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
Accounts payable
3,795 
3,367 
Accrued payroll and related liabilities
635 
784 
Accrued expenses and other current liabilities
533 
497 
Accrued engineering charges
500 
450 
Current portion of long-term debt
 
3,493 
Total current liabilities
5,463 
8,591 
Long-term debt, net of current portion and debt discount
5,099 
 
Other liabilities
100 
94 
Total liabilities
10,662 
8,685 
Commitments and contingencies
   
   
Stockholders' equity:
 
 
Preferred stock, $0.001 par value - 10,000 shares authorized; no shares issued and outstanding
   
   
Common stock, $0.001 par value - 90,000 shares authorized; 31,776 (2013) and 30,348 (2012) shares issued and outstanding
31 
30 
Additional paid-in capital
104,469 
100,403 
Accumulated deficit
(97,487)
(86,721)
Total stockholders' equity
7,013 
13,712 
Total liabilities and stockholders' equity
$ 17,675 
$ 22,397 
Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share data, unless otherwise specified
Dec. 28, 2013
Dec. 29, 2012
Consolidated Balance Sheets [Abstract]
 
 
Accounts receivable, allowance for doubtful accounts
$ 72 
$ 47 
Preferred stock, par value
$ 0.001 
$ 0.001 
Preferred stock, shares authorized
10,000,000 
10,000,000 
Preferred stock, shares issued
Preferred stock, shares outstanding
Common stock, par value
$ 0.001 
$ 0.001 
Common stock, shares authorized
90,000,000 
90,000,000 
Common stock, shares issued
31,776,000 
30,348,000 
Common stock, shares outstanding
31,776,000 
30,348,000 
Consolidated Statements of Comprehensive Loss (USD $)
In Thousands, except Per Share data, unless otherwise specified
12 Months Ended
Dec. 28, 2013
Dec. 29, 2012
Condensed Consolidated Statements Of Operations [Abstract]
 
 
Net sales
$ 23,048 
$ 36,873 
Cost of sales
19,943 1
27,474 1
Gross profit
3,105 
9,399 
Operating expenses:
 
 
Research and development
6,683 1
12,845 1
Selling, general and administrative
6,267 1
10,075 1
Total operating expenses
12,950 
22,920 
Operating loss
(9,845)
(13,521)
Other expense, net:
 
 
Interest expense, net
(932)
(338)
Realized loss on sale of marketable securities reclassified from other comprehensive loss
 
(56)
Other income (expense), net
20 
(78)
Total other expense, net
(912)
(472)
Loss before income tax provision (benefit)
(10,757)
(13,993)
Provision (benefit) for income taxes
(12)
Net loss
(10,766)
(13,981)
Net loss per common share:
 
 
Basic and diluted
$ (0.35)
$ (0.50)
Weighted-average common shares outstanding:
 
 
Weighted Average Number of Shares Outstanding, Basic and Diluted
30,881 
27,853 
Other comprehensive loss:
 
 
Unrealized loss transferred from other comprehensive loss to earnings
 
56 
Comprehensive loss
$ (10,766)
$ (13,925)
Consolidated Statements of Comprehensive Loss (Parenthetical) (USD $)
In Thousands, unless otherwise specified
12 Months Ended
Dec. 28, 2013
Dec. 29, 2012
Stock-based compensation expense
$ 1,669 
$ 1,891 
Cost Of Sales [Member]
 
 
Stock-based compensation expense
49 
114 
Research And Development [Member]
 
 
Stock-based compensation expense
588 
667 
Selling, General and Administrative Expenses [Member]
 
 
Stock-based compensation expense
$ 1,032 
$ 1,110 
Condensed Consolidated Statements Of Stockholders' Equity (USD $)
In Thousands, except Share data, unless otherwise specified
Common Stock [Member]
Additional Paid-In Capital [Member]
Accumulated Deficit [Member]
Accumulated Other Comprehensive Loss [Member]
Total
Balance at Dec. 31, 2011
$ 26 
$ 92,709 
$ (72,740)
$ (56)
$ 19,939 
Balance, shares at Dec. 31, 2011
26,390,000 
 
 
 
 
Stock-based compensation
 
1,891 
 
 
1,891 
Stock-based compensation,shares
(48,000)
 
 
 
 
Exercise of stock options
687 
 
 
688 
Exercise of stock options, shares
1,032,000 
 
 
 
1,032,000 
Repurchase of common stock
 
(64)
 
 
(64)
Repurchase of common stock, shares
(24,000)
 
 
 
 
Issuance of common stock
5,180 
 
 
5,183 
Issuance of common stock, shares
2,998,000 
 
 
 
1,685,394 
Components of comprehensive loss:
 
 
 
 
 
Change in net unrealized loss on investments
 
 
 
56 
56 
Net loss
 
 
(13,981)
 
(13,981)
Balance at Dec. 29, 2012
30 
100,403 
(86,721)
 
13,712 
Balance, shares at Dec. 29, 2012
30,348,000 
 
 
 
 
Stock-based compensation
 
1,669 
 
 
1,669 
Exercise of stock options
 
40 
 
 
40 
Exercise of stock options, shares
118,000 
 
 
 
117,000 
Repurchase of common stock
 
(14)
 
 
(14)
Repurchase of common stock, shares
(29,000)
 
 
 
 
Issuance of common stock
1,156 
 
 
1,157 
Issuance of common stock, shares
1,339,000 
 
 
 
 
Estimated relative fair value of common stock warrants
 
1,215 
 
 
1,215 
Components of comprehensive loss:
 
 
 
 
 
Net loss
 
 
(10,766)
 
(10,766)
Balance at Dec. 28, 2013
$ 31 
$ 104,469 
$ (97,487)
 
$ 7,013 
Balance, shares at Dec. 28, 2013
31,776,000 
 
 
 
 
Condensed Consolidated Statements Of Cash Flows (USD $)
In Thousands, unless otherwise specified
12 Months Ended
Dec. 28, 2013
Dec. 29, 2012
Cash flows from operating activities:
 
 
Net loss
$ (10,766)
$ (13,981)
Adjustments to reconcile net loss to net cash used in operatng activities:
 
 
Depreciation and amortization
1,476 
1,987 
Capitalized payment in kind interest
111 
 
Amortization of debt discount and debt issuance costs
366 
 
Realized loss on sale of investments in marketable securities
 
85 
Realized loss on sale of equipment
26 
53 
Provision for bad debts
25 
 
Stock-based compensation
1,669 
1,891 
Changes in operating assets and liabilities:
 
 
Restricted cash
(1,100)
 
Accounts receivable
(1,457)
7,965 
Inventories
4,760 
(1,323)
Prepaid expenses and other current assets
140 
263 
Other assets
358 
31 
Accounts payable
428 
(2,938)
Accrued payroll and related liabilities
(149)
(1,029)
Accured expenses and other current liabilities
42 
37 
Accrued engineering charges
50 
 
Net cash used in operating activities
(4,021)
(6,959)
Cash flows from investing activities:
 
 
Acquisition of property and equipment
(119)
(1,698)
Proceeds from sale of equipment
34 
43 
Proceeds from maturities and sales of investments in marketable securities
415 
 
Net cash provided by (used in) investing activities
330 
(1,655)
Cash flows from financing activities:
 
 
Borrowings on lines of credit
 
3,200 
Payments on lines of credit
 
(3,200)
Proceeds of bank term loan
2,483 
1,319 
Payments on debt
(1,029)
(1,292)
Proceeds from public offering, net
1,157 
5,183 
Proceeds from exercise of equity awards, net of taxes remitted for restricted stock
26 
624 
Net cash provided by financing activities
2,637 
5,834 
Net decrease in cash and cash equivalents
(1,054)
(2,780)
Cash and cash equivalents at beginning of period
7,755 
10,535 
Cash and cash equivalents at end of period
$ 6,701 
$ 7,755 
Description Of Business
Description Of Business

Note 1—Description of Business

Netlist, Inc. (the “Company” or “Netlist”) designs and manufactures a wide variety of high performance, logic‑based memory subsystems for the global datacenter, storage and high-performance computing and communications markets. The Company’s memory subsystems consist of combinations of dynamic random access memory integrated circuits (“DRAM ICs” or “DRAM”), NAND flash memory (“NAND”), application-specific integrated circuits (“ASICs”) and other components assembled on printed circuit boards (“PCBs”). Netlist primarily markets and sells its products to leading original equipment manufacturer (“OEM”) customers. The Company’s solutions are targeted at applications where memory plays a key role in meeting system performance requirements. The Company leverages 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, reduced power consumption and low cost per bit. Our NVvault™ product is the first to offer both DRAM and NAND in a standard form factor memory subsystem as a persistent DIMM in mission critical applications.

Netlist was incorporated in June 2000 and is headquartered in Irvine, California. In 2007, the Company established a manufacturing facility in the People’s Republic of China (the “PRC”), which became operational in July 2007 upon the successful qualification of certain key customers.

Summary Of Significant Accounting Policies
Summary Of Significant Accounting Policies

Note 2Summary 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 (U.S.).

Principles of Consolidation

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

Fiscal Year

The Company operates under a 52/53-week fiscal year ending on the Saturday closest to December 31. The 2013 and 2012 fiscal years ended on December 28, 2013 and December 29, 2012, respectively. Fiscal years 2013 and 2012 each consisted of 52 weeks.

