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As filed with the Securities and Exchange Commission on August 18, 2006
Registration No. 333-                     .

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

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

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

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

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

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

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

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.
        If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.     o
        If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o
        If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o
        If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     o

CALCULATION OF REGISTRATION FEE

Title of Each Class of
Securities to be Registered	 	Amount to
be Registered(1)	 	Proposed Maximum
Offering Price
Per Share(2)	 	Proposed Maximum
Aggregate
Offering Price	 	Amount of
Registration Fee	
	
Common Stock, $0.001 par value per share	 	 	 	 	 	$57,500,000	 	$6,152.50	
	
(1)
Includes over-allotment option of                          .
(2)
Estimated solely for the purposes of computing the registration fee in accordance with Rule 457(a).

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

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell securities, and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED AUGUST 18, 2006

             Shares
Common Stock

Netlist, Inc. is selling             shares of our common stock. The selling stockholders named in this prospectus, including members of our management, have granted the underwriters a 30-day option to purchase up to an additional             shares to cover over-allotments, if any. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.
This is an initial public offering of our common stock. We currently expect the initial public offering price to be between $                        and $                        per share. We intend to apply for approval for quotation of our common stock on the Nasdaq Global Market under the symbol "NLST."

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

 	 	Per Share	 	Total	
Public offering price	 	 $          	 	 $	                       	
Underwriting discount	 	 $          	 	 $	                       	
Proceeds, before expenses, to us	 	 $          	 	 $	                       	
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

Thomas Weisel Partners LLC	 	 	
Needham & Company, LLC	
 	 	WR Hambrecht + Co	
The date of this prospectus is                           , 2006

Inside Front Cover:
        At the top of the page is a colored banner, with two lines of text in black type as follows:
        "Netlist designs and manufactures high performance memory subsystems for the server, high performance computing and communications markets."
        At the top left of the page, partially on top of the banner, is a red stylized "N" logo with the name "Netlist" appearing in black type directly beneath the logo.
        On the left-hand side of the page, below the stylized "N" logo and the name "Netlist," is the following caption in red type:
"Our memory subsystems bridge
the gap between industry standard
approaches and the requirements
of complex OEM systems"
        Appearing across the center and right-hand side of the page, centered vertically, is a collage of pictures of representative Netlist products, in clockwise order beginning at the bottom, center, as follows: DDR VLP RDIMMs, DDR2 RDIMMs, FBDIMM With IFHS, DDR2 FBDIMMs, DDR2 VLP RDIMM, DDR DIMMs, DRAM Load Simulators, Enterprise Server DIMMs, SO-DIMMs. Each of these pictures is captioned with the exact product name described in the prior sentence.
        At the bottom of the page is a banner of the same color as the banner appearing at the top of the page. This colored banner on the bottom of the page has a series of 9 pictures of applications, appearing from left to right, which are representative of OEM systems in which Netlist's products are used, as follows: communications router, communications blade server, tower server, rack server, blade server, high performance computing cluster, communications switch, rack server (another make), tower server (another make). None of these pictures are captioned.

 
 TABLE OF CONTENTS

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

        You should rely only on the information contained or incorporated by reference in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.
        In this prospectus "our company," "we," "us" and "our" refer to Netlist, Inc. and its subsidiaries.
        All trademarks, service marks or trade names appearing in this prospectus are the property of their respective owners.
        Effective January 1, 2003, we changed our fiscal year from a calendar year to a 52- or 53-week fiscal year ending on the Saturday closest to December 31. Each of the first three quarters of our fiscal year end on the last Saturday in each of March, June and September. As a result, each fiscal quarter consists of 13 weeks during a 52-week fiscal year. During a 53-week fiscal year, one quarter will have 14 weeks and three quarters will consist of 13 weeks. For simplicity of presentation, we have expressed the end of each fiscal period presented in this prospectus as ending on the last day of the final month of that period.
        Market data and industry statistics used throughout this prospectus are based on independent industry publications and other publicly available information. We do not guarantee, and we have not independently verified, this information. Accordingly, investors should not place undue reliance on this information.
i

 
 PROSPECTUS SUMMARY
         You should read the following summary together with the more detailed information concerning our company, the common stock being sold in this offering and our consolidated financial statements appearing in this prospectus and in the documents incorporated by reference in this prospectus. Read this entire prospectus carefully, especially the risks described under "Risk Factors," before you invest in our common stock.
 
 Netlist, Inc.
        We design and manufacture high performance memory subsystems. We sell our subsystems to original equipment manufacturers, or OEMs, in the server, high performance computing and communications markets. Within these markets, we target applications in which memory plays a key role in enabling overall system performance. Our memory subsystems are incorporated into multiple platforms at International Business Machines Corporation, or IBM, Dell Inc., Gateway, Inc., Lenovo Group Limited, or Lenovo, and Hewlett-Packard Company.
        Electronic systems of all types are continually evolving to keep pace with user demands for higher performance, as measured by speed, functionality or smaller physical size. In order to meet these performance expectations, OEM designers rely on increasing amounts of memory to take advantage of the latest advances in processor technology and operating system functionality. Dynamic random access memory, or DRAM, represents the most common type of memory used across these electronic systems today. In memory-intensive applications, OEMs often seek memory solutions which integrate multiple DRAM integrated circuits, or ICs, into a subsystem that delivers high memory density in a small form factor. These memory subsystems are available in both standard and application-specific configurations. Standard memory modules have proven generally inadequate to meet the demanding customer requirements in our target markets. Our memory subsystems are primarily designed and manufactured to specifically address the high performance needs of our customers' systems more completely than is possible using standard memory modules.
        We collaborate with our OEM customers in the earliest stages of their new product design cycles. This collaboration provides us with unique insight into the OEM's system architecture and performance requirements and expands our systems expertise. In addition, we have developed a portfolio of proprietary technologies and design techniques to meet OEM needs, including efficient planar design, alternative packaging techniques and custom semiconductor logic. As a result of our systems expertise and proprietary technologies, we are able to design application-specific memory subsystems with optimal combinations of high memory density, small form factor, high signal integrity, effective heat dissipation and low cost per bit. We also offer our OEM customers flexible order fulfillment and rapid turnaround times once we begin volume production of a specific product.
        Designing memory subsystems that meet the requirements of high performance electronic systems has become increasingly difficult. One approach to meeting these requirements is to add more memory ICs to a memory module, which requires more space, complicates board and system design and exacerbates signal integrity and heat dissipation issues. A second approach is to use next-generation memory ICs that offer greater memory density, but the high cost and low availability of these ICs discourages their immediate adoption in high performance systems. A third approach is to stack prior generation memory ICs, yet this technique can still constitute a significant portion of the cost of materials for a memory module. These industry standard approaches generally do not by themselves meet the requirements of high performance electronic systems. We leverage our proprietary technology and our extensive systems expertise to bridge this gap between industry standard approaches and the requirements of complex OEM systems.
1

        Our memory subsystems offer differentiated features and performance characteristics. For example, our innovative printed circuit board, or PCB, designs enhance signal integrity, allowing our customers to design and market products that operate at the highest commercially available speeds. Another technique we utilize is to embed passive devices within the PCB, thereby freeing valuable board space to reduce form factors and improve signal integrity. Our solutions also address system-level thermal issues encountered at high operating speeds through such innovations as planar designs and proprietary heat dissipation technologies.
        Our objective is to be the leading provider of high performance memory subsystems. Key elements of our strategy include:
•
Further Sales Penetration of Existing Customers .    We have established deep relationships, and qualified our products, with leading OEMs. Our current OEM customers have a large and diverse portfolio of system platforms that require high performance memory subsystems. We believe we have an attractive opportunity to provide them with memory solutions for a greater number of their existing and future platforms.

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

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

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

•
Establish International Operations and Manufacturing Capabilities.     We plan to establish a manufacturing facility in China during the first half of 2007. We believe that this will allow us to better support leading OEMs with design and manufacturing sites in China, lower our production costs and provide access to new pools of engineering talent.
        We were incorporated in Delaware in June 2000 and commenced operations in September 2000. Our principal executive offices are located at 475 Goddard, Irvine, California 92618, and our telephone number is (949) 435-0025. Our web site is www.netlistinc.com. The information on our web site is not incorporated by reference into this prospectus.
2

  
 
 The Offering

Common stock offered	
 	
                          shares	

Common stock to be outstanding after this offering	
 	
                          shares	

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

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

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

Proposed Nasdaq Global Market symbol	
 	
NLST	
        The common stock to be outstanding after this offering is based on 11,223,334 shares of common stock outstanding as of June 30, 2006, plus the following number of shares of common stock issuable upon the conversion of our outstanding convertible securities effective immediately prior to the completion of this offering:
•
1,000,000 shares issuable upon the conversion of all of our outstanding convertible preferred stock; and

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

        The common stock to be outstanding after this offering excludes the following number of shares of common stock, each described as of June 30, 2006:
•
382,500 shares of common stock issuable upon the exercise of outstanding warrants with a weighted-average exercise price of $1.13 per share;

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

•
1,122,166 shares of common stock available for future issuance under our 2000 Equity Incentive Plan.
3

        Unless otherwise indicated, all information in this prospectus assumes: an initial public offering price of $              per share; no exercise of the underwriters' over-allotment option; and the filing of a restated certificate of incorporation and adoption of restated bylaws prior to the completion of this offering.
4

 
 Summary Consolidated Financial Data
        The summary consolidated financial data set forth below should be read in conjunction with the information presented in this prospectus under "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," and with our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus.
        The summary consolidated financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2003, 2004 and 2005 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the years ended December 31, 2001 and 2002 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for the six month periods ended June 30, 2005 and 2006, and the consolidated balance sheet data as of June 30, 2006, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus.
        Our historical results are not necessarily indicative of results for any future period. The "Pro Forma" column of the consolidated balance sheet data reflects the automatic conversion immediately prior to the completion of this offering of $1.75 million of convertible notes and $2.0 million of convertible preferred stock into common stock, and the repayment of $950,000 of convertible debt, plus accrued interest, with proceeds of $1.0 million received from a term loan in August 2006. The "Pro Forma as Adjusted" column of the consolidated balance sheet data adjusts the pro forma amounts to reflect the sale of             shares of common stock offered by us at an assumed initial public offering price of $                         per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	
 	 	2001
	 	2002
	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	
 	 	(in thousands, except per share data)
	
Consolidated Statement of Operations Data:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net sales	 	$	2,660	 	$	13,994	 	$	100,375	 	$	143,659	 	$	79,856	 	$	36,495	 	$	65,934	
Cost of sales(1)	 	 	3,035	 	 	12,147	 	 	86,107	 	 	133,503	 	 	73,892	 	 	34,319	 	 	57,447	
 	 		 		 		 		 		 		 		
Gross profit (loss)	 	 	(375	)	 	1,847	 	 	14,268	 	 	10,156	 	 	5,964	 	 	2,176	 	 	8,487	
Research and development(1)	 	 	220	 	 	491	 	 	11,759	 	 	3,770	 	 	2,961	 	 	1,876	 	 	1,514	
Selling, general and administrative(1)	 	 	842	 	 	1,652	 	 	15,218	 	 	6,314	 	 	5,062	 	 	2,300	 	 	3,911	
 	 		 		 		 		 		 		 		
Operating income (loss)	 	 	(1,437	)	 	(296	)	 	(12,709	)	 	72	 	 	(2,059	)	 	(2,000	)	 	3,062	
Net income (loss)	 	$	(959	)	$	(632	)	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,306	

Net income (loss) per common share:	

 	

 	

 	

 	

 	

 	

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

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

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	
 	 	2001
	 	2002
	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	
Cost of sales	 	$	—	 	$	—	 	$	69	 	$	29	 	$	56	 	$	(9	)	$	14	
Research and development	 	 	—	 	 	371	 	 	9,733	 	 	80	 	 	(52	)	 	(22	)	 	22	
Selling, general and administrative	 	 	87	 	 	424	 	 	10,872	 	 	141	 	 	(65	)	 	(17	)	 	111	
5

 
 	 	June 30, 2006
	
 	 	Actual
	 	Pro Forma
	 	Pro Forma,
as Adjusted
	
 	 	(in thousands)
	
Consolidated Balance Sheet Data:	 	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	27	 	$	77	 	$	 	
Total assets	 	 	34,516	 	 	34,566	 	 	 	
Total debt(1)	 	 	14,739	 	 	13,039	 	 	 	
Stockholders' equity	 	 	4,671	 	 	6,421	 	 	 	

(1)
Amounts include revolving line of credit balance as of June 30, 2006 of $10,714,000.
        We use a 52-53 week fiscal year. As a result, a fiscal year or quarter may not end as of the same day as the calendar period. However, for convenience of presentation, the above summary consolidated financial data have been shown as ending on June 30 and December 31 of each applicable period.
6

 
 RISK FACTORS
         You should carefully consider the risks described below before making an investment decision. These risks are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations, operating results, cash flows and financial condition. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to the occurrence of any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this prospectus, including our consolidated financial statements and related notes.
Risks Related to Our Business and Industry
We have a limited operating history, and we expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.
        Our limited operating history makes it difficult to predict our future performance. Our operating results have varied significantly in the past and will continue to fluctuate from quarter-to-quarter or year-to-year in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these quarterly and annual fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:
•
the loss of, or a significant reduction in sales to, a key customer;

•
the cyclical nature of the industry in which we operate;

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

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

•
the timing of introductions of competing products or technologies;

•
our ability to adequately support future growth;

•
our ability to procure an adequate supply of key components;

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

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

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

•
the loss of any of our key personnel;

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

•
disputes regarding intellectual property rights;

•
litigation involving our products;

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

•
changes in accounting principles or policies.
7

        Due to the various factors mentioned above, and others, the results of any prior quarterly or annual periods should not be relied upon as an indication of our future operating performance.
Our three largest customers comprised approximately 68% and 81% of our net sales for 2005 and the first six months of 2006, respectively, and the loss of, or a significant reduction in sales to, any one of these customers could materially harm our business.
        Sales to Dell, IBM and Lenovo represented 35%, 20% and 13%, respectively, of our net sales in 2005, and 33%, 46% and 2%, respectively, of our net sales in the first six months of 2006. We expect that sales to these customers will continue to represent a significant percentage of our net sales for at least the next 12 months. We do not have long-term agreements with these three customers, or with any other customer. Any one of these three customers could decide at any time to discontinue, decrease or delay their purchase of our products. In addition, the prices that these three customers pay for our products are subject to negotiation and could change at any time. The loss of either Dell or IBM as a customer, or a significant reduction in sales to either of them, would significantly reduce our net sales and adversely affect our operating results.
        Our ability to maintain or increase our net sales to our key customers depends on a variety of factors, many of which are beyond our control. These factors include the customers' continued sales of servers and other computing systems that incorporate our memory subsystems and the customers' continued use of our products in their systems.
        Because of these and other factors, we cannot assure you that net sales to these customers will continue or that the amount of such net sales will reach or exceed historical levels in any future period. Because these customers account for a substantial portion of our net sales, the failure of any one of these customers to pay on a timely basis would negatively impact our cash flow.
A limited number of relatively large potential customers dominate the markets for our products.
        Our target markets are characterized by a limited number of large companies. Consolidation in one or more of our target markets may further increase this industry concentration. As a result, we anticipate that sales of our products will continue to be concentrated among a limited number of large customers in the foreseeable future. We believe that our financial results will depend in significant part on our success in establishing and maintaining relationships with, and effecting substantial sales to, these potential customers. Even if we establish these relationships, our financial results will be largely dependent on these customers' sales and business results.
The markets in which we compete are cyclical in nature, and any future downturn could adversely affect our business.
        The markets in which we compete and in which our customers operate have been cyclical and are characterized by wide fluctuations in product supply and demand. These markets have experienced significant downturns, often connected with, or in anticipation of, maturing product cycles, reductions in technology spending and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and the erosion of average selling prices. As a result, our sales will likely decline during these periods. In addition, if we are unable to control our expenses adequately in response to reduced net sales, our results of operations would be negatively impacted.
We are subject to risks relating to product concentration and lack of market diversification.
        In 2005 and the first six months of 2006, we generated 51% and 83%, respectively, of our net sales from sales of our high performance memory subsystems for use in the server market. We
8

expect these memory subsystems to continue to account for most of our net sales in the near term. Continued market acceptance of these products for use in servers is critical to our success. If the demand for servers deteriorates or if the demand for our products to be incorporated in servers declines, our operating results would be adversely affected, and we would be forced to diversify our product portfolio and our target markets. We may not be able to achieve this diversification, and our inability to do so may adversely affect our business.
We have historically incurred losses and may continue to incur losses.
        We have incurred net losses each year since the inception of our business. Our cumulative net losses were $21.4 million and $20.1 million as of December 31, 2005 and June 30, 2006, respectively. We may not be able to attain profitability on a quarterly or annual basis in the future.
We use a small number of DRAM IC suppliers and are subject to risks of disruption in the supply of DRAM ICs.
        Our ability to fill customer orders is dependent on a sufficient supply of DRAM ICs, which are an essential component of our memory subsystems. There is a relatively small number of suppliers of DRAM ICs, and we purchase from only a subset of these suppliers. We have no long-term DRAM supply contracts. Our dependence on a small number of these suppliers and our lack of any guaranteed sources of DRAM supply expose us to several risks, including the inability to obtain an adequate supply of DRAM ICs, price increases, delivery delays and poor quality.
        From time to time, shortages in DRAM ICs have required some suppliers to limit the supply of their DRAM ICs. As a result, we may be unable to obtain the DRAM ICs necessary to fill customers' orders for our products in a timely manner. If we are unable to obtain a sufficient supply of DRAM ICs to meet our customers' requirements, these customers may reduce future orders for our products or not purchase our products at all, which would cause our net sales to decline and harm our operating results. In addition, our reputation could be harmed, we may not be able to replace any lost business with new customers, and we may lose market share to our competitors.
        Our customers qualify the DRAM ICs of our suppliers for use in their systems. If one of our suppliers should experience quality control problems, it may be disqualified by one or more of our customers. This would disrupt our supplies of DRAM ICs and reduce the number of suppliers available to us, and may require that we qualify a new supplier.
The price of DRAM ICs is volatile, and excess inventory of DRAM ICs, other components, and finished products could adversely affect our gross margin.
        The prices of our products are adjusted periodically based largely on the market price of DRAM ICs, which constituted more than 82% and 75% of the total cost of our memory subsystems sold during 2005 and the first six months of 2006, respectively. Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. Consequently, we are exposed to the risks associated with the volatility of the price of DRAM ICs during that period. If the market price for DRAM ICs increases, we generally cannot pass this price increase on to our customers for products purchased under an existing purchase order. As a result, our cost of sales could increase and our gross margins could decline. Alternatively, if there is a decline in the price of DRAM ICs, we will need to reduce our selling prices for subsequent purchase orders, which may result in a decline in our expected net sales.
        Customer demand for our products, and thus DRAM ICs, can be difficult to estimate because we do not have long-term commitments from our customers, and our customers may cancel or defer purchase orders for any reason. If we overestimate customer demand, we will have excess
9

inventory of DRAM ICs. If there is a subsequent decline in the price of DRAM ICs, the value of our inventory will fall. As a result, we may need to write-down the value of our DRAM IC inventory, which may result in a significant decrease in our gross margin and financial condition. If we underestimate customer demand, we will not have sufficient inventory of DRAM ICs to manufacture our products. This will lead to delays in the delivery of our products, which could cause order cancellations, the loss of customers and a decrease in our net sales.
If the supply of other component materials used to manufacture our products is interrupted, or if our inventory becomes obsolete, our results of operations and financial condition could be adversely affected.
        We use consumables and other components, including PCBs, to manufacture our memory subsystems. We sometimes procure PCBs and other components from single or limited sources to take advantage of volume pricing discounts. Material shortages or transportation problems could interrupt the manufacture of our products from time to time in the future. These delays in manufacturing could adversely affect our results of operations.
        Frequent technology changes and the introduction of next-generation products also may result in the obsolescence of other items of inventory, such as our custom-built PCBs, which could reduce our gross margin and adversely affect our operating performance and financial condition. We may not be able to sell some products developed for one customer to another customer because our products are often designed to address specific customer requirements, and if we are able to sell these products our margin on such products may be reduced.
We may lose our competitive position if we are unable to timely and cost-effectively develop new or enhanced products that meet our customers' requirements and achieve market acceptance.
        Our industry is characterized by intense competition, rapid technological change, evolving industry standards and rapid product obsolescence. Evolving industry standards and technological change or new, competitive technologies could render our existing products obsolete. Accordingly, our ability to compete in the future will depend in a large part on our ability to identify and develop new or enhanced products on a timely and cost-effective basis, and to respond to changing customer requirements. In order to develop and introduce new or enhanced products, we need to:
•
identify and adjust to the changing requirements of our current and potential customers;