 

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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.  Significant estimates made by management include, among others, provisions for uncollectible receivables and sales returns, warranty liabilities, valuation of inventories, fair value of financial instruments, recoverability of long-lived assets, stock-based transactions and realization of deferred tax assets. The Company bases its estimates on historical experience, knowledge of current conditions and the Company’s belief of what could occur in the future considering available information.  The Company reviews its estimates on an on-going basis. The actual results experienced by the Company may differ materially and adversely from its estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

 

Revenue Recognition

The Company’s revenues primarily consist of product sales of high performance memory subsystems to original equipment manufacturers (“OEMs”).

The Company recognizes revenues in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605. Accordingly, the Company recognizes revenues when there is persuasive evidence that an arrangement exists, product delivery and acceptance have occurred, the sales price is fixed or determinable, and collectability of the resulting receivable is reasonably assured.

The Company generally uses customer purchase orders and/or contracts as evidence of an arrangement. Delivery occurs when goods are shipped for customers with shipping point terms and upon receipt for customers with destination terms, at which time title and risk of loss transfer to the customer. Shipping documents are used to verify delivery and customer acceptance. The Company assesses whether the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund. Customers are generally allowed limited rights of return for up to 30 days, except for sales of excess component inventories, which contain no right-of-return privileges. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve. The Company offers a standard product warranty to our customers and has no other post-shipment obligations. The Company assesses collectability based on the creditworthiness of the customer as determined by credit checks and evaluations, as well as the customer’s payment history.

 

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.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and short-term investments with original maturities of three months or less, other than short-term investments in securities that lack an active market.

Restricted Cash

 

Restricted cash of $1.1 million, as of December 28, 2013, consists of cash to secure three standby letters of credit.

 

Investments in Marketable Securities

The Company accounts for its investments in marketable securities in accordance with ASC Topic 320. The Company determines the appropriate classification of its investments at the time of purchase and reevaluates such designation at each balance sheet date. The Companys investments in marketable securities have been classified and accounted for as available-for-sale based on managements investment intentions relating to these securities. Available-for-sale securities are stated at fair value, generally based on market quotes, to the extent they are available. Unrealized gains and losses, net of applicable deferred taxes, are recorded as a component of other comprehensive income (loss). Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in other income, net in the consolidated statements of comprehensive loss.

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

Fair Value of Financial Instruments

The Company’s financial instruments consist principally of cash and cash equivalents, investments in marketable securities, accounts receivable, accounts payable, accrued expenses and debt instruments. The fair value of our cash equivalents and investments in marketable securities is determined based on quoted prices in active markets for identical assets or Level 1 inputs.  The Company recognizes transfers between Levels 1 through 3 of the fair value hierarchy at the beginning of the reporting period.  The Company believes that the carrying values of all other financial instruments approximate their current fair values due to their nature and respective durations.

 

Allowance for Doubtful Accounts

The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customers ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company records allowances for doubtful accounts based primarily on the length of time the receivables are past due based on the terms of the originating transaction, the current business environment and its historical experience. Uncollectible accounts are charged against the allowance for doubtful accounts when all cost effective commercial means of collection have been exhaustedGenerally, the Company’s credit losses have been within expectations and the provisions established. However, the Company cannot guarantee that it will continue to experience credit loss rates similar to those experienced in the past.

 

Concentration of Credit Risk

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

The Company invests its cash equivalents primarily in money market mutual funds.  Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. The Company had $1.4 million of Federal Deposit Insurance Corporation and Securities Investor Protection Corporation insured cash and cash equivalents at December 28, 2013.  Investments in marketable securities are generally in high-credit quality debt instruments. Such investments are made only in instruments issued or enhanced by high-quality institutions.  The Company has not incurred any credit losses related to these investments.

The Companys trade accounts receivable are primarily derived from sales to OEMs in the computer industry (see Note 12). 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. Credit quality is monitored by evaluation of credit scores and collection history.  The Company believes that the concentration of credit risk in its trade receivables is moderated by its credit evaluation process, relatively short collection terms, the high level of credit worthiness of its customers, foreign credit insurance and letters of credit issued on the Company’s behalf.   Reserves are maintained for potential credit losses, and such losses historically have not been significant and have been within managements expectations.  Potential credit losses are limited to the gross value of accounts receivable.

Inventories

Inventories are valued at the lower of actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on an average cost basis which approximates actual cost 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 inventory quantities on hand and on order and records a provision for excess quantities and obsolescence. 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. In addition, the Company considers changes in the market value of components in determining the net realizable value of its inventory. 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 seven 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.

Deferred Financing Costs, Debt Discount and Detachable Debt-Related Warrants.

 Costs incurred to issue debt are deferred and included in debt issuance costs in the accompanying consolidated balance sheet. The Company amortizes debt issuance costs over the expected term of the related debt using the effective interest method. Debt discounts related to the relative fair value of any warrants issued in conjunction with the debt are recorded as a reduction to the debt balance and accreted over the expected term of the debt to interest expense using the effective interest method.

Impairment of Long-Lived Assets

The Company evaluates the recoverability of the carrying value of long-lived assets held and used by the Company for impairment on at least an annual basis or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future net cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. 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 exceeds the estimated fair value of the asset. The fair value of the asset or asset group is based on market value when available, or when unavailable, on discounted expected cash flows. The Companys management believes there is no impairment of long-lived assets as of December 28, 2013. There can be no assurance, however, that market conditions will not change or demand for the Companys products will continue, which could result in future impairment of long-lived assets.

Warranty Reserve

The Company offers product warranties generally ranging from one to three years, depending on the product and negotiated terms of any purchase agreements with 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. Warranties are not offered on sales of excess component inventory. The Company records an estimate for warranty‑related costs at the time of sale based on its historical and estimated product return rates and expected repair or replacement costs (see Note 3). Such costs have historically been within managements expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on the Company, requiring additional warranty reserves, and could adversely affect the Company’s gross profit and gross margins.

Stock‑Based Compensation

The Company accounts for equity issuances to non-employees in accordance with ASC Topic 505.  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.

 

In accordance with ASC Topic 718, employee and director stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period.  Given that stock-based compensation expense recognized in the consolidated statements of comprehensive loss is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC Topic 718 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 Company’s estimated average forfeiture rates are based on historical forfeiture experience and estimated future forfeitures.

 

The fair value of common stock option 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, along with assumptions about the risk-free interest rate and expected dividends, all of which affect the estimated fair values of the Company’s common stock option awards.  The expected term of options granted is calculated as the average of the weighted vesting period and the contractual expiration date of the option.  This calculation is based on the safe harbor method permitted by the SEC in instances where the vesting and exercise terms of options granted meet certain conditions and where limited historical exercise data is available.  The expected volatility is based on the historical volatility of the Company’s common stock.  The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the expected term of the grant effective as of the date of the grant. The expected dividend assumption is based on the Company’s history and management’s expectation regarding dividend payouts.  The Company evaluates the assumptions used to value their common stock awards on a quarterly basis.  If factors change and the Company employs different assumptions, stock-based compensation may differ significantly from what has been recorded in prior periods. Compensation expense for common stock option awards with graded vesting schedules is recognized on a straight-line basis over the requisite service period for the last separately vesting portion of the award, provided that the accumulated cost recognized as of any date at least equals the value of the vested portion of the award.

 

The Company recognizes the fair value of restricted stock awards issued to employees and outside directors as stock-based compensation expense on a straight-line basis over the vesting period for the last separately vesting portion of the awards.  Fair value is determined as the difference between the closing price of our common stock on the grant date and the purchase price of the restricted stock award, if any, reduced by expected forfeitures.

 

If there are any modifications or cancellations of the underlying vested or unvested stock-based awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense, or record additional expense for vested stock-based awards.  Future stock-based compensation expense and unearned stock- based compensation may increase to the extent that the Company grants additional common stock options or other stock-based awards.

 

Income Taxes

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 net deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized.

ASC Topic 740 prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under ASC Topic 740 the Company may only recognize or continue to recognize tax positions that meet a more likely than not threshold.

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

Research and Development Expenses

Research and development expenditures are expensed in the period incurred.

Collaborative Agreements

In 2011, the Company entered into two memory technology Collaboration Agreements. The first agreement is a HyperCloud® Technology Collaboration Agreement (the “IBM Agreement”) with International Business Machines (“IBM”). Under the IBM Agreement, IBM and the Company have agreed to cooperate with respect to the qualification of HyperCloud® technology for use with IBM servers and to engage in certain joint marketing efforts if qualification is achieved. IBM and the Company have agreed to commit resources and funds in support of these activities. The IBM Agreement is non-exclusive.

The second agreement is a Collaboration Agreement (the “HP Agreement”) with Hewlett‑Packard Company (“HP”). Under the HP Agreement, HP and the Company agreed to cooperate and commit resources in furtherance of qualifying of HyperCloud® technology for use with HP servers and to engage in certain joint marketing efforts if qualification is achieved. HP and the Company agreed to commit resources and funds in support of these activities. The HP Agreement expires in September 2014.   HP and the Company agreed to collaborate on the future use of HyperCloud® load reduction and rank multiplication technologies for next generation server memory for HP.

In total, the Company reimbursed IBM and HP $0.2 million and $1 million, respectively, for the cost of certain qualification activities.  In addition, the Company made $0.8 million of payments to IBM for joint HyperCloud® marketing activities, all of which have been amortized based on actual unit shipments compared with estimated total shipments over the term of the Collaboration Agreement.  The Company’s net sales were determined after deduction of such customer allowances, in accordance with ASC 605-50. There can be no assurance that the efforts undertaken under either of the IBM or HP collaboration agreements will result in revenues for the Company that are sufficient to cover the cost of qualification activities, including payments made to HP and IBM under the collaboration agreements.