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

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

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

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

•
develop and maintain effective marketing strategies.
        Our product development efforts are costly and inherently risky. It is difficult to foresee changes or developments in technology or anticipate the adoption of new standards. Moreover, once these things are identified, if at all, we will need to hire the appropriate technical personnel, develop the product and identify and eliminate design flaws. As a result, we may not be able to successfully develop new or enhanced products, or we may experience delays in the development and introduction of new or enhanced products. Delays in product development and introduction could
10

result in the loss of, or delays in generating, net sales and the loss of market share, as well as damage to our reputation. Even if we develop new or enhanced products, they may not meet our customers' requirements or gain market acceptance. Accordingly, we cannot assure you that our future product development efforts will result in the development of new or enhanced products or that such products will achieve market acceptance.
Our customers require that our products undergo a lengthy and expensive qualification process without any assurance of net sales.
        Our prospective customers generally make a significant commitment of resources to test and evaluate our memory subsystems prior to purchasing our products and integrating them into their systems. This extensive qualification process involves rigorous reliability testing and evaluation of our products, which may continue for six months or longer and is often subject to delays. Qualification by a prospective customer does not ensure any sales to that prospective customer. Even after successful qualification and sales of our products to a customer, changes in our products, our manufacturing facilities, our production processes or our component suppliers may require a new qualification process, which may result in additional delays.
        The qualification process is generally both product-specific and platform-specific, and as a result, our existing customers sometimes require us to requalify our products, or to qualify our new products, for use in new platforms or applications. For example, as our OEM customers transition from prior generation double data rate, or DDR, to current generation DDR2 DRAM architectures, we must design and qualify new products for use by those customers. In the past, this process of design and qualification has taken up to six months to complete, during which time our net sales to those customers declined significantly. After our products are qualified, it can take several months before the customer begins production and we begin to generate net sales. We must devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualify our products with prospective customers in anticipation of sales. If we delay or do not succeed in qualifying a product with a prospective customer, we will not be able to sell that product to that prospect, which would harm our operating results and business.
We may not be able to maintain our competitive position because of the intense competition in our target markets.
        We participate in highly competitive markets, and we expect competition to intensify. Many of our competitors have longer operating histories, significantly greater resources and name recognition, a larger base of customers and longer-standing relationships with customers and suppliers than we have. As a result, some of these competitors are able to devote greater resources to the development, promotion and sale of products and are better positioned than we are to influence customer acceptance of their products over our products. These competitors also may be able to respond better to new or emerging technologies or standards and may be able to deliver products with comparable or superior performance at a lower price. For these reasons, we may not be able to compete successfully against these competitors.
        In addition to the competitors described above, some of our OEM customers have their own internal design groups that may develop solutions that compete with ours. These design groups have some advantages over us, including direct access to their respective companies' technical information and technology roadmaps. Our OEM customers also have substantially greater resources, financial or otherwise, than we do, and may have lower cost structures than ours. As a result, they may be able to design and manufacture competitive products more efficiently or inexpensively. If any of these OEM customers are successful in competing against us, our sales could decline, our margins could be negatively impacted and we could lose market share, any or all of which could harm our business and results of operations.
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        We expect our competitors to continue to improve the performance of their current products, reduce their prices and introduce new or enhanced technologies that may offer greater performance and improved pricing. If we are unable to match or exceed the improvements made by our competitors, our market position would deteriorate and our net sales would decline. In addition, our competitors may develop future generations and enhancements of their products that may render our technologies obsolete or uncompetitive.
        We also expect to face competition from new and emerging companies that may enter our existing or future markets. These potential competitors may have similar or alternative products which may be less costly or provide additional features.
The establishment and ongoing operation of our planned manufacturing facility in China could expose us to new and significant risks.
        We are planning to establish a new manufacturing facility in China. To prepare this facility for operation, we will need to purchase new equipment, replicate our current manufacturing processes and hire additional technical personnel. The difficulties normally associated with this complicated process will be compounded by language and cultural differences, as well as the geographic distance from our current facility. Our management has limited experience in creating or overseeing foreign operations, and this new facility may divert substantial amounts of their time. Further, this new facility may be subject to factory audits by our customers. We may not be able to begin operations at this new facility on a timely basis, or at all. Even if this facility becomes operational and is qualified by our customers, we cannot assure you that we will be able to maintain control over product quality, delivery schedules, manufacturing yields and costs as we increase our output. We will also have to manage a local workforce that may subject us to uncertainties or regulatory policies. Any difficulties in operating this new facility could cause product delivery delays and harm our operating results.
        We currently anticipate that our new manufacturing facility in China will become operational in the first half of 2007. Although we are currently planning to establish a manufacturing facility in China, we have not completed our analysis and planning, and the establishment of this new manufacturing facility will require approval by our board of directors. Once this facility is established and becomes operational, some of our net sales will be denominated in Chinese Renminbi, or Yuan. The Chinese government controls the procedures by which Yuan is converted into other currencies, and conversion of Yuan generally requires government consent. As a result, Yuan may not be freely convertible into other currencies at all times. If the Chinese government institutes changes in currency conversion procedures, or imposes restrictions on currency conversion, those actions may negatively impact our operations and could reduce our operating results. In addition, fluctuations in the exchange rate between Yuan and U.S. dollars may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. These fluctuations may also adversely affect the comparability of our period-to-period results. If we decide to declare dividends and repatriate funds from our Chinese operations, we will be required to comply with the procedures and regulations of applicable Chinese law. Any changes to these procedures and regulations, or our failure to comply with those procedures and regulations, could prevent us from making dividends and repatriating funds from our Chinese operations, which could adversely affect our financial condition. If we are able to make dividends and repatriate funds from our Chinese operations, these dividends would be subject to U.S. corporate income tax.
We depend on a few key employees, and if we lose the services of any of those employees or are unable to hire additional personnel, our business could be harmed.
        Our success to date has been highly dependent on the experience, relationships and technical knowledge of Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board,
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Jayesh Bhakta, our Vice President of Engineering, and Christopher Lopes, our Vice President of Sales. We believe that our future success will be dependent on our ability to retain the services of these key employees, develop their successors, reduce our reliance on them, and properly manage the transition of their roles should departures occur.
        The loss of these key employees could delay the development and introduction of, and negatively impact our ability to sell our products and otherwise harm our business. We do not have employment agreements with these key employees. We do not carry key man life insurance on any of our key employees.
        Our future success also depends on our ability to attract, retain and motivate highly skilled engineering, manufacturing, other technical and sales personnel. Competition for experienced personnel is intense. We may not be successful in attracting new engineers or other technical personnel, or in retaining or motivating our existing personnel. If we are unable to hire and retain engineers with the skills necessary to keep pace with the evolving technologies in our markets, our ability to continue to provide our current products and to develop new or enhanced products will be negatively impacted, which would harm our business. In addition, the shortage of experienced engineers, and other factors, may lead to increased recruiting, relocation and compensation costs for such engineers, which may exceed our expectations and resources. These increased costs may make hiring new engineers difficult, or may reduce our margins.
        As of June 30, 2006, 41% of our workforce consisted of contract personnel. We invest considerable time and expense in training these contract employees. We may experience high turnover rates in our contract employee workforce, which may require us to expend additional resources in the future. If we convert any of these contract employees into permanent employees, we may have to pay finder's fees to the contract agency.
Our lack of a significant backlog of unfilled orders, and the difficulty inherent in forecasting customer demand, makes it difficult to forecast our short-term production requirements to meet that demand.
        We do not have long-term purchase agreements with our customers. Instead, our customers generally place purchase orders no more than two weeks in advance of their desired delivery date, and these purchase orders generally have no cancellation or rescheduling penalty provisions. This fact, combined with the quick turn-around times that apply to each order, makes it difficult to forecast our production needs and allocate production capacity efficiently. Our production expense levels are based in part on our forecasts of our customers' future product requirements and to a large extent are fixed in the short term. As a result, we likely will be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in those orders. Any significant shortfall of customer orders in relation to our expectations could hurt our operating results, cash flows and financial condition. Also, any rapid increases in production required by our customers could strain our resources and reduce our margins. If such a rapid increase were to occur at any given time, we may not have sufficient short-term manufacturing capacity to meet our customers' immediate demands.
        We attempt to forecast the demand for the DRAM ICs and other components needed to manufacture our products. Lead times for components vary significantly and depend on various factors, such as the specific supplier and the demand and supply for a component at a given time. If we underestimate customer demand or if we have not provided for sufficient manufacturing capacity, we would not be able to manufacture a sufficient quantity of our products and could forego sales opportunities, lose market share and damage our customer relationships.
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If we are unable to manufacture our products efficiently, our operating results could suffer.
        We must continuously review and improve our manufacturing processes in an effort to maintain satisfactory manufacturing yields and product performance, lower our costs and otherwise remain competitive. For example, we began implementing lead-free soldering technologies in our manufacturing processes in the second quarter of 2005, and "Reduction of Hazardous Substances" manufacturing processes in the fourth quarter of 2005, both of which have been fully implemented as of the date of this prospectus. Implementing process improvements in the future could negatively impact our manufacturing yields, which would in turn adversely affect our results of operations.
        As we manufacture more complex products, the risk of encountering delays or difficulties increases. The start-up costs associated with implementing new manufacturing technologies, methods and processes, including the purchase of new equipment, and any resulting manufacturing delays and inefficiencies, could negatively impact our results of operations.
        If we need to add manufacturing capacity, an expansion of our existing manufacturing facility or establishment of a new facility could be subject to factory audits by our customers. For example, our new manufacturing facility in China will need to be audited and approved by our key customers. Any delays or unexpected costs resulting from this audit process could adversely affect our net sales and results of operations. In addition, we cannot be certain that we will be able to increase our manufacturing capacity on a timely basis or meet the standards of any applicable factory audits.
If we fail to protect our proprietary rights, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could adversely affect our operating results.
        We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in the remaining applications will be allowed. To date we have had only four patents issued. We intend to continue filing patent applications with respect to most of the new processes and technologies that we develop. However, patent protection may not be available for some of these processes or technologies.
        It is possible that our efforts to protect our intellectual property rights may not:
•
prevent challenges to, or the invalidation or circumvention of, our existing intellectual property rights;

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

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

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

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

•
otherwise adequately protect our intellectual property rights.
        Others may attempt to reverse engineer, copy or otherwise obtain and use our proprietary technologies without our consent. Monitoring the unauthorized use of our technologies is difficult. We cannot be certain that the steps we have taken will prevent the unauthorized use of our technologies. This is particularly true in foreign countries, such as China, where we intend to
14

establish a new manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.
        If some or all of the claims in our patent applications are not allowed, or if any of our intellectual property protections are limited in scope by a court or circumvented by others, we could face increased competition with regard to our products. Increased competition could significantly harm our business and our operating results.
We may be involved in costly legal proceedings to defend against claims that we infringe the intellectual property rights of others or to enforce or protect our intellectual property rights.
        Lawsuits claiming that we are infringing others' intellectual property rights may be brought against us, and we may have to defend against claims of infringement or invalidity. Litigation is inherently uncertain, and an adverse outcome could subject us to significant liability for damages or invalidate our proprietary rights. An adverse outcome also could force us to take specific actions, including causing us to:
•
cease selling products that are claimed to be infringing a third party's intellectual property;