Comprehensive Loss

ASC Topic 220 establishes standards for reporting and displaying comprehensive income (loss) and its components in the consolidated financial statements. Accumulated other comprehensive loss includes unrealized gains or losses on investments.

Risks and Uncertainties

The Company is subject to certain risks and uncertainties including their ability to obtain profitable operations due to the Company’s history of losses and accumulated deficits, the Company’s dependence on a few customers for a significant portion of revenues, risks related to intellectual property matters, market development of and demand for the Company’s products, and the length of the sales cycle.  Such risks could have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

The Company has invested and expects to continue to invest a significant portion of its research and development budget into the design of ASIC devices, including the HyperCloud® memory subsystem family of products. These new designs and the products they are incorporated into are subject to increased risks as compared to the Company’s existing products. The Company may be unable to achieve customer or market acceptance of the HyperCloud® memory subsystem family of products or other new products, or achieve such acceptance in a timely manner. The Company has experienced a longer qualification cycle than anticipated with its HyperCloud® memory subsystems, and as of December 28, 2013, the product has not generated significant revenue relative to the Company’s investment in the product. The Company has entered into collaborative agreements with both HP and IBM pursuant to which these OEMs have cooperated with the Company to qualify HyperCloud® for use in their respective products. The qualifying OEMs have engaged and continue to engage with the Company in joint marketing and further product development efforts. The Company and each of the OEMs have committed financial and other resources toward the collaboration. There can be no assurance that the efforts undertaken pursuant to either of the collaborative agreements will result in any new revenues for the Company. Further delays or any failure in placing or qualifying this product with HP, IBM or other potential customers would adversely impact the Company’s consolidated results of operations.

The Company’s operations in the PRC are subject to various political, geographical and economic risks and uncertainties inherent to conducting business in the PRC. These include, but are not limited to, (i) potential changes in economic conditions in the region, (ii) managing a local workforce that may subject the Company to uncertainties or certain regulatory policies, (iii) changes in other policies of the Chinese governmental and regulatory agencies, and (iv) changes in the laws and policies of the U.S. government regarding the conduct of business in foreign countries, generally, or in the PRC, in particular. Additionally, the Chinese government controls the procedures by which its local currency, the Chinese Renminbi (“RMB”), is converted into other currencies and by which dividends may be declared or capital distributed for the purpose of repatriation of earnings and investments. If restrictions in the conversion of RMB or in the repatriation of earnings and investments through dividend and capital distribution restrictions are instituted, the Company’s operations and operating results may be negatively impacted. The liabilities of the Company’s subsidiaries in the PRC exceeded its assets as of December 28, 2013 and December 29, 2012.

Foreign Currency Remeasurement

The functional currency of the Companys foreign subsidiary is the U.S. dollar. Local currency financial statements are remeasured into U.S. dollars at the exchange rate in effect as of the balance sheet date for monetary assets and liabilities and the historical exchange rate for nonmonetary assets and liabilities. Expenses are remeasured using the average exchange rate for the period, except items related to nonmonetary assets and liabilities, which are remeasured using historical exchange rates. All remeasurement gains and losses are included in determining net loss.  Transaction gains and losses were not significant in 2013 and 2012.

Net Loss Per Share

Basic net loss per share is calculated by dividing net loss by the weighted-average common shares outstanding during the year, excluding unvested shares issued pursuant to restricted share awards under the Company’s share-based compensation plans.  Diluted net loss per share is calculated by dividing the net loss by the weighted-average shares and dilutive potential common shares outstanding during the year. Dilutive potential shares consist of dilutive shares issuable upon the exercise or vesting of outstanding stock options and restricted stock awards, respectively, computed using the treasury stock method.  In periods of losses, basic and diluted loss per share are the same, as the effect of stock options and unvested restricted share awards on loss per share is anti-dilutive.

 

Supplemental Financial Information
Supplemental Financial Information

Note 3Supplemental Financial Information

Inventories

Inventories consist of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Raw materials

$

1,737 

 

$

4,544 

Work in process

 

67 

 

 

70 

Finished goods

 

816 

 

 

2,766 

 

$

2,620 

 

$

7,380 

Property and Equipment

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

 

 

 

 

 

 

Useful

 

 

December 28,

 

 

December 29,

 

Lives

 

2013

 

2012

 

 

 

 

 

 

 

 

Machinery and equipment

3 - 7 yrs.

 

$

8,956 

 

$

9,060 

Leasehold improvements

*

 

 

1,873 

 

 

1,851 

Furniture and fixtures

5 yrs.

 

 

368 

 

 

457 

Computer equipment and software

3 - 7 yrs.

 

 

3,580 

 

 

3,903 

 

 

 

 

14,777 

 

 

15,271 

Less accumulated depreciation and amortization

 

 

 

(13,634)

 

 

(12,711)

 

 

 

$

1,143 

 

$

2,560 

*Estimated useful life is generally 7 years, or the remaining lease term, whichever is shorter.

Included in property and equipment are assets under capital leases with a cost of approximately $0.5 million and accumulated amortization of approximately $0.2 million at December 29, 2012.  There were no assets under capital lease at December 28, 2013. Amortization of assets recorded under capital leases is included as a component of depreciation and amortization expense.

Warranty Liability

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

December 28,

 

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Beginning balance

$

235 

 

$

189 

Estimated cost of warranty claims charged to cost of sales

 

122 

 

 

164 

Cost of actual warranty claims

 

(108)

 

 

(118)

Ending balance

 

249 

 

 

235 

Less current portion

 

(149)

 

 

(141)

Long-term warranty obligations

$

100 

 

$

94 

 

The allowance for warranty liabilities expected to be incurred within one year is included as a component of accrued expenses and other current liabilities in the accompanying consolidated balance sheets.  The allowance for warranty liabilities expected to be incurred after one year is classified as other liabilities in the accompanying consolidated balance sheets.

 

Computation of Net Loss Per Share

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Basic and diluted net loss per share:

 

 

 

 

 

Numerator: Net loss

$

(10,766)

 

$

(13,981)

Denominator: Weighted-average common shares

 

 

 

 

 

outstanding, basic and diluted

 

30,881 

 

 

27,853 

Basic and diluted net loss per share

$

(0.35)

 

$

(0.50)

 

The following table sets forth potentially dilutive common share equivalents, consisting of shares issuable upon the exercise or vesting of outstanding stock options and restricted stock awards, respectively, and the exercise of warrants, computed using the treasury stock method.  These potential common shares have been excluded from the diluted net loss per share calculations above as their effect would be anti-dilutive for the years then ended (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Common share equivalents

 

219 

 

 

622 

 

The above common share equivalents would have been included in the calculation of diluted earnings per share had the Company reported net income for the years then ended.

Cash Flow Information

The following table sets forth supplemental disclosures of cash flow information and non-cash investing and financing activities (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

Interest

$

484 

 

$

332 

Income taxes

$

 

$

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Purchase of equipment not paid for at the end of the period

$

 -

 

$

150 

Debt financed acquisition of fixed assets

$

240 

 

$

180 

Debt issuance costs associated with July debt financing

$

323 

 

$

 -

Debt discount related to the relative fair value of detachable warrants issued

$

1,215 

 

$

 -

Paydown of SVB term loan directly with proceeds from July debt financing

$

2,731 

 

$

 -

Reversal of unrealized loss charged to other comprehensive income

$

 -

 

$

56 

 

Fair Value Measurements
Fair Value Measurements

Note 4Fair Value Measurements

The following tables detail the fair value measurements within the fair value hierarchy of the Companys investments in marketable securities (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 28, 2013 Using

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

Fair Value at

 

Active Markets for

 

Observable

 

Unobservable

 

December 28,

 

Identical Assets

 

Inputs

 

Inputs

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Money market mutual funds

$

2,988 

 

$

2,988 

 

$

 -

 

$

 -

         Total

$

2,988 

 

$

2,988 

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 29, 2012 Using

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

Fair Value at

 

Active Markets for

 

Observable

 

Unobservable

 

December 29,

 

Identical Assets

 

Inputs

 

Inputs

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

 

    Money market mutual funds

$

2,338 

 

$

2,338 

 

$

 -

 

$

 -

    Auction and variable floating rate notes

 

415 

 

 

 -

 

 

 -

 

 

415 

         Total

$

2,753 

 

$

2,338 

 

$

 -

 

$

415 

 

 

The following tables summarize the Company’s assets measured at fair value on a recurring basis as presented in the Company’s consolidated balance sheets at December 28, 2013 and December 29, 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 28, 2013 Using

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

December 28,

 

Identical Assets

 

Inputs

 

Inputs

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents

$

2,988 

 

$

2,988 

 

$

 -

 

$

 -

         Total

$

2,988 

 

$

2,988 

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 29, 2012 Using

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

Fair Value at

 

Active Markets for

 

Observable

 

Unobservable

 

December 29,

 

Identical Assets

 

Inputs

 

Inputs

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents

$

2,338 

 

$

2,338 

 

$

 -

 

$

 -

Marketable securities

 

415 

 

 

 -

 

 

 -

 

 

415 

    Total assets measured at fair value

$

2,753 

 

$

2,338 

 

$

 -

 

$

415 

 

 

 

 

Fair value measurements using Level 3 inputs in the table above relate to the Company’s investments in auction rate securities The Company estimated the fair value of these investments using a discounted cash flow model which included assumptions about the credit quality and expected duration of the investments, along with discount rates affected for the general lack of liquidity. These assumptions reflected the Company’s estimates about the reasonable assumptions market participants would likely use in valuing the investments, including assumptions about risk, developed based on the best information available in the circumstances.