•
pay royalties on past or future sales;

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

•
redesign those products that are claimed to be infringing a third party's intellectual property.
        There is a limited pool of experienced technical personnel that we can draw upon to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or potential competitors at some point during their careers, and we anticipate that a number of our future employees will have similar work histories. In the past, some of these competitors have claimed that our employees misappropriated their trade secrets or violated non-competition or non-solicitation agreements. Some of our competitors may threaten or bring legal action involving similar claims against us or our existing employees or make such claims in the future to prevent us from hiring qualified candidates. Lawsuits of this type may be brought, even if there is no merit to the claim, simply as a strategy to drain our financial resources and divert management's attention away from our business.
        We also may find it necessary to litigate against others, including our competitors, customers and former employees, to enforce our intellectual property and contractual and commercial rights including, in particular, our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. We could become subject to counterclaims or countersuits against us as a result of this litigation. Moreover, any legal disputes with customers could cause them to cease buying or using our products or delay their purchase of our products and could substantially damage our relationship with them.
        Any litigation, regardless of its outcome, would be time consuming and costly to resolve, divert our management's time and attention and negatively impact our results of operations.
If we are required to obtain licenses to use third party intellectual property and we fail to do so, our business could be harmed.
        Although some of the components used in our final products contain the intellectual property of third parties, we believe that our suppliers bear the sole responsibility to obtain any rights and licenses to such third party intellectual property. While we have no knowledge that any third party licensor disputes our belief, we cannot assure you that disputes will not arise in the future. The operation of our business and our ability to compete successfully depends significantly on our
15

continued operation without claims of infringement or demands resulting from such claims, including demands for payments of money in the form of, for example, ongoing licensing fees.
        If it is determined that we are required to obtain inbound licenses and we fail to obtain licenses, or if such licenses are not available on economically feasible terms, our business, operating results and financial condition could be significantly harmed.
If our products are defective or are used in defective systems, we may be subject to product recalls or product liability claims.
        If our products are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could be subject to product liability claims and product recalls, safety alerts or advisory notices. While we have product liability insurance coverage, it may not be adequate to satisfy claims made against us. We also may be unable to obtain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims or product recalls, regardless of their ultimate outcome, could have an adverse effect on our business, financial condition and reputation, and on our ability to attract and retain customers. In addition, while we may not be contractually obligated to accept returned products, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. Accepting product returns may negatively impact our operating results.
If we acquire other businesses or technologies in the future, these acquisitions could disrupt our business and harm our operating results and financial condition.
        We will evaluate opportunities to acquire businesses or technologies that might complement our current product offerings or enhance our technical capabilities. We have no experience in acquiring other businesses or technologies. Acquisitions entail a number of risks that could adversely affect our business and operating results, including:
•
difficulties in integrating the operations, technologies or products of the acquired companies;

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

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

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

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

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

•
the potential loss of key employees of the acquired companies.

        Future acquisitions also could cause us to incur debt or be subject to contingent liabilities. In addition, acquisitions could cause us to issue equity securities that could negatively impact the ownership percentages of our existing stockholders. Furthermore, acquisitions may result in material charges or adverse tax consequences, substantial depreciation, deferred compensation charges, in-process research and development charges, the amortization of amounts related to deferred stock-based compensation expense and identifiable purchased intangible assets or impairment of goodwill, any or all of which could negatively affect our results of operations.
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If we do not effectively manage our growth, our resources, systems and controls may be strained and our results of operations may suffer.
        We have expanded, and plan to continue to expand, our operations, both domestically and internationally. Any future growth may strain our resources, management information and telecommunication systems, and operational and financial controls. To manage our growth effectively, including our planned development of a new manufacturing facility in China, we must continue to improve and expand our systems and controls. We may not be able to do this in a timely or cost-effective manner, and our current systems and controls may not be adequate to support our future operations. In addition, our officers have relatively limited experience in managing a rapidly growing business or a public company. As a result, they may not be able to provide the guidance necessary to continue our growth or maintain our market position. Any failure to manage our growth or improve or expand our existing systems and controls, or unexpected difficulties in doing so, could harm our business.
Our internal controls over financial reporting may not be effective, and our independent auditors may not be able to certify as to their effectiveness, which could have a significant and adverse effect on our business.
        We plan to evaluate our internal controls over financial reporting to allow management to report on, and our independent auditors to attest to, those internal controls as will be required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the Securities and Exchange Commission, which we collectively refer to as Section 404. This will involve system and process evaluations and testing to comply with the management assessment and auditor certification requirements of Section 404, which will initially apply to us for the year ended December 31, 2007. Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. In the course of our Section 404 evaluations, we may identify conditions that may result in significant deficiencies or material weaknesses and we may conclude that enhancements, modifications or changes to our internal controls are necessary or desirable. Implementing any such controls would divert the attention of our management, could involve significant costs, and may negatively impact our results of operations.
        We note that there are inherent limitations on the effectiveness of internal controls, as they cannot prevent collusion, management override or failure of human judgment. If we fail to maintain an effective system of internal controls or if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls, we may be unable to produce reliable financial reports or prevent fraud, and it could harm our financial condition and results of operations, result in a loss of investor confidence and negatively impact our share price.
If a standardized memory solution which addresses the demands of our customers is developed, our net sales and market share may decline.
        Many of our memory subsystems are specifically designed for our OEM customers' high performance systems. Our business would be harmed if these high performance systems were to become standardized so that DRAM IC manufacturers or other companies could develop and manufacture a commodity memory module addressing the requirements of some or all of these high performance applications. If DRAM IC manufacturers or other companies are able to develop a standardized solution, our future business may be limited to identifying the next generation of high performance memory demands of OEM customers and developing a solution that addresses such demands. Until fully implemented, this next generation of products may constitute a much smaller market, which may reduce our net sales and market share.
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Our failure to comply with environmental laws and regulations could subject us to significant fines and liabilities or cause us to incur significant costs.
        We are subject to various and frequently changing U.S. federal, state and local and foreign governmental laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. We could incur substantial costs, including clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or personal injury, as a result of violations of, or noncompliance with, environmental laws and regulations. These laws and regulations also could require us to incur significant costs to remain in compliance.
Economic, political and other risks associated with international sales and operations could adversely affect our net sales.
        Part of our growth strategy involves making sales to foreign corporations and delivering our products to facilities located in foreign countries. To facilitate this process and to meet the long-term projected demand for our products, we are planning to set up a new manufacturing facility in China. Selling and manufacturing in foreign countries subjects us to additional risks not present with our domestic operations. We will begin operating in business and regulatory environments in which we have little or no previous experience. We will need to overcome language and cultural barriers to effectively conduct our operations in these new environments. In addition, the economies of China and other countries have been highly volatile in the past, resulting in significant fluctuations in local currencies and other instabilities. These instabilities affect a number of our customers and suppliers in addition to our foreign operations and continue to exist or may occur again in the future. International turmoil and the threat of future terrorist attacks both domestically and internationally, have contributed to an uncertain political and economic climate, both in the U.S. and globally, and have negatively impacted the worldwide economy. The occurrence of one or more of these instabilities could adversely affect our foreign operations and some of our customers or suppliers, each of which could adversely affect our net sales. In addition, our failure to meet applicable regulatory requirements or overcome cultural barriers could result in production delays and increased turn-around times, which would adversely affect our business.
Our operations could be disrupted by power outages, natural disasters or other factors.
        Our current manufacturing facility is located in Irvine, California. Due to this geographic concentration, a disruption of our manufacturing operations, resulting from equipment failure, power failures, quality control issues, human error, government intervention or natural disasters, including earthquakes, fires or floods, could interrupt or interfere with our manufacturing operations and consequently harm our business, financial condition and results of operations. Such disruptions would cause significant delays in shipments of our products and adversely affect our operating results.
Risks Related to This Offering
There has been no prior public market for our common stock, and an active trading market may not develop.
        Prior to this offering, there has been no public market for our common stock. The initial public offering price for the shares of our common stock sold in this offering will be determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. An active trading market may not develop following completion of this offering or, if it is developed, may not be sustained. The lack of an
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active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. We cannot assure you that the market price will equal or exceed the public offering price of your shares. An inactive market may also impair our ability to raise capital by selling shares in the future and may impair our ability to acquire complementary companies or technologies by using our shares as consideration.
Our common stock price may fluctuate substantially, and your investment could suffer a decline in value.
        The market price of our common stock may be volatile and could fluctuate substantially due to a number of factors, many of which are beyond our control and some of which are only indirectly related to our business, including:
•
actual or anticipated fluctuations in our net sales or operating results;

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

•
actual or anticipated changes in our growth rate;

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

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

•
our ability to raise additional capital;

•
the trading volume of our common stock;

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

•
changes in market conditions within our industry, the industries of our customers, the financial markets and the economy as a whole.
        In addition, the stock market in general has experienced extreme price and volume fluctuations in recent years that have often been unrelated or disproportionate to the operating performance of listed companies. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance.
        If our net sales or operating results for future quarters are below our estimates or the estimates or expectations of securities analysts and investors, our stock price could decline. In the past, securities class action litigation has often been brought against companies following a decline in the market price of their securities. Technology companies have experienced stock price volatility that is greater, on average, than companies in many other industries in recent years and, as a result, have, on average, been subject to a greater number of securities class action claims. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of our management's attention and resources that are needed to successfully run our business.
Our principal stockholders have significant voting power and may take actions that may not be in the best interest of our other stockholders.
        Upon completion of this offering, our executive officers, directors and principal stockholders will beneficially own, in total, approximately    % of our outstanding common stock. As a result, these stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and
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any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of our executive officers, directors and principal stockholders. For example, our executive officers, directors and principal stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders. In addition, this significant concentration of share ownership may adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in companies with stockholders that have the ability to exercise significant control.
Substantial future sales of our common stock may depress our stock price.
        After this offering, we will have             shares of common stock outstanding. The             shares sold in this offering, or             shares if the underwriters' over-allotment option is exercised in full, will be freely tradable without restriction or further registration under federal securities laws unless purchased by our affiliates. Currently outstanding shares of our common stock will be available for sale in the public market after this offering, subject to the current information, manner of sale and volume restrictions of Rule 144 and Rule 701, as follows:

Date
	 	Number of Shares
	 	Comment

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

90 days after the date of this prospectus	
 	
shares	
 	
Shares not locked up and eligible for resale under Rule 144 and Rule 701	

180 days after the date of this prospectus	
 	
shares	
 	
Lock-up released; shares eligible for sale under Rule 144 and Rule 701	
        The above table assumes the effectiveness of the lock-up agreements under which holders of our common stock have agreed not to sell or otherwise dispose of their shares of common stock. The underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to such lock-up agreements. In addition, as soon as practicable after the completion of this offering, we intend to file a registration statement on Form S-8 under the Securities Act covering             shares of our common stock issuable under our Amended and Restated 2000 Equity Incentive Plan. See "Management—Employee Benefit Plans" for a description of this plan. Shares registered under that registration statement will be available for sale in the open market, subject to the contractual lock-up agreements described in "Shares Eligible for Future Sale—Lock-up Agreements."
We may need to raise additional funds in the future which may not be available on acceptable terms or at all.
        Our future capital requirements are uncertain and will depend on many factors, including:
•
market acceptance of, and demand for, our products;

•
the costs of developing new products, designs or technologies;

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

•
the number and timing of acquisitions; and

•
the costs associated with the growth of our business, if any.
20

        If the proceeds from this offering together with our existing sources of cash and cash flows are not sufficient to fund our activities, we may need to raise additional capital, which may not be available on favorable terms, or at all. Furthermore, if we issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our products and technologies, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements.
You will experience immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering.
        The initial public offering price of our common stock is expected to exceed substantially the net tangible book value per share of our common stock immediately after this offering. Therefore, based on an assumed initial public offering price of $                        per share, if you purchase our common stock in this offering, you will suffer an immediate dilution of $                        per share. If outstanding options and warrants to purchase our common stock are exercised, you will experience additional dilution.
Our management team may invest or spend the net proceeds of this offering in ways with which you may not agree or in ways that may not yield an acceptable return.
        We currently intend to use the net proceeds in the general manner set forth in "Use of Proceeds." At this time, however, we cannot state with certainty how we will use the net proceeds of this offering or our existing cash balance with respect to specific expenditures. Accordingly, our management will have considerable discretion in the application of the net proceeds, and you will not have the opportunity to assess whether the proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase our operating results or market value.
We will incur increased costs as a result of being a public company.
        As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and Nasdaq, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. For example, we intend to create board committees and adopt additional policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements. It may become more expensive for us to maintain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.
Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our stock.
        Following this offering, our certificate of incorporation, as amended, and our bylaws, as amended, will contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. In addition, these
21

provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. The following are examples of provisions which we intend to include in our certificate of incorporation and bylaws, each as amended:
•
our board of directors will be authorized, without prior stockholder approval, to designate and issue preferred stock, commonly referred to as "blank check" preferred stock, with rights senior to those of our common stock;

•
stockholder action by written consent will be prohibited;

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

•
our board of directors will be expressly authorized to make, alter or repeal our bylaws.
        In addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our certificate of incorporation and bylaws, each as amended, and of Delaware law could make it more difficult for stockholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including delaying or impeding a merger, tender offer, or proxy contest or other change of control transaction involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could prevent the consummation of a transaction in which our stockholders could receive a substantial premium over the then-current market price for their shares.
22

 
 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
        This prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. All statements in this prospectus other than statements of historical fact, including statements regarding future events, our future financial performance, business strategy and plans and objectives of management for future operations, are forward-looking statements.
        In some cases, you can identify forward-looking statements by terminology including "anticipates," "believes," "can," "continue," "could," "estimates," "expects," "intends," "may," "might," "must," "plans," "potential," "predicts," "should," "will" or "would," or the negative of these terms or other comparable terminology. Forward-looking statements used in this prospectus address topics such as, among other things:
•
our business strategy;

•
our development of new products;

•
our anticipated growth strategies;

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

•
competition and competitive factors or trends in the memory market;

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

•
our intended use of proceeds;

•
our ability to continue to control costs and maintain quality;

•
anticipated changes in our expenses over future periods;

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

•
our intention to establish a manufacturing facility in China; and

•
the plans, objectives, expectations and intentions expressed in this prospectus that are not historical facts.
        These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks described in this prospectus under "Risk Factors." We cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
23

 
 
 USE OF PROCEEDS
        We estimate that the net proceeds we will receive from this offering will be approximately $                        million at an assumed initial public offering price of $                        per share, after deducting underwriting discounts and commissions and estimated offering costs. If the over-allotment option is exercised in full, the selling stockholders will receive $                        million in net proceeds at an initial public offering price of $                        per share. We will not receive any proceeds from the sale of shares by the selling stockholders.
        The principal purposes of this offering are to obtain additional capital, to establish a public market for our common stock and to facilitate our future access to public capital markets. We intend to use the net proceeds of this offering:
•
for working capital and other general corporate purposes;

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

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

•
to establish a manufacturing facility in China;

•
to expand our research and development activities; and

•
to acquire complementary businesses, products or technologies.
        Our term loan and revolving line of credit each have an interest rate of prime plus one-half percent. Our term loan has a maturity date of the earlier of July 2008 or the completion of this offering. Our revolving line of credit has a maturity date of July 2008. We have used the proceeds to date under our term loan to repay $950,000 in outstanding principal amount, plus accrued interest, on our convertible promissory notes issued in December 2005.
        We are in the preliminary stages of establishing a manufacturing facility in China and cannot estimate with certainty the expenditures that will be required to develop this facility. We currently believe that we may spend up to $6 million to develop this facility over the next 12 months. We may also use a portion of the net proceeds to us to fund possible investments in, or acquisitions of, complementary businesses, products or technologies or to establish joint ventures. We have no current agreements or commitments with respect to any investment, acquisition or joint venture, and we currently are not engaged in negotiations with respect to any investment, acquisition or joint venture.
        Other than amounts to be used to pay offering fees and expenses, the amount and timing of what we spend for the intended uses of proceeds above may vary significantly and will depend on a number of factors, including our future net sales and cash generated by operations and the other factors described in this prospectus under "Risk Factors." We will have broad discretion in the way that we use the net proceeds of this offering. Pending their ultimate use, we intend to invest the net proceeds to us from this offering in short-term, interest-bearing, investment grade securities.
 
 DIVIDEND POLICY
        We have never declared or paid cash dividends on our capital stock. Our current credit facility prohibits the payment of cash dividends. Accordingly, we do not anticipate declaring or paying cash dividends on our capital stock in the foreseeable future. Any payments of cash dividends will be at the discretion of our board of directors, and will depend upon our results of operations, earnings, capital requirements, legal and contractual restrictions, and other factors deemed relevant by our board of directors.
24

 
 CAPITALIZATION
        The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2006, on:
•
an actual basis;

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

•
a pro forma as adjusted basis to give effect to receipt of the estimated net proceeds from the sale by us in this offering of             shares of our common stock at an assumed initial public offering price of $             per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.
        You should read the following table in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus.

 	 	June 30, 2006
	
 	 	Actual
	 	Pro Forma
	 	Pro Forma
as Adjusted
	
 	 	(in thousands)

Cash and cash equivalents	
 	
$	
27	
 	
$	
77	
 	
$	

Debt:	

 	

 	

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

Total debt	

4,025	

2,325	

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

Total stockholders' equity	

4,671	

6,421	

 	

Total capitalization	
 	
$	
8,696	
 	
$	
8,746	
 	
$	

        The table above excludes the following shares, each as of June 30, 2006:
•
382,500 shares issuable upon the exercise of warrants with a weighted-average exercise price of $1.13 per share;

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

•
1,122,166 shares available for future grant or issuance under our 2000 Equity Incentive Plan.
25

 
 
 DILUTION
        Our historical net tangible book value as of June 30, 2006, was approximately $4.7 million, or $0.42 per share of common stock. Historical net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by 11,223,334 shares of common stock outstanding as of June 30, 2006.
        Our pro forma net tangible book value as of June 30, 2006 was approximately $6.4 million, or $0.48 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by 13,273,334 shares of common stock outstanding on a pro forma basis as of June 30, 2006. These pro forma numbers reflect the conversion of $1.75 million of our convertible notes and all of our convertible preferred stock into shares of our common stock.
        Dilution in pro forma net tangible book value per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma as adjusted net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to our sale of             shares of common stock in this offering at an assumed initial public offering price of $             per share, after deducting the underwriting discount and estimated offering expenses payable by us, our adjusted pro forma net tangible book value as of June 30, 2006 would have been $             million, or $             per share of common stock. This amount represents an immediate increase of $             per share in our pro forma net tangible book value. It also represents an immediate dilution to new investors of $             per share. The following table illustrates this per share dilution:

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

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

 	

 	

Dilution per share to new investors	

 	
 	
$	

        The following table summarizes, on a pro forma basis as of June 30, 2006, the differences between the number of shares of common stock purchased from us, the aggregate cash consideration paid to us, and the average price per share paid by our existing stockholders and by new investors purchasing shares of common stock from us in this offering. These pro forma numbers reflect the automatic conversion of $1.75 million of our outstanding convertible notes and all of our convertible preferred stock into common stock. The calculation below is based on an
26

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

 	 	Shares Purchased
	 	Total Consideration
	 	 	
 					 	Average
Price Per
Share
	
 	 	Number
	 	Percent
	 	Amount
	 	Percent
			
Existing stockholders	 	 	 	 	%	$	 	 	 	%	$	 	
New investors	 	 	 	 	 	 	 	 	 	 	 	 	
 	
Total	

 	
 	
%	
$	

 	
%	
$	
 	
        This discussion and table assume no exercise of any stock options or warrants outstanding as of June 30, 2006. As of June 30, 2006, there were outstanding options issued under our stock option plan to purchase a total of 2,254,500 shares of common stock with a weighted-average exercise price of $1.35 per share and warrants to purchase a total of 382,500 shares of common stock with a weighted-average exercise price of $1.13 per share. To the extent that any of these options or warrants are exercised, there will be further dilution to new investors. If all of these options and warrants are exercised, the percentage of shares sold by us in this offering compared to the total number of shares outstanding would decrease from    % to    %, the percentage of consideration paid by investors to us in this offering compared to the total consideration paid by all investors would decrease from    % to    % and the dilution per share to new investors would decrease from $             per share to $             per share.
27

 
 SELECTED CONSOLIDATED FINANCIAL DATA
        The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited and unaudited consolidated financial statements and the related notes appearing elsewhere in this prospectus.
        The selected consolidated financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2003, 2004 and 2005, and the consolidated balance sheet data as of December 31, 2004 and 2005, are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the years ended December 31, 2001 and 2002, and the consolidated balance sheet data as of December 31, 2001, 2002 and 2003 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for the six month periods ended June 30, 2005 and 2006, and the consolidated balance sheet data as of June 30, 2006, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus.