The following table provides a reconciliation of the beginning and ending balances for the Companys assets measured at fair value using Level 3 inputs (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Beginning balance

$

415 

 

$

444 

Sales of available-for-sale marketable securities

 

(415)

 

 

 -

Realized loss included in other expense, net

 

 -

 

 

(85)

Unrealized loss transferred from other comprehensive loss to earnings

 

 -

 

 

56 

Ending balance

$

 -

 

$

415 

 

Investments In Marketable Securities
Investments In Marketable Securities

Note 5Investments in Marketable Securities

Investments in marketable securities consist of the following at December 29, 2012 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 29, 2012

 

 

 

 

Net

 

 

 

 

Amortized

 

Unrealized

 

Fair

 

Cost

 

Gain (Loss)

 

Value

 

 

 

 

 

 

 

 

 

Auction and variable floating rate notes

$

415 

 

$

 

 

$

415 

At December 29, 2012, the Level 3 fair value of the Company’s auction rate securities consisted of the par value of $500,000 adjusted for a realized loss of $85,000, recorded as other expense, net in the accompanying consolidated statement of operations for the year ended December 29, 2012.

Realized gains and losses on the sale of investments in marketable securities are determined using the specific identification method. Other than the sale of the Company’s auction rate security, described below, there were no sales of available-for-sale securities prior to maturity in 2013 or 2012.

 

 

The following table presents the amortized cost and fair value of the Companys investments in marketable securities classified as available-for-sale at December 29, 2012 by contractual maturity (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 29, 2012

 

Amortized

 

Fair

 

Cost

 

Value

 

 

 

 

 

 

Maturity

 

 

 

 

 

Greater than two years*

$

415 

 

$

415 

*Comprised of auction rate securities which generally have interest rate reset dates of 90 days or less but final contractual maturity dates in excess of 15 years.

Auction Rate Securities

As of December 29, 2012, the Company held one investment in a Baa1 rated auction rate debt security of a municipality with a total purchase cost of $0.5 million and recorded a permanent impairment of this asset for a realized loss of $85,000.  During the first quarter of 2013, the Company sold this auction rate security for $415,000.

 

 

 

Credit Agreements
Credit Agreements

Note 6—Credit Agreements

Silicon Valley Credit Agreement

 

On October 31, 2009, the Company entered into a credit agreement with Silicon Valley Bank (“SVB”), which was most recently amended on July 18, 2013 (as amended, the “SVB Credit Agreement”). Currently, the SVB Credit Agreement provides that the Company can borrow up to the lesser of (i) 80% of eligible accounts receivable, or (ii) $5.0 million.  

Pursuant to the September 2010 amendment to the SVB Credit Agreement, SVB extended a $1.5 million term loan, bearing interest at a rate of prime plus 2.00%. The Company was required to make monthly principal payments of $41,666 over the 36 month term of the loan, or $0.5 million annually. In May 2011, SVB extended an additional $3.0 million term loan, bearing interest at a rate of prime plus 2.75%. The Company was required to make monthly principal payments of $125,000 over the 24 month term of the loan, or $1.5 million annually. In May 2012, SVB consolidated both term loans and extended additional credit, resulting in a combined balance of $3.5 million as of May 2012 (the “Consolidated Term Loan”). The Consolidated Term Loan was payable in 36 installments of $97,222, beginning December 2012, with interest at a rate of prime plus 2.50%. Interest was payable monthly from the date of funding through final payoff of the loan.  On July 18, 2013, as part an amendment to the SVB Credit Agreement entered into with SVB and following the Company’s receipt of additional loan financing from DBD Credit Funding, LLC, an affiliate of Fortress Investment Group, LLC ("DBD"), the Consolidated Term Loan and outstanding interest was paid in full.

On July 18, 2013, the Company and SVB entered into a loan amendment (“SVB Amendment”) to the Company’s loan and security agreement with SVB.  Pursuant to the SVB Amendment, SVB allowed for the financing and security interests contemplated under the loan agreement entered into with DBD and released certain patents and related assets relating to the NVvault™ product line from the collateral subject to SVB’s security interest under the SVB Credit Agreement.  Additionally, pursuant to the SVB Amendment, advances under the revolving line now accrue interest at a rate equal to SVB’s most recently announced “prime rate” plus 2.75%.  The SVB Amendment also relaxed the Company’s tangible net worth covenant under the SVB Credit Agreement and waived certain events of default in connection therewith.  Certain reporting requirements under the SVB Credit Agreement were modified while certain reserves with respect to the borrowing base and the availability of revolving loans were removed pursuant to the SVB Amendment. Under the terms of the SVB Credit Agreement, the Company may draw revolving advances in an aggregate outstanding principal amount of up to the lesser of $5 million or the available borrowing base, subject to reserve amounts.  The Company’s borrowing base under the SVB Credit Agreement is subject to certain adjustments and up to the lesser of 80% of eligible accounts receivable.

 

SVB Amendment requires letters of credit to be secured by cash, which is classified as restricted cash in the accompanying condensed consolidated balance sheet. At December 28, 2013, letters of credit in the amount of $1.1 million were outstanding.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Interest expense

$

139 

 

$

112 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 28,

 

December 29,

 

2013

 

2012

Availability under the revolving line of credit

$

4,042 

 

$

1,486 

 

 All obligations under the SVB Credit Agreement are secured by a first priority lien on the Company’s tangible and intangible assets, other than its intellectual property, which is subject to a first priority lien held by DBD.  The SVB Credit Agreement subjects the Company to certain affirmative and negative covenants, including financial covenants with respect to the Company’s liquidity and tangible net worth and restrictions on the payment of dividends. As of December 28, 2013, the Company was in compliance with its debt covenants. As of December 29, 2012, the Company was in violation of the tangible net worth covenant but remained in compliance with the quick ratio covenant. In connection with the SVB Amendment, the Company obtained a waiver of such non-compliance and amended the tangible net worth covenant which resulted in the Company’s compliance with all financial covenants as of July 18, 2013.

On January 23, 2013, the Company entered into a Forbearance Agreement with SVB (the “Forbearance Agreement”), pursuant to which SVB agreed to forbear from filing any legal action or instituting or enforcing any rights and remedies it may have against the Company as a result of its violation of the financial covenants until February 28. 2013. On March 27, 2013, the effectiveness of the Forbearance Agreement was extended until April 30, 2013. As a result of the Company’s non-compliance with a loan covenant at December 29, 2012, and in accordance with relevant accounting guidance, the Company reclassified the long-term portion of the Consolidated Term Loan to current portion of debt in the accompanying consolidated balance sheet as of December 29, 2012.  In connection with the SVB Amendment to the SVB Credit Agreement the Company obtained a waiver of such non-compliance.  

Pursuant to the Forbearance Agreement that was in effect prior to the SVB Amendment, any principal amount outstanding under the revolving line accrued interest at a per annum rate equal to the following (i) at all times that a Streamline Period (as defined) is in effect, 1.75% above the Prime Rate; and (ii) at all times that a Streamline Period is not in effect, 2.75% above the Prime Rate, which interest was payable monthly. In addition, the reserve on the revolving line was increased to $2 million. The SVB Credit Agreement requires payment of an unused line fee, as well as anniversary and early termination fees, as applicable.  On July 18, 2013, as part of the SVB Amendment, the Streamline Period interest was eliminated and any principal amount outstanding under the Revolving Line accrues interest at 2.75% above the Prime Rate.  The SVB Amendment eliminates the reserve on the revolving line of $2 million, thereby increasing the borrowing availability.

DBD Credit Funding, LLC Loan and Security Agreement and Related Agreements

 

On July 18, 2013, the Company, entered into a loan agreement (“Loan Agreement”) with DBD, an affiliate of Fortress Investment Group LLC, providing for up to $10 million in term loans and up to $5 million in revolving loans.  The term loans are available in an initial $6 million tranche (the “Initial Term Loan”) with a second tranche in the amount of $4 million becoming available upon achievement of certain performance milestones relating to intellectual property matters (the “IP Monetization Milestones” and such second tranche loan, “IP Milestone Term Loan”). The $5 million in revolving loans are available at DBD’s discretion and subject to customary conditions precedent.  The $6 million Initial Term Loan was fully drawn at closing on July 18, 2013. Proceeds from the Initial Term Loan were used in part to repay the Company’s existing Consolidated Term Loan with SVB. The remainder of such funds will be used to fund the Company’s ongoing working capital needs.

 

The loans bear interest at a stated fixed rate of 11.0% per annum.  During the first eighteen (18) months following the closing date, the payments on the term loans are interest-only at a cash rate of 7.0% per annum and a payment-in-kind deferred cash interest rate of 4.0%, which payment-in-kind interest is capitalized semi-annually, beginning with December 31, 2013.  Following the eighteen (18) month interest-only period, the term loans are amortized with 65% of the principal amount due in equal monthly installments over the following eighteen (18) months with a balloon payment equal to 35% of the remaining principal amount of the term loans, plus accrued interest, being payable on July 18, 2016. 

 

The Company’s obligations under the Loan Agreement are secured by a first-priority security interest in the Company’s intellectual property assets (other than certain patents and related assets relating to the NVvault™ product line) pursuant to an intellectual property security agreement with  (the “IP Security Agreement”) and a second-priority security interest in substantially all of the Company’s other assets.