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	 	
 	 	2001
	 	2002
	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	(in thousands, except per share data)
	 	
Consolidated Statement of Operations Data:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net sales	 	$	2,660	 	$	13,994	 	$	100,375	 	$	143,659	 	$	79,856	 	$	36,495	 	$	65,934	 	
Cost of sales(1)	 	 	3,035	 	 	12,147	 	 	86,107	 	 	133,503	 	 	73,892	 	 	34,319	 	 	57,447	 	

Gross profit (loss)	

(375	
)	
 	
1,847	

14,268	

10,156	

5,964	

2,176	

8,487	

Operating expenses:	

 	

 	

 	

 	

 	

 	

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

Total operating expenses	

1,062	

2,143	

26,977	

10,084	

8,023	

4,176	

5,425	

Operating income (loss)	

(1,437	
)	
 	
(296	
)	
 	
(12,709	
)	
 	
72	

(2,059	
)	
 	
(2,000	
)	
 	
3,062	
 	
Other expense, net	 	 	(154	)	 	(290	)	 	(879	)	 	(1,386	)	 	(1,200	)	 	(483	)	 	(944	)	

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

(1,591	
)	
 	
(586	
)	
 	
(13,588	
)	
 	
(1,314	
)	
 	
(3,259	
)	
 	
(2,483	
)	
 	
2,118	
 	
Provision (benefit) for income taxes	 	 	(632	)	 	46	 	 	2,317	 	 	(340	)	 	(912	)	 	(695	)	 	812	 	

Net income (loss)	
 	
$	
(959	
)	
$	
(632	
)	
$	
(15,905	
)	
$	
(974	
)	
$	
(2,347	
)	
$	
(1,788	
)	
$	
1,306	

Net income (loss) per common share:	

 	

 	

 	

 	

 	

 	

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

Weighted-average shares outstanding:	

 	

 	

 	

 	

 	

 	

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

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

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	
 	 	2001
	 	2002
	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	
Cost of sales	 	$	—	 	$	—	 	$	69	 	$	29	 	$	56	 	$	(9	)	$	14	
Research and development	 	 	—	 	 	371	 	 	9,733	 	 	80	 	 	(52	)	 	(22	)	 	22	
Selling, general and administrative	 	 	87	 	 	424	 	 	10,872	 	 	141	 	 	(65	)	 	(17	)	 	111	
28

 
 	 	December 31,
	 	 	
 			 	June 30,
2006
	
 	 	2001
	 	2002
	 	2003
	 	2004
	 	2005
			
 	 	(in thousands)
	
Consolidated Balance Sheet Data:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	59	 	$	91	 	$	1,907	 	$	759	 	$	953	 	$	27	
Total assets	 	 	4,283	 	 	9,129	 	 	22,404	 	 	22,110	 	 	25,842	 	 	34,516	
Total debt(1)	 	 	3,037	 	 	3,778	 	 	3,464	 	 	9,379	 	 	13,921	 	 	14,739	
Stockholders' equity	 	 	621	 	 	754	 	 	5,981	 	 	5,261	 	 	2,855	 	 	4,671	

(1)
Amounts include outstanding revolving line of credit balance as of each respective date.
        We use a 52-53 week fiscal year. As a result, a fiscal year or quarter may not end as of the same day as the calendar period. However, for convenience of presentation, the above summary consolidated financial data have been shown as ending on June 30 and December 31 of each applicable period.
29

 
 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
         The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Consolidated Financial Data" and our audited and unaudited consolidated financial statements and the related notes included elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, estimates and assumptions. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed in this prospectus under "Risk Factors" and elsewhere in this prospectus.
Overview
        We design, manufacture and sell high performance memory subsystems for the server, high performance computing and communications markets. Our memory subsystems consist of DRAM ICs and other components assembled on a PCB. We engage with our OEM customers from the earliest stages of new product definition, which provides us unique insight into their full range of system architecture and performance requirements. This close collaboration has also allowed us to develop a significant level of systems expertise. We leverage a portfolio of proprietary technologies and design techniques, including efficient planar design, alternative packaging techniques and custom semiconductor logic, to deliver memory subsystems with high memory density, small form factor, high signal integrity, attractive thermal characteristics and low cost per bit.
        Due to their importance to overall system architecture and performance, our products must undergo lengthy qualification periods by our OEM customers, which may last up to six months. In addition, in order to penetrate large OEMs, we have typically been required to demonstrate our ability to meet strict standards for quality, customer service and turnaround time by first supplying lower complexity products into a limited range of high volume applications. For example, the initial products we sold to IBM were used in mobile computing applications. The majority of our sales of subsequent products to IBM have been for high-end server applications, our primary market focus. Consistent with the concentrated nature of the OEM customer base in our target markets, a small number of large customers have historically accounted for a significant portion of our net sales. Dell, IBM and Lenovo represented 35%, 20% and 13%, respectively, of our net sales in 2005, and 33%, 46% and 2%, respectively, of our net sales in the first six months of 2006. We expect that these customers will continue to represent a significant percentage of our net sales for at least the next 12 months.
        We commenced operations in September 2000 and initially focused on memory subsystems for the telecommunications markets. Beginning in the second quarter of 2001, we shifted our focus to the server and high performance computing markets, due in large part to the telecommunications market downturn. In 2002, we became a qualified supplier for RLX Technologies, Inc., a blade server manufacturer. One of the products we initially developed for RLX, our proprietary 2-inch form factor, 1-gigabyte memory subsystem, led to the development of a range of additional memory subsystems.
        We began qualifying our 2-inch form factor, 1-gigabyte memory subsystem with Dell in the second quarter of 2002 and started shipping it to Dell in the fourth quarter of 2002. Our sales to Dell continued to increase throughout 2003 and the first three quarters of 2004, as we began to ship more of our memory subsystems to a larger number of Dell facilities in the U.S., Europe and Asia. During this time, we also qualified new products with other leading server and high performance computing OEMs. Beginning in the fourth quarter of 2004, issues associated with the transition from DDR to DDR2 DRAM architectures resulted in a significant decrease in our sales to
30

Dell. Our sales to Dell began to recover in the fourth quarter of 2005. Also during 2005, our sales to IBM and Lenovo began to increase significantly.
        Our sales to IBM continued to grow significantly in the first six months of 2006, driven by high demand for IBM's line of blade servers that incorporates our proprietary very low profile memory subsystem. Sales to Dell also grew significantly as our DDR2 products began to ship in volume. In addition, we began shipments to other leading OEMs, including Gateway and Hewlett-Packard. We have several new products in various stages of qualification that we anticipate will be incorporated into additional platforms currently in development at our customers.
Key Business Metrics
        The following describes certain line items in our statements of operations that are important to management's assessment of our financial performance:
        Net Sales.     Net sales consist primarily of sales of our high performance memory subsystems, net of a provision for estimated returns under our right of return policies, which range up to 30 days. We generally do not have long-term sales agreements with our customers. Although OEM customers typically provide us with non-binding forecasts of future product demand over specific periods of time, they generally place purchase orders with us approximately two weeks in advance of scheduled delivery. Selling prices are typically negotiated monthly, based on competitive market conditions and the current price of DRAM ICs. Purchase orders generally have no cancellation or rescheduling penalty provisions. We often ship our products to our customers' international manufacturing sites. All of our sales to date, however, are denominated in U.S. dollars. We also sell excess component inventory of DRAM ICs to distributors and other users of memory ICs. These sales accounted for 24% and 11% of our net sales in 2005 and the first six months of 2006, respectively. We expect that component inventory sales will decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.
        Cost of Sales.     Our cost of sales includes the cost of materials, manufacturing costs, depreciation and amortization of equipment, inventory valuation provisions, and occupancy costs and other allocated fixed costs. The DRAM ICs incorporated into our products constitute a significant portion of our cost of sales, and thus our cost of sales will fluctuate based on the current price of DRAM ICs. We attempt to pass through such DRAM IC cost fluctuations to our customers by frequently renegotiating pricing prior to the placement of their purchase orders. To the extent we are successful, a large majority of our product cost is variable, and thus our cost of sales and gross margin percentages may not be significantly impacted by changes in sales volume. However, the sales prices of our memory subsystems can also fluctuate due to competitive situations unrelated to the pricing of DRAM ICs, which will affect gross margins. The gross margin on our sales of excess component DRAM IC inventory is much lower than the gross margin on our sales of our memory subsystems. As a result, a decrease in DRAM IC inventory sales as a percentage of our overall sales would result in an improved overall gross margin. We assess the valuation of our inventories on a monthly basis and record a provision to cost of sales as necessary to reduce inventories to the lower of cost or market value.
        Research and Development.     Research and development expense consists primarily of employee and independent contractor compensation and related costs, stock-based compensation, computer-aided design software licenses, reference design development costs, patent-related fees, depreciation or rental of evaluation equipment, and occupancy and other allocated overhead costs. Also included in research and development expense are the costs of material and overhead related to the production of engineering samples of new products under development or products used solely in the research and development process. Our customers typically do not separately
31

compensate us for design and engineering work involved in developing application-specific products for them. All research and development costs are expensed as incurred. As we continue to develop additional proprietary technologies, we anticipate that research and development expenditures will increase.
        Selling, General and Administrative.     Selling, general and administrative expenses consist primarily of employee salaries and related costs, stock-based compensation, independent sales representative commissions, professional services, promotional and other selling and marketing expenses, and occupancy and other allocated overhead costs. A significant portion of our selling efforts is directed at building relationships with OEMs and working through the product approval and qualification process with them. Therefore, the cost of material and overhead related to products manufactured for qualification is included in selling expenses. As we continue to service existing and penetrate new OEM customers, we anticipate that our sales and marketing expenses will increase. We also anticipate that our general and administrative expenses will increase as a percentage of net sales as we incur accounting and legal expenses associated with our ongoing public reporting obligations and compliance with the requirements of the Sarbanes-Oxley Act of 2002.
        Provision (Benefit) for Income Taxes.     Our income tax provision (benefit) is based on the statutory federal tax rate of 35% and is typically impacted by state taxes and other permanent differences, the largest of which relates to the amortization of deferred stock-based compensation expense.
Critical Accounting Policies
        The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of net sales and expenses during the reporting period. By their nature, these estimates and assumptions are subject to an inherent degree of uncertainty. We base our estimates on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. We review our estimates on an on-going basis. Actual results may differ from these estimates, which may result in material adverse effects on our operating results and financial position. We believe the following critical accounting policies involve our more significant assumptions and estimates used in the preparation of our consolidated financial statements:
        Revenue Recognition.     We account for revenue from product sales when there is persuasive evidence of an arrangement, delivery has occurred, the fee is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Under the provisions of Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition , these conditions are typically met upon shipment and transfer of title for customers with free-on-board, or FOB, shipping point terms and upon receipt and transfer of title for customers with FOB destination terms. Most of our international shipments are made to third party inventory warehouses, or hubs, and we recognize revenue when the inventory is pulled from the hub for use in production by the customer.
        Customers are generally allowed limited rights of return for up to 30 days. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve. While these returns have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience similar return rates in the future. Any significant increase in product failure rates and the resulting product returns could have a material adverse effect on our operating results for the period or periods in which such returns materialize.
32