 

In connection with the Loan Agreement, the Company paid certain facility, due diligence and legal fees of DBD on the closing date and is obligated to pay a conditional facility fee upon satisfaction of the IP Monetization Milestones.  If the Company repays or prepays all or a portion of the term loans prior to maturity, the Company is obligated to pay DBD a prepayment fee based on a percentage of the then outstanding principal balance being prepaid, equal to 4.0% if the prepayment occurs on or prior to July 18, 2014 (or 2.0% if such prepayment is made in connection with the early repayment option premium discussed in the preceding sentence), 2.0% if the prepayment occurs between July 18, 2014 and July 18, 2015, or 0.0% if the prepayment occurs after July 18, 2015.

 

The Loan Agreement contains customary representations, warranties and indemnification provisions.  The Loan Agreement also contains affirmative and negative covenants that, among other things restrict the ability of the Company to:

 

                  incur additional indebtedness or guarantees;

                  incur liens;

                  make investments, loans and acquisitions;

                  consolidate or merge;

                  sell or exclusively license assets, including capital stock of subsidiaries;

                  alter the business of the Company;

                  engage in transactions with affiliates; and

                  pay dividends or make distributions.

 

The Loan Agreement also includes events of default, including, among other things, payment defaults, breaches of representations, warranties or covenants, certain bankruptcy events, the failure to maintain its listing on a nationally recognized securities exchange or alternatively for its shares to be qualified for trading on the OTC Bulletin Board and certain material adverse changes, including an impairment of the perfection or priority of the lender’s lien. Upon the occurrence of an event of default and following any applicable cure periods, a default interest rate of an additional 5.0% per annum may be applied to the outstanding loan balances, and DBD may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Loan Agreement.

 

Concurrently with the execution of the Loan Agreement, the Company and an affiliate of DBD entered into a Patent Monetization Side Letter Agreement (the “Letter Agreement”).  The Letter Agreement provides, among other things, that DBD may be entitled to share in certain monetization revenues that the Company may derive in the future related to its patent portfolio (the “Patent Portfolio”).  The Patent Portfolio does not include certain patents relating to the NVvault™ product line.  Monetization revenues subject to this arrangement include revenues recognized during the seven year term of the Letter Agreement from amounts (whether characterized as settlement payments, license fees, royalties, damages, or otherwise) actually paid to the Company or its subsidiaries in connection with any assertion of, agreement not to assert, or license of, the Patent Portfolio (in whole or in part) either (A) in consideration of the grant of a license or covenant not sue, or other immunity with respect to the Patent Portfolio, or (B) as a damages award with respect to such assertion of the Patent Portfolio, less (i) actual legal fees and expenses (including fees payable on a contingency basis) and actual court costs paid or payable by the Company or its subsidiaries in connection with any such assertion and/or grant of a license or covenant not to sue, or other immunity with respect to the Patent Portfolio, provided that such legal fees and expenses shall be capped at forty percent (40%) of such gross, aggregate amounts paid to the Company, (ii) all reasonable and actual legal fees, filing fees, maintenance fees, annuities, and other reasonable and actual costs and expenses paid or required to be paid by the Company or its subsidiaries after the effective date in connection with the prosecution, maintenance, and defense of any patents or patent applications within the Patent Portfolio, (iii) reasonable and actual legal fees and reasonable and actual other costs and expenses paid or required to be paid by the Company or its subsidiaries in connection with the enforcement of any agreement, undertaking, commitment or court order that would generate monetization revenues and the collection thereof, and (iv) reasonable and actual costs of acquisition of patents and patent applications included in the Patent Portfolio that are acquired by or licensed to the Company or its subsidiaries after the effective date.  Monetization revenues also include the value attributable to the Patent Portfolio in any sale of the Company during the seven year term, subject to a maximum amount payable to DBD.  The Letter Agreement also requires that the Company use commercially reasonable efforts to pursue opportunities to monetize the Patent Portfolio during the term of the Letter Agreement, provided that the Company is under no obligation to pursue any such opportunities that Company does not deem to be in the Company’s best interest in the Company’s reasonable business judgment.  Notwithstanding the foregoing, there can be no assurance that the Company will be successful in these efforts, and the Company may expend resources in pursuit of monetization revenues that may not result in any benefit to the Company.

 

Concurrently with the execution of the Loan Agreement, the Company issued to an affiliate of DBD a seven-year warrant (the “Warrant”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at an exercise price of $1.00 per share, of which 989,011 shares are exercisable immediately on a cash or cashless basis in whole or in part. Pursuant to the stock purchase warrant agreement, (i) 329,670 shares will become exercisable upon the achievement of the IP Monetization Milestones and (ii) the remaining 329,670 shares will become exercisable upon the Company’s receipt of an IP Milestone Term Loan. The Warrant was issued in a private placement transaction that was exempt from registration under Section 4(2) of the Securities Act of 1933 (the “Securities Act”).  The Company accounted for the warrants as a debt discount and has valued them based on the relative fair value at approximately $1,215,000, to be amortized over the term of the debt instrument, or three years, using the effective interest method.  For the year ended December 28, 2013, the Company amortized approximately $203,000 as interest expense in the consolidated statements of operations.

 

Also in connection with the Loan Agreement, the Company agreed to pay to a consultant a consulting fee equal to (i) $300,000 to the consultant in connection with the Company’s receipt of the Initial Term Loan and (ii) 5% of any additional principal amount loaned to the Company as an IP Milestone Term Loan.  The initial $300,000 has been recorded as debt issuance cost to be amortized over the term of the debt instrument, or three years, using the effective interest method.  During the year ended December 28, 2013, the Company amortized approximately $135,000 as interest expense in the consolidated statements of comprehensive loss.

Long-Term Debt
Long-Term Debt

Note 7Debt

Debt consists of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Obligations under capital leases

$

 -

 

$

118 

Consolidated Term Loan, net of issuance cost of $28

 

 -

 

 

3,375 

Term Loan, DBD, net of debt discount of $1,012 

 

5,099 

 

 

 -

 

 

5,099 

 

 

3,493 

Less current portion

 

 -

 

 

(3,493)

 

$

5,099 

 

$

 -

 

As of December 28, 2013, maturities of long-term debt were as follows (in thousands):

 

 

 

 

 

 

 

Fiscal Year

 

 

2014

$

 -

2015

 

4,074

2016

 

2,037

Total payments on long-term debt

 

6,111

Debt discount

 

(1,012)

Long-term debt

$

5,099

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Interest expense

$

796 

 

$

234 

 

Income Taxes
Income Taxes

Note 8Income Taxes 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Companys deferred tax assets and liabilities are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 28,

 

December 29,

 

2013

 

2012

Deferred tax assets:

 

 

 

 

 

Reserves and allowances

$

1,460 

 

$

1,670 

State taxes, net of federal income tax benefit

 

 

 

Depreciation and amortization

 

505 

 

 

591 

Other accruals

 

447 

 

 

413 

Compensatory stock options and rights

 

2,024 

 

 

1,988 

Other

 

15 

 

 

45 

Tax credit carryforwards

 

3,048 

 

 

2,669 

Operating loss carryforward

 

19,157 

 

 

17,239 

Foreign operating loss carryforward

 

1,866 

 

 

1,193 

Total deferred tax assets

 

28,524 

 

 

25,810 

Deferred tax liabilities:

 

 

 

 

 

Prepaid expenses

 

(379)

 

 

(205)

Basis difference in warrant value

 

(90)

 

 

 

Total deferred tax liabilities

 

(469)

 

 

(205)

       Subtotal

 

28,055 

 

 

25,605 

 

 

 

 

 

 

       Valuation allowance

 

(28,055)

 

 

(25,605)

 

$

 -

 

$

 -

 

The Company evaluates whether a valuation allowance should be established against its deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified.  As of December 28, 2013 and December 29, 2012, a valuation allowance of $28.1 million and $25.6 million, respectively, has been provided based on the Company’s assessment that it is more likely than not, that sufficient taxable income will not be generated to realize the tax benefits of the temporary differences. The valuation allowance increased by approximately $2.5 million and $5.3 million during the years ended December 28, 2013 and December 29, 2012, respectively, primarily related to the increase in the net operating loss carryforward.

At December 28, 2013, the Company has approximately $53.6 million of federal net operating loss (“NOL”) carryforwards which begin to expire in year 2029, and approximately $34.9 million of state net operating loss carryforwards which begin to expire in year 2017, and Federal and state tax credit carryforwards of approximately $1.5 million and $1.6 million, respectively at December 28, 2013.  Federal tax credit carryforwards begin to expire in 2026 and state tax credits carry forward indefinitely.  In addition, the Company has approximately $7.5 million of operating loss carryforwards in the PRC and Taiwan and had $2.7 million of net operating losses expire at the end of the current year.

The deferred tax asset at December 28, 2013 does not include approximately $1.6 million and $1.8 million of excess tax benefits from employee stock option exercises that are a component of the federal and state net operating loss carryover, respectively. The Company’s stockholders’ equity balance will be increased if and when such excess tax benefits are ultimately realized.

For financial reporting purposes, loss before benefit of income taxes includes the following components (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

United States

$

(9,229)

 

$

(12,640)

Foreign

 

(1,528)

 

 

(1,353)

 

$

(10,757)

 

$

(13,993)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

 

2013

 

 

2012

 

 

 

 

 

 

Current:

 

 

 

 

 

Federal

$

 -

 

$

(22)

State

 

 

 

10 

Total current

 

 

 

(12)

Deferred:

 

 

 

 

 

Federal

 

(2,849)

 

 

(4,335)

State

 

1,071 

 

 

(764)

Foreign

 

(672)

 

 

(160)

Change in valuation allowance

 

2,450 

 

 

5,259 

Total deferred

 

 -

 

 

 -

Income tax benefit

$

 

$

(12)

A reconciliation of income taxes computed by applying the statutory U.S. income tax rate to the Companys loss before income taxes to the income tax benefit is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

U.S. federal statutory tax

 

  35%

 

 

  35%

Valuation allowance

 

(27)

 

 

(32)

Loss from foreign subsidiary

 

(5)

 

 

(3)

Other

 

(3)

 

 

-

Effective income tax benefit rate

 

   0%

 

 

   0%

 

Unrecognized Tax Benefits

The following table summarizes the activity related to the Companys unrecognized tax benefits (in thousands):

 

 

 

 

 

 

 

Balance at December 31, 2011

 

 

 

$

22 

Reversal of liability for expiration of statute of limitations

 

 

 

 

(22)

Accrual of potential interest related to unrecognized tax benefits

 

 

 

 

 -

Balance at December 29, 2012

 

 

 

 

 -

Reversal of liability for expiration of statute of limitations

 

 

 

 

 -

Accrual of potential interest related to unrecognized tax benefits

 

 

 

 

 -

Balance at December 28, 2013

 

 

 

$

 -

 

Unrecognized tax benefits of tax positions, if recognized, would affect the Company’s annual effective tax rate.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.  Interest and penalty accruals were insignificant at December 29, 2012.  No interest and penalties are recorded at December 28, 2013.

The Company files tax returns with federal, state and foreign jurisdictions. The Company is no longer subject to IRS or state examinations for periods prior to 2008 although certain carryforward attributes that were generated prior to 2008 may still be adjusted by the IRS.

Tax Holidays

In 2008, the Company began operating under tax holidays in the PRC, which are effective from January 2008 through December 2012. Since the Company operated at a loss in the PRC in 2013 and 2012, it did not realize any benefit to its consolidated results of operations attributable to the tax holidays.

Commitments And Contingencies
Commitments And Contingencies

 

Note 9Commitments and Contingencies

Leases

The Company leases certain of its facilities and equipment under non-cancelable operating leases that expire at various dates through 2017. Rental expense, net of amortization of deferred gain and sublease income, is presented in the following table (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

December 28,

 

December 29,

 

2013

 

2012

 

 

 

 

 

 

Rental expense

$

774 

 

$

959 

 

A summary of future minimum payments under operating lease commitments as of December 28, 2013 is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating

 

 

 

Fiscal Year

Leases

 

 

 

2014

 

364 

 

 

 

2015

 

339 

 

 

 

2016

 

308 

 

 

 

2017

 

34 

 

 

 

Total minimum lease payments

$

1,045 

 

 

 

 

Litigation and Patent Reexaminations 

 

The Company owns numerous patents and continues to enlarge and strengthen its patent portfolios, which cover different aspects of the Company’s technology innovations with various claim scopes. The Company plans to generate revenue by selling or licensing its technology, and intends to vigorously enforce its patent rights against infringers of such rights. The Company dedicates substantial resources in protecting its intellectual property, including its efforts to defend its patents against challenges made by way of reexamination proceedings at the United States Patent and Trademark Office (“USPTO”). These activities are likely to continue for the foreseeable future, without any guarantee that any ongoing or future patent protection and litigation activities will be successful. The Company is also subject to litigation claims that it has infringed on the intellectual property of others, against which the Company intends to defend vigorously.

 

Litigation, whether or not eventually decided in the Company’s favor or settled, is costly and time-consuming and could divert management’s attention and resources. Because of the nature and inherent uncertainties of litigation, should the outcome of any of such actions be unfavorable, the Company’s business, financial condition, results of operations or cash flows could be materially and adversely affected. Additionally, the outcome of pending litigation, and the related patent reexaminations, as well as any delay in their resolution, could affect the Company’s ability to license its intellectual property in the future or to protect against competition in the current and expected markets for its products.

 

Google Litigation 

  

In May 2008, the Company initiated discussions with Google, Inc. (“Google”) based on information and belief that Google had infringed on a U.S. patent owned by the Company, U.S. Patent No. 7,289,386 (“the ‘386 patent”), which relates generally to technologies to implement rank multiplication in memory modules. Preemptively, Google filed a declaratory judgment lawsuit against the Company in the U.S. District Court for the Northern District of California (the “Northern District Court”), seeking a declaration that Google did not infringe the ‘386 patent and that the ‘386 patent was invalid. The Company filed a counterclaim for infringement of the ‘386 patent by Google. Claim construction proceedings were held in November 2009, and the Company prevailed on every disputed claim construction issue. In June 2010, the Company filed motions for summary judgment of patent infringement and dismissal of Google’s affirmative defenses. In May 2010, Google requested and was later granted an Inter Partes Reexamination of the ‘386 patent by the USPTO. The reexamination proceedings are described below. The Northern District Court granted Google’s request to stay the litigation pending result of the reexamination, and therefore has not ruled on the Company’s motions for summary judgment.

 

In December 2009, the Company filed a patent infringement lawsuit against Google in the Northern District Court, seeking damages and injunctive relief based on Google’s infringement of U.S. Patent No. 7,619,912 (“the ‘912 patent”), which is related to the ‘386 patent and relates generally to technologies to implement rank multiplication. In February 2010, Google answered the Company’s complaint and asserted counterclaims against the Company seeking a declaration that the patent is invalid and not infringed, and claiming that the Company committed fraud, negligent misrepresentation and breach of contract based on the Company’s activities in the JEDEC standard-setting organization. The counterclaim seeks unspecified compensatory damages. Accruals have not been recorded for loss contingencies related to Google’s counterclaim because it is not probable that a loss has been incurred and the amount of any such loss cannot be reasonably estimated. In October 2010, Google requested and was later granted an Inter Partes Reexamination of the ‘912 patent by the USPTO. The reexamination proceedings are described below. In connection with the reexamination request, the Northern District Court granted the Company and Google’s joint request to stay the ‘912 patent infringement lawsuit against Google until the completion of the reexamination proceedings.

  

Inphi Litigation 

  

In September 2009, the Company filed a patent infringement lawsuit against Inphi Corporation (“Inphi”) in the U.S. District Court for the Central District of California (the “Central District Court”). The complaint, as amended, alleges that Inphi is contributorily infringing and actively inducing the infringement of U.S. patents owned by the Company, including the ‘912 patent, U.S. Patent No. 7,532,537 (“the ‘537 patent”), which relates generally to memory modules with load isolation and memory domain translation capabilities, and U.S. Patent No. 7,636,274 (“the ‘274 patent”), which is related to the ‘537 patent and relates generally to load isolation and memory domain translation technologies. The Company is seeking damages and injunctive relief based on Inphi’s use of the Company’s patented technology. Inphi denied infringement and claimed that the three patents are invalid. In April 2010, Inphi requested but was later denied Inter Partes Reexaminations of the ‘912, ‘537 and ‘274 patents by the USPTO. In June 2010, Inphi submitted new requests and was later granted Inter Partes Reexaminations of the ‘912, ‘537 and ‘274 patents by the USPTO. The reexamination proceedings are described below. In connection with the reexamination requests, Inphi filed a motion to stay the patent infringement lawsuit with the Central District Court, which was granted. The Central District Court has requested that the Company notify it within one week of any action taken by the USPTO in connection with the reexamination proceedings, at which time the Central District Court may decide to maintain or lift the stay.

  

Smart Modular, Smart Storage, Smart Worldwide, and Diablo Litigations

 

In September 2012, Smart Modular, Inc. (“Smart Modular”) filed a patent infringement lawsuit against the Company in the U.S. District Court for the Eastern District of California (the “Eastern District Court”). The complaint alleges that the Company willfully infringes and actively induces the infringement of six claims of a U.S. patent newly issued to Smart Modular, U.S. Patent No. 8,250,295 (“the ‘295 patent”), and seeks damages and injunctive relief. Smart Modular also filed a motion for preliminary injunction and a memorandum in support of the motion on the same day of the complaint. The Company promptly filed a request for reexamination of the ‘295 patent with the USPTO setting forth six different combinations of prior art that would render the six asserted claims of the ‘295 patent unpatentable. The Company also filed an answer to Smart Modular’s complaint with the Eastern District Court in October 2012 to deny infringement of the ‘295 patent, assert that the ‘295 patent is invalid and unenforceable, and bring a set of counterclaims against Smart . Smart Modular filed various motions on the pleadings on November 1, 2012, which were opposed by the Company in its briefs filed in late November 2012.

 

In December 2012, the USPTO granted the Company’s request for the reexamination of the ‘295 patent, and issued an Office Action rejecting all of the six asserted claims over the six different combinations of prior art set forth by the Company in its request. The Company promptly moved to stay litigation pending result of reexamination. On February 19, 2013, a few days after Smart Modular filed replies in support of its motions, the Eastern District Court issued a Minute Order, in which the court on its own motion took the preliminary injunction; the motion to dismiss and the motion to stay under submission without oral argument and vacated the hearing dates.

 

On February 7, 2013, Smart Modular filed a response to the Office Action in the reexamination of the ‘295 patent. Thereafter, the Company and Smart Modular made various filings to address certain apparent defects contained in Smart Modular’s response. On March 13, 2013, the USPTO issued a Notice of Defective Paper, in which the USPTO found Smart Modular’s responses, both the initial filing and a supplemental filing, to be improper, and both responses were expunged from the record. The USPTO gave Smart Modular 15 days to submit another response, which Smart Modular submitted on March 26, 2013. The Company timely filed its comments on Smart Modular’s corrected response on April 25, 2013.  The USPTO ultimately accepted Smart Modular’s corrected response on July 17, 2013.