        All amounts billed to customers related to shipping and handling are classified as net sales, while all costs incurred by us for shipping and handling are classified as cost of sales.
        Warranty Reserve.     We offer warranties on our memory subsystems generally ranging from one to three years, depending on the product and negotiated terms of purchase agreements with our customers. Such warranties require us to repair or replace defective product returned to us during such warranty period at no cost to the customer. Our estimates for warranty related costs are recorded at the time of sale based on historical and estimated future product return rates and expected repair or replacement costs. While such costs have historically been insignificant, unexpected changes in failure rates could have a material adverse impact on us.
        Accounts Receivable.     We perform credit evaluations of our customers' financial condition and limit the amount of credit extended to our customers as deemed necessary, but generally require no collateral. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. Generally, these credit losses have been within our expectations and the provisions established. However, we cannot guarantee that we will continue to experience credit loss rates similar to those we have experienced in the past.
        Our accounts receivable are highly concentrated among a small number of customers, and a significant change in the liquidity or financial position of one of these customers could have a material adverse effect on the collectibility of our accounts receivable, our liquidity and our future operating results.
        Inventories.     We value our inventories at the lower of the actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. We regularly review inventory quantities on hand and on order and record a provision for excess and obsolete inventories based primarily on our estimated forecast of product demand and production requirements for the next three to six months. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories. A significant decrease in demand for our products could result in an increase in the amount of excess inventory quantities on hand. In addition, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventories are determined to be overvalued, we would be required to recognize additional expense in our cost of sales at the time of such determination. Likewise, if our inventories are determined to be undervalued, we may have over-reported our costs of sales in previous periods and would be required to recognize additional gross profit at the time such inventories are sold. Although we make every reasonable effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a material effect on the value of our inventories and our reported operating results.
        Long-Lived Assets.     We review the recoverability of the carrying value of long-lived assets on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is determined based upon the forecasted undiscounted future net cash flows from the operations to which the assets relate, utilizing our best estimates, appropriate assumptions and projections at the time. These projected future cash flows may vary significantly over time as a result of increased competition, changes in technology, fluctuations in demand, consolidation of our customers and reductions in average selling prices. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized to the extent the carrying value exceeded the estimated fair market value of the asset.
33

        Stock-Based Compensation.     We account for equity issuances to non-employees in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock Based Compensation , and Emerging Issues Task Force ("EITF") Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services . All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the third-party performance is complete or the date on which it is probable that performance will occur.
        Prior to January 1, 2006, we accounted for stock-based compensation issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees and related pronouncements. Under this method, compensation expense was recognized over the respective vesting period based on the excess, on the date of grant, of the fair value of our common stock over the grant price, net of forfeitures. Deferred stock-based compensation was amortized on a straight-line basis over the vesting period of each grant. During the years ended December 31, 2003, 2004 and 2005, stock-based compensation expense, net of forfeitures, was $20.7 million, $250,000 and $(61,000), respectively.
        On January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment , which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors related to our 2000 Equity Incentive Plan based on estimated fair values. We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our consolidated financial statements as of and for the six months ended June 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statement of operations. As stock-based compensation expense recognized in the consolidated statement of operations for the six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the six months ended June 30, 2006 of 8% was based on historical forfeiture experience and estimated future employee forfeitures. In our pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, we accounted for forfeitures as they occurred.
        Employee stock-based compensation expense recognized under SFAS No. 123(R) for the six months ended June 30, 2006 was $138,000, determined by the Black-Scholes valuation model. As of June 30, 2006, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options was $743,000, which is expected to be recognized as an expense over a weighted-average period of approximately 4 years. See Note 2 to our consolidated financial statements for additional information.
        Income Taxes.     We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we operate at a loss for an extended period of time or are unable to generate sufficient future taxable income, or if there is a material change in the actual
34

effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to record a valuation allowance against all or a significant portion of our deferred tax assets which could substantially increase our effective tax rate for such period. Any significant changes in statutory tax rates or the amount of our valuation allowance could have a material effect on the value of our deferred tax assets and liabilities, and our reported financial results.
        Our current effective tax rate is approximately 38%. We expect this rate to decrease if we generate profits from our planned manufacturing facility in China in 2007. This decrease is expected to be attributable to the favorable tax treatment available in the region in which we intend to establish our operation. The magnitude of the decrease is not known, as we have not finalized our tax strategy as it relates to the planned China operation.
Results of Operations
        The following table sets forth our consolidated statements of operations for the periods indicated:

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

Net sales	
 	
$	
100,375	
 	
$	
143,659	
 	
$	
79,856	
 	
$	
36,495	
 	
$	
65,934	
 	
Cost of sales(1)	 	 	86,107	 	 	133,503	 	 	73,892	 	 	34,319	 	 	57,447	 	
 	 		 		 		 		 		 	
Gross profit	 	 	14,268	 	 	10,156	 	 	5,964	 	 	2,176	 	 	8,487	 	

Operating expenses:	

 	

 	

 	

 	

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

Operating income (loss)	

(12,709	
)	
 	
72	

(2,059	
)	
 	
(2,000	
)	
 	
3,062	
 	
Other expense, net	 	 	(879	)	 	(1,386	)	 	(1,200	)	 	(483	)	 	(944	)	

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

(13,588	
)	
 	
(1,314	
)	
 	
(3,259	
)	
 	
(2,483	
)	
 	
2,118	
 	
Provision (benefit) for income taxes	 	 	2,317	 	 	(340	)	 	(912	)	 	(695	)	 	812	 	
 	 		 		 		 		 		 	
Net income (loss)	 	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,306	 	

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

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

Cost of sales	
 	
$	
69	
 	
$	
29	
 	
$	
56	
 	
$	
(9	
)	
$	
14	
Research and development	 	 	9,733	 	 	80	 	 	(52	)	 	(22	)	 	22	
Selling, general and administrative	 	 	10,872	 	 	141	 	 	(65	)	 	(17	)	 	111	
35

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

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

Net sales	
 	
100.0	
%	
100.0	
%	
100.0	
%	
100.0	
%	
100.0	
%	
Cost of sales	 	85.7	 	92.9	 	92.5	 	94.1	 	87.1	 	
 	 		 		 		 		 		 	
Gross profit	 	14.3	 	7.1	 	7.5	 	5.9	 	12.9	 	

Operating expenses:	

 	

 	

 	

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

Operating income (loss)	
 	
(12.6	
)	
0.1	
 	
(2.6	
)	
(5.5	
)	
4.6	
 	
Other expense, net	 	(0.9	)	(1.0	)	(1.5	)	(1.3	)	(1.4	)	

Income (loss) before provision (benefit) for income taxes	
 	
(13.5	
)	
(0.9	
)	
(4.1	
)	
(6.8	
)	
3.2	
 	
Provision (benefit) for income taxes	 	2.3	 	(0.2	)	(1.1	)	(1.9	)	1.2	 	
 	 		 		 		 		 		 	
Net income (loss)	 	(15.8	)%	(0.7	)%	(3.0	)%	(4.9	)%	2.0	%	
 	 		 		 		 		 		 	
Six Months Ended June 30, 2006 Compared to the Six Months Ended June 30, 2005
        Net Sales.     Net sales for the six months ended June 30, 2006 were $65.9 million, an increase of $29.4 million, or 81%, over the first six months of 2005. Approximately $26.7 million of the increase was attributable to higher unit sales of our very low profile memory subsystems. In addition, DDR2 server memory subsystem sales increased by $13.9 million and DDR subsystem sales decreased by $6.7 million due to customers transitioning to DDR2 architectures. Finally, sales of laptop and desktop personal computer, or PC, memory subsystems decreased $6.1 million as we focused on sales of higher margin server memory subsystems.
        Sales of our component inventory to distributors and other users of memory ICs represented 11% and 23% of net sales for the six months ended June 30, 2006 and 2005, respectively. We expect that component inventory sales will decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.
        Gross Profit and Gross Margin.     Gross profit for the six months ended June 30, 2006 was $8.5 million, an increase of $6.3 million, or 290%, over the comparable period in 2005. Gross margin increased to 12.9% for the first six months of 2006 from 5.9% for the first six months of 2005. The increase in both gross profit and gross margin is primarily attributable to increased sales of our very low profile memory subsystems, which generate higher margins due to their innovative design, as well as lower margin products becoming a smaller portion of our overall product sales mix.
        Research and Development.     Research and development expenses for the six months ended June 30, 2006 were $1.5 million, a decrease of $0.4 million compared to the same period in 2005. The decrease is related in part to a reduction of personnel that occurred in the third quarter of 2005, as well as a recovery of costs through the liquidation of engineering samples.
36

        Selling, General and Administrative.     Selling, general and administrative expenses for the six months ended June 30, 2006 were $3.9 million, an increase of $1.6 million compared to the same period of 2005. The increase is attributable to higher sales commissions related to increased net sales, increased salaries and related costs due to an increase in personnel, higher costs related to qualification of new products at customers, and a provision for bad debt of approximately $0.4 million related to a single distribution customer.
        Other Expense, Net.     Other expense, net, for the first six months of 2006 was $0.9 million, an increase of $0.5 million compared to 2005 due to higher interest expense related to increased borrowings under our revolving line of credit.
        Provision (Benefit) for Income Taxes.     The provision for income taxes for the first six months of 2006 was $0.8 million compared to an income tax benefit of $0.7 million in 2005. The change was due to our attaining profitability in 2006.
Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
        Net Sales.     Net sales for the year ended December 31, 2005 were $79.9 million, a decrease of $63.8 million, or 44%, from the year ended December 31, 2004. This decrease was due to a $72.6 million decrease in net sales to one key customer, partially offset by the commencement of shipments of our very low profile subsystem during 2005. The decrease in net sales to the key customer was attributable to its shift in memory technology from DDR to DDR2. Our net sales decreased significantly as the key customer delayed qualifying new suppliers during this transition.
        Sales of our component inventory to distributors and other users of memory ICs represented 24% and 20% of net sales in 2005 and 2004, respectively. The increase in the proportion of component sales was due to the overall decrease in net sales, as sales of component inventory decreased $8.9 million from 2004.
        Gross Profit and Gross Margin.     Gross profit for the year ended December 31, 2005 was $6.0 million a decrease of $4.2 million, or 41%, from 2004. Gross margin increased to 7.5% in 2005 from 7.1% in 2004. The decrease in gross profit was attributable to the overall decrease in net sales. The increase in gross margin was attributable to the higher margins realized on sales of our very low profile memory subsystems compared to our other products.
        Research and Development.     Research and development expenses in 2005 were $3.0 million, a decrease of $0.8 million from 2004. This decrease was attributable to reductions in personnel, a decrease in stock-based compensation expense due to forfeitures of equity awards related to personnel reductions, as well as a recovery of costs through the liquidation of engineering samples.
        Selling, General and Administrative.     Selling, general and administrative costs in 2005 were $5.1 million, a decrease of $1.2 million compared to 2004. This decrease was primarily related to the absence in 2005 of costs incurred in 2004 related to our proposed equity financing through an initial public offering. These offering-related costs totaled $1.0 million in 2004.
        Other Expense, Net.     Other expense, net, in 2005 was $1.2 million, a decrease of $0.2 million compared to 2004. The decrease was related to a reduction in interest expense due to decreased usage of accounts receivable financing related to a key customer.
        Provision (Benefit) for Income Taxes.     The benefit for income taxes in 2005 increased $0.6 million compared to 2004 due to the increased pre-tax losses in 2005.
37

Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
        Net Sales.     Net sales for the year ended December 31, 2004 were $143.7 million, an increase of $43.3 million, or 43%, from the year ended December 31, 2003. This increase was entirely due to increased net sales to one key customer of our planar memory subsystem.
        Sales of our component inventory to distributors and other users of memory ICs represented 20% and 20% of net sales in 2004 and 2003, respectively. Although sales of component inventory increased $10.4 million from 2003, the proportion of component sales remained constant due to the overall increase in net sales.
        Gross Profit and Gross Margin.     Gross profit for the year ended December 31, 2004 was $10.2 million, a decrease of $4.1 million, or 29%, from 2003. Gross margin decreased to 7.1% in 2004 from 14.3% in 2003. The decrease in both gross profit and gross margin was attributable to price decreases related to the deteriorating cost advantage of our planar memory subsystem relative to competing alternatives.
        Research and Development.     Research and development expenses in 2004 were $3.8 million, a decrease of $8.0 million from 2003. This decrease was attributable to the absence in 2004 of $9.7 million of stock-based compensation expense incurred in 2003 related to the forgiveness of debt used to purchase restricted stock by one of our company's founders, offset by an increase in personnel and higher material and overhead costs related to production of engineering samples.
        Selling, General and Administrative.     Selling, general and administrative costs in 2004 were $6.3 million, a decrease of $8.9 million compared to 2003. This decrease was primarily related to the absence in 2004 of $10.0 million in stock-based compensation expense incurred in 2003 related to the forgiveness of debt used to purchase restricted stock by one of our company's founders, offset by costs incurred in 2004 related to our proposed equity financing via an initial public offering. These offering-related costs totaled $1.0 million. In addition, we incurred higher material and overhead costs related to qualification of our products at customers.
        Other Expense, Net.     Other expense, net, in 2004 was $1.4 million, an increase of $0.5 million compared to 2003. The increase was related to interest costs due to higher borrowings under our revolving line of credit.
        Provision (Benefit) for Income Taxes.     The benefit for income taxes was $0.3 million in 2004 compared to an income tax provision of $2.3 million in 2003. The change was due to our incurring pre-tax losses in 2004 compared to pre-tax income before stock-based compensation expenses in 2003.
Selected Quarterly Financial Information
        The following table presents our unaudited quarterly statements of operations for each of the four quarters in the year ended December 31, 2005, for the quarter ended March 31, 2006, and for the quarter ended June 30, 2006. You should read the following table in conjunction with our audited and unaudited consolidated financial statements and related notes contained elsewhere in this prospectus. We have prepared the underlying unaudited financial statements on the same basis as our audited consolidated financial statements included in this prospectus, which include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future periods.
38

 
 	 	Three Months Ended,
	
 	 	March 31,
2005
	 	June 30,
2005
	 	September 30,
2005
	 	December 31,
2005
	 	March 31,
2006
	 	June 30,
2006
	
 	 	(in thousands, except per share data)

Net sales	
 	
$	
20,956	
 	
$	
15,539	
 	
$	
20,057	
 	
$	
23,304	
 	
$	
26,020	
 	
$	
39,914	
Cost of sales	 	 	20,087	 	 	14,232	 	 	18,163	 	 	21,410	 	 	23,466	 	 	33,981	
 	 		 		 		 		 		 		
Gross profit	 	 	869	 	 	1,307	 	 	1,894	 	 	1,894	 	 	2,554	 	 	5,933	
Operating expenses:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Research and development	 	 	916	 	 	960	 	 	617	 	 	468	 	 	666	 	 	848	
 	Selling, general & administrative	 	 	1,194	 	 	1,106	 	 	1,394	 	 	1,368	 	 	1,803	 	 	2,108	
 	 		 		 		 		 		 		
 	 	Total operating expenses	 	 	2,110	 	 	2,066	 	 	2,011	 	 	1,836	 	 	2,469	 	 	2,956	

Operating income (loss)	

(1,241	
)	
 	
(759	
)	
 	
(117	
)	
 	
58	

85	

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

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

(1,489	
)	
 	
(994	
)	
 	
(371	
)	
 	
(405	
)	
 	
(325	
)	
 	
2,443	
Provision (benefit) for income taxes	 	 	(399	)	 	(296	)	 	(116	)	 	(101	)	 	(83	)	 	895	
 	 		 		 		 		 		 		
Net income (loss)	 	$	(1,090	)	$	(698	)	$	(255	)	$	(304	)	$	(242	)	$	1,548	

Net income (loss) per common share:	

 	

 	

 	

 	

 	

 	
 	Basic	 	$	(0.10	)	$	(0.07	)	$	(0.03	)	$	(0.02	)	$	(0.02	)	$	0.14	
 	Diluted	 	$	(0.10	)	$	(0.07	)	$	(0.03	)	$	(0.02	)	$	(0.02	)	$	0.11	
Weighted-average common shares outstanding:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Basic	 	 	10,672	 	 	10,672	 	 	10,673	 	 	10,673	 	 	10,753	 	 	11,223	
 	Diluted	 	 	10,672	 	 	10,672	 	 	10,673	 	 	10,673	 	 	10,753	 	 	15,681	
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         Historically, our quarterly operating results have fluctuated significantly. These fluctuations are primarily attributable to the cyclical nature of the industry in which we operate, including changes in revenue related to additions of new customers, the ramp up of new products, products reaching the end of their life cycles, customers' technology transitions, and other similar reasons. As a result, we believe that the period-to-period comparisons of our net sales and operating results are not necessarily meaningful measures of future operating performance and should not be relied upon as indications of that future performance. We expect that our future operating results will fluctuate from quarter-to-quarter and year-to-year, which may make it difficult to predict our future performance and could cause our stock price to fluctuate and decline.
Liquidity and Capital Resources
Cash Flows
        The following table summarizes our cash flows for the periods indicated:

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	 	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	 	 	 	 	 	 	(unuadited)
	 	
 	 	(in thousands)
	 	
Net cash provided by (used in):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating activities	 	$	3,659	 	$	(6,567	)	$	(4,608	)	$	566	 	$	(1,816	)	
Investing activities	 	 	(1,515	)	 	(496	)	 	1,332	 	 	(325	)	 	(291	)	
Financing activities	 	 	(328	)	 	5,915	 	 	3,470	 	 	(979	)	 	1,181	 	
 	 		 		 		 		 		 	
 	Net increase (decrease) in cash and cash equivalents	 	$	1,816	 	$	(1,148	)	$	194	 	$	(738	)	$	(926	)	
 	 		 		 		 		 		 	
        Since our inception in 2000, we have financed our operations primarily through issuances of equity and debt securities and cash generated from operations. We received gross proceeds of $2.0 million from the sale of shares of our capital stock in 2000. During 2001 and 2003, we received total proceeds of approximately $1.8 million from the sale of convertible notes. During 2005, we received total proceeds of $1.0 million from the sale of convertible notes. In August 2006, we received proceeds of $1.0 million under a new term loan facility. We have also funded our operations with a revolving line of credit under our bank credit facility, from capitalized lease obligations, financing of receivables and from the sale and leaseback of our manufacturing facility.
        Operating Activities.     Cash used in operating activities for the six months ended June 30, 2006 was $1.8 million compared to cash generated by operating activities of $0.6 million for the six months ended June 30, 2005. This change was due to an increase in cash flow related to net income of $3.1 million offset by a decrease in cash flow related to accounts receivable of $8.7 million due to a higher proportion of net sales being generated by customers with longer payment terms; a decrease in cash flow related to net inventory of $3.4 million as we increased inventory levels to support higher sales volumes; and an increase in cash flow related to accounts payable of $4.0 million as we trade financed our inventory increase and other operating expenses. In addition, cash flow related to income taxes payable increased $0.9 million as we attained profitability in the first half of 2006 and started to accumulate income tax liability that will be paid later in 2006.
        Cash used in operating activities for 2005 was $4.6 million compared to $6.6 million in 2004. This change was attributable to a decrease in cash flow related to net loss of $1.3 million, a decrease in cash flow related to accounts receivable of $0.8 million due to a higher proportion of sales being generated by customers with longer payment terms, and a decrease in cash flow related
40

to inventories of $2.2 million. These declines were offset by an increase in cash flow related to accounts payable of $4.0 million and an increase in cash flow related to income taxes of $2.6 million as we continued to incur losses, did not have to pay income taxes and received a tax refund in 2005 as a result of carrying back net operating losses to prior years.
        Cash used in operating activities in 2004 was $6.6 million compared to cash generated by operating activities of $3.7 million in 2003. This change was primarily due to a decrease in cash flow related to net loss of $5.5 million, before stock compensation charges, a decrease in cash flow related to accounts receivable of $1.4 million due to higher sales volumes, a decrease in cash flow related to accounts payable of $7.5 million, and a decrease in cash flow related to income taxes of $5.8 million as we paid prior tax liabilities and increased refunds receivable due to tax losses in the year. These decreases were offset by an increase in cash flow related to inventories of $10.7 million as we transitioned from building inventory in 2003 to lower inventory levels as volumes with one of our key customers decreased.
        Investing Activities.     Net cash used in investing activities for the six months ended June 30, 2006 was $0.3 million compared to $0.3 million for the six months ended June 30, 2005. This change is not considered significant.
        Net cash provided by investing activities was $1.3 million in 2005 compared to net cash used in investing activities of $0.5 million in 2004. This change is attributable to the proceeds of $1.8 million from the sale of the building containing our manufacturing operation in 2005 to raise capital