 

On May 30, 2013, the Eastern District Court issued an order granting Netlist’s motion to stay pending results of the reexamination of the ‘295 patent and denied Smart Modular’s motion for preliminary injunction.

 

On July 1, 2013, Netlist filed a complaint against Smart Modular in the Santa Ana Division of the U.S. District Court for the Central District of California, seeking, among other things, relief under federal antitrust laws for Smart Modular’s violation of Section 2 of the Sherman Act, and damages and other equitable relief under California statutory and common law for Smart Modular’s unfair competition, deceptive trade practices and fraud.

 

On August 23, 2013, Netlist filed an amended complaint for patent infringement, antitrust violations and trade secret misappropriation against Smart Modular, Smart Storage Systems (Smart Storage), Smart Worldwide Holdings (Smart Worldwide) and Diablo Technologies (Diablo) in the Santa Ana Division of the U.S. District Court for the Central District of California. Netlist’s amended complaint alleges infringement of five Netlist patents by the defendants based on the manufacture and sale of the ULLtraDIMM memory module. Netlist’s complaint also alleges antitrust violations by Smart Modular and Smart Worldwide, contending that Smart Modular procured a patent (U.S. Patent No. 8,250,295) with blatant inequitable conduct at the USPTO, withheld the patent application leading to the patent from relevant JEDEC committees for more than eight years, sought to improperly enforce that patent against Netlist’s JEDEC-compliant HyperCloud® product by seeking a preliminary injunction against Netlist based on the patent, which was denied by the Court, and made deceptive statements to the public about its lawsuit against Netlist. Netlist’s complaint also alleges trade secret misappropriation and trademark infringement against Diablo, claiming that Diablo misused Netlist trade secrets to create the ULLtraDIMM product for Smart Storage Systems, and that Diablo used Netlist’s HyperCloud® technology to create competing products.

 

On the same day Netlist filed its amended complaint, Smart Modular and Diablo each filed a complaint in the San Francisco Division of the U.S. District Court Northern District of California, seeking declaratory judgment of non-infringement and invalidity of the patents asserted in the Netlist’s amended complaint. On September 9, 2013, Netlist filed a Motion to Dismiss or Transfer Complaint to the Central District of California.  This motion was denied on October 10, 2013. 

 

In the Central District Court, Smart Modular and Smart Worldwide filed motions on September 13, 2013, to dismiss or sever various counts related to the ‘295 patent.  On September 26, 2013, Diablo filed a motion to dismiss Netlist’s claims for trade secret misappropriation, breach of contract, and unfair competition.  On October 29, 2013,Smart Modular and Diablo filed motions to dismiss or transfer the patent claims related to the ULLtraDIMM memory module.  On November 26, 2013, the Central District Court: (i) severed and transferred the claims related to the ‘295 patent to the Eastern District of California, which were stayed by the Court on March 7, 2014, along with the other ‘295 related claims pending results of the ‘295 reexamination; (ii) severed and transferred to the Northern District of California the patent claims related to the ULLtraDIMM memory module; (iii) issued an order to show cause why the remaining claims should not also be transferred to the Northern District; and (iv) held in abeyance Diablo’s pending motion to dismiss and motion for judgment on the pleadings.  The parties filed briefs in response to the order to show cause, and then on December 23, 2013, the Central District Court ordered the remaining claims to be transferred to the Northern District.  All of the claims from the amended complaint filed on August 23, 2013, in the Central District Court have now been transferred to either the Northern District or Eastern District of California. 

 

As reported in its Form 8-K filed on December 13, 2013, Netlist received a whistleblower letter postmarked from Canada (where Diablo is based) on November 13, 2013, and obviously written by a current or former Diablo employee.  The letter begins by bluntly stating that Diablo stole Netlist’s architecture and design, and goes on to explain that Diablo used Netlist’s HyperCloudTM product “as-is” in creating the ULLtraDIMM product, which it then used in demonstrations to major customers including IBM and Hewlett-Packard.  The letter further states that Diablo’s management conspired to hide this theft by instructing its employees not to speak to customers about the fact that Netlist’s product was incorporated into ULLtraDIMM.  The letter includes diagrams showing precisely how Diablo implemented the theft of Netlist’s trade secrets, as well as the names of former Diablo employees, customers and suppliers who can verify the theft.  The Form 8-K included as an exhibit a partially redacted copy of the whistleblower letter.  On December 13, 2013, Diablo filed an ex parte application in the Northern District Court requesting that the Court issue an order to show cause by Netlist should not be sanctioned for filing the Form 8-K.  The Northern District Court heard the parties’ arguments on December 16, 2013, and on January 3, 2014, issued an order denying Diablo’s application for sanctions, finding that Diablo had not established a basis for finding the information in the Form 8-K and its attachments “confidential” and therefore had not shown why it should be granted the relief it sought. 

 

On January 21, 2014, Netlist filed a motion for leave to file a second amended answer and counterclaims in the Northern District Court to assert two additional patents against, bringing the total to seven patents asserted against the ULLtraDIMM.  Diablo did not oppose Netlist’s motion, and the parties filed a joint stipulation and proposed order on February 3, 2014, requesting an additional two months be added to the case schedule to account for the additional patents.  On February 5, 2014, the Northern District Court granted Netlist’s motion to add the two patents and entered a new case schedule.

 

‘386 Patent Reexamination 

  

As noted above, in May 2010, Google requested and was later granted an Inter Partes Reexamination of the ‘386 patent by the USPTO. In October 2010, Smart Modular requested and was later granted an Inter Partes Reexamination of the ‘386 patent. The reexaminations requested by Google and Smart Modular were merged by the USPTO into a single proceeding. In April 2011, a Non-Final Action was issued by the USPTO, rejecting all claims in the patent. In July 2011, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims in view of cited references. Both Google and Smart Modular filed their comments to the Company’s response in October 2011. In October 2012, the USPTO issued an Action Closing Prosecution (“ACP”) rejecting all 60 claims. The Company filed a response to the ACP on December 3, 2012. On June 21, 2013, the USPTO issued a Right of Appeal Notice (RAN) in which the Examiner maintained his rejection of the claims. Netlist filed a notice of appeal on July 19, 2013. Google filed a notice of cross-appeal on August 2, 2013, and a cross-appeal brief on October 1, 2013. The Company filed an appeal brief and an amendment canceling some of the remaining claims on October 2, 2013 to further focus the issues on appeal.  On February 24, 2014, the Examiner entered the amendment canceling claims, withdrew the rejections related to those claims, but otherwise maintained the positions previously set forth in the RAN.  Thus, the reexamination of the ‘386 patent remains pending and will continue in accordance with established procedures for merged reexamination proceedings.

 

912 Patent Reexamination 

 

As noted above, in April 2010, Inphi requested but was later denied an Inter Partes Reexamination of the ‘912 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘912 patent by the USPTO. In September 2010, the USPTO confirmed the patentability of all fifty-one claims of the ‘912 patent. In October 2010, Google and Smart Modular each filed and were later granted requests for reexamination of the ‘912 patent. In February 2011, the USPTO merged the Inphi, Google and Smart Modular ‘912 reexaminations into a single proceeding. In an April 2011 Non-Final Action in the merged reexamination proceeding, the USPTO rejected claims 1-20 and 22-51 and confirmed the patentability of claim 21 of the ‘912 patent. In July 2011, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi, Google, and Smart Modular filed their comments on the Company’s response in August 2011. In October 2011, the USPTO mailed a second Non-Final Action confirming the patentability of twenty claims of the ‘912 patent, including claims that were added in the reexamination process. In January 2012, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Google, Inphi and Smart Modular filed their comments to the Company’s response in February 2012. The USPTO determined that Smart Modular’s comments were defective, and issued a notice to Smart Modular to rectify and resubmit its comments. Smart Modular filed corrected comments and a petition for the USPTO to withdraw the notice in March 2012. The USPTO issued a non-final Office Action on November 13, 2012 maintaining the patentability of many key claims while rejecting some claims that were previously determined to be patentable. The Company filed a response to the Office Action on January 14, 2013. The requesters filed their comments on February 13, 2013. The reexamination of the ‘912 patent remains pending and will continue in accordance with established procedures for merged reexamination proceedings.

  

‘627 Patent Reexamination 

  

In September 2011, Smart Modular filed a request for reexamination of U.S. Patent No. 7,864,627 (“the ‘627 patent”) issued to the Company on January 4, 2011. The ‘627 patent is related to the ‘912 patent. In November 2011, the USPTO granted Smart Modular’s request for reexamination of the ‘627 patent and concurrently issued a Non-Final Action confirming the patentability of three claims. In February 2012, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Smart Modular filed its comments to the Company’s response in March 2012. The USPTO determined that Smart Modular’s comments were defective and issued a notice in April 2012 to Smart Modular to rectify and resubmit its comments. Smart Modular filed corrected comments and a petition for the USPTO to withdraw the notice in April 2012. The USPTO posted an Office Action on December 19, 2012, confirming one claim and rejecting the rest of the claims in the ‘627 patent. The Company filed a response to the Office Action on March 19, 2013. Smart Modular filed its comments on the Office Action on April 24, 2013. The USPTO issued another Non-Final Office Action on September 26, 2013, withdrawing certain rejections while adopting new rejections for certain of the pending claims.  The Company responded to the Non-Final Office Action on November 26, 2013, by amending some of the claims and making arguments as to the validity of the rejected claims.  The reexamination of the ‘627 patent remains pending and will continue in accordance with established Inter Partes Reexamination procedures.

  

‘537 Patent Reexamination 

  

As noted above, in April 2010, Inphi requested and was later denied an Inter Partes Reexamination of the ‘537 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘537 patent by the USPTO. In September 2010, the USPTO issued a Non-Final Action confirming the patentability of four claims. In October 2010, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi filed its comments on the Company’s response in January 2011. In June 2011, the USPTO issued an ACP, which reconfirmed the patentability of the four claims. In August 2010, the Company responded by amending some of the claims and making arguments as to the validity of the rejected claims. Inphi filed its comments to the Company’s response in September 2011. The USPTO issued a Right of Appeal Notice (“RAN”) in February 2012, in which the claim rejections were withdrawn, thus confirming the patentability of all sixty (60) claims in view of all the previously submitted comments by both Inphi and the Company. Inphi filed a notice of appeal in March 2012 followed by an appeal brief in May 2012. In response, the USPTO issued a Notice of Defective Appeal Brief. Inphi filed a corrective appeal brief in late May 2012, and the Company filed its reply brief to the corrected Inphi appeal brief in early July 2012. The examiner responded to Inphi’s corrected appeal brief as well as the Company’s reply brief by Examiner’s Answer on April 16, 2013, in which he maintained his position confirming all sixty (60) claims. Inphi filed a rebuttal brief on May 16, 2013. Netlist filed a request for oral hearing on June 14, 2013. The Company and the examiner jointly defended the ‘537 patent in a hearing on November 20, 2013 before the Patent Trial and Appeal Board (PTAB) at the USPTO.  On January 16, 2014, the PTAB issued a decision upholding the validity of all 60 claims, dismissing every single validity challenge raised by Inphi and affirming the examiner’s decision to allow the claims.  The reexamination of the ‘537 patent remains pending and will continue in accordance with established procedures for Inter Partes Reexamination.

  

‘274 Patent Reexamination

 

As noted above, in April 2010, Inphi requested and was later denied an Inter Partes Reexamination of the ‘274 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘274 patent by the USPTO. In September 2011, the USPTO issued a Non-Final Action, confirming the patentability of six claims. The Company has responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi filed its comments on the Company’s response in November 2011. The USPTO issued an ACP in March 2012, which confirmed the patentability of one hundred and four (104) claims in view of all the previously submitted comments by both Inphi and the Company. The USPTO subsequently issued a RAN in June 2012. This RAN triggered Inphi’s right as the losing party to file a notice of appeal and corresponding appeal brief, which Inphi filed when due. The Company responded to Inphi’s appeal brief by filing a reply brief in October 2012. The examiner responded to Inphi’s appeal brief and the reply brief by Examiner’s Answer on April 16, 2013, in which he maintained his position confirming the one hundred and four (104) claims. Inphi filed a rebuttal brief on May 16, 2013. Netlist filed a request for oral hearing on June 14, 2013. The Company and the USPTO examiner jointly defended the ‘274 patent in a hearing on November 20, 2013 before the PTAB, in accordance with established procedures for Inter Partes Reexamination.  On January 16, 2014, the PTAB issued a decision affirming the Examiner in part, but reversing the Examiner on new grounds and rejecting the one hundred and four (104) claims.  Because the claims were rejected on new grounds, the Company may file a response requesting reopening of prosecution before the Examiner.  The Company was granted an extension of time to file this response, and will do so prior to the new due date which will be on or about March 17, 2014.  The reexamination of the ‘274 patent remains pending and will continue in accordance with established procedures for Inter Partes Reexamination.

  

 Other Contingent Obligations 

  

During its normal course of business, the Company has made certain indemnities, commitments and guarantees pursuant to 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 Company’s negligence or willful misconduct; (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 condensed consolidated balance sheets.

Stockholders' Equity
Stockholders' Equity

Note 10Stockholders Equity

Serial Preferred Stock

The Company’s authorized capital includes 10,000,000 shares of Serial Preferred Stock, with a par value of $0.001 per share.  No shares were outstanding at December 28, 2013 or December 29, 2012.

Common Stock

 

In November 2011, the Company entered into a sales agreement with Ascendiant Capital Markets LLC (“Ascendiant”), whereby shares with a total value of up to $10.0 million may be released for sale to the public at the discretion of management at a price equal to the current market price in an “at-the-market” offering as defined in Rule 415 under the Securities Act of 1933. During 2013 and 2012, the Company received net proceeds of approximately $0.2 million and $3.9 million, respectively, raised through the sale of 240,373 and 1,312,669 shares of common stock, respectively. The sales agreement with Ascendiant expired on November 21, 2013.

On December 20, 2012, the Company raised gross proceeds of $1.5 million in a registered public offering (“Offering”) of its securities. The Offering closed on December 26, 2012, and the Company received net proceeds of $1.3 million after deducting commissions and offering costs. The Offering resulted in the issuance of 1,685,394 shares of common stock and warrants to purchase up to an aggregate of 2,275,282 shares of the Company’s common stock, which represents 135% of the number of shares issued and sold in the Offering. Each warrant grants the holder the right to purchase one share of the Company’s common stock at an exercise price of $0.89 per share and expires in June 2018. These warrants became exercisable 181 days following the December 26, 2012 issuance date.  In February 2014, 750,000 of these warrants were exercised. 

On July 17, 2013, the Company entered into a definitive securities purchase agreement for the sale of common stock and warrants in a registered public offering (“2013 Offering”) of its securities for gross proceeds of $1.0 million.  The 2013 Offering closed on July 19, 2013, and the Company received net proceeds of $960,000 after deducting commissions and offering costs.  The 2013 Offering resulted in the issuance 1,098,902 shares of the Company’s common stock and a warrant to purchase up to an aggregate of 1,098,902 shares of the Company’s common stock. The warrant is exercisable as of the date of its issuance, has a term of seven years, and an exercise price of $1.00 per share.  The exercise price and the number of warrant shares issuable upon exercise of warrant is subject to adjustment in the event of, among other things, certain transactions affecting the Company’s common stock (including without limitation stock splits and stock dividends), and certain fundamental transactions (including without limitation a merger or other sale-of-company transaction).

 

In addition, on July 18, 2013, concurrent with the execution of the Loan Agreement, the Company issued to an affiliate of DBD, a seven-year warrant (the “Warrant”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at a per share price of $1.00, of which 989,011 shares are exercisable immediately on a cash or cashless basis in whole or in part. Pursuant to the terms of the stock purchase warrant agreement, (i) 329,670 shares will become exercisable upon the achievement of the IP Monetization Milestones and (ii) the remaining 329,670 shares will become exercisable upon the Company’s receipt of an IP Milestone Term Loan. The Warrant was issued in a private placement transaction that was exempt from registration under Section 4(2) of the Securities Act of 1933 (the “Securities Act”).   See Note 6 for treatment of the warrant.

 

During the years ended December 28, 2013 and December 29, 2012, the Company cancelled 19,575 and 23,631 shares of common stock, respectively, valued at approximately $14,000 and $64,000, respectively, in connection with its obligation to holders of restricted stock to withhold the number of shares required to satisfy the holders’ tax liabilities in connection with the vesting of such shares.

The Company is incorporated in the state of Delaware, and as such, is subject to various state laws which may restrict the payment of dividends or purchase of treasury shares.

Stock-Based Compensation

The Company has stock-based compensation awards outstanding pursuant to the Amended and Restated 2000 Equity Incentive Plan (the “2000 Plan”) and the Amended and Restated 2006 Equity Incentive Plan (the “2006 Plan”), under which a variety of option and direct stock‑based awards may be granted to employees and nonemployees of the Company. Further grants under the 2000 Plan were suspended upon the adoption of the 2006 Plan. In addition to awards made pursuant to the 2006 Plan, the Company periodically issues inducement grants outside the 2006 Plan to certain new hires.

Subject to certain adjustments, as of December 28, 2013, the Company was authorized to issue a maximum of 6,605,566 shares of common stock pursuant to awards under the 2006 Plan. That maximum number will automatically increase on the first day of each subsequent calendar year by the lesser of (i) 5.0% of the number of shares of common stock that are issued and outstanding as of the first day of the calendar year, and (ii) 1,200,000 shares of common stock, subject to adjustment for certain corporate actions. At December 28, 2013, the Company had 753,010 shares available for grant under the 2006 Plan.  Options granted under the 2000 Plan and the 2006 Plan equity incentive plans primarily vest at a rate of at least 25% per year over four years and expire 10 years from the date of grant. Restricted stock awards vest in eight equal increments at intervals of approximately six months from the date of grant.

 

A summary of the Company’s common stock option activity is presented below (shares in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Weighted-

 

Remaining

 

Aggregate

 

Number of

 

Average

 

Contractual

 

Intrinsic

 

Shares

 

Exercise

 

Life

 

Value

 

(in thousands)

 

Price

 

(in years)

 

(in thousands)

Options outstanding - December 31, 2011

 

5,368 

 

 

2.62 

 

 

 

 

 

 

Options granted

 

1,667 

 

 

3.40 

 

 

 

 

 

 

Options exercised

 

(1,032)

 

 

0.67 

 

 

 

 

 

 

Options cancelled

 

(1,251)

 

 

2.83 

 

 

 

 

 

 

Options outstanding - December 29, 2012

 

4,752 

 

 

$         3.22

 

 

 

 

 

 

Options granted

 

2,080 

 

 

0.77 

 

 

 

 

 

 

Options exercised

 

(117)

 

 

0.34 

 

 

 

 

 

 

Options cancelled

 

(878)

 

 

2.05 

 

 

 

 

 

 

Options outstanding - December 28, 2013

 

5,837 

 

$

2.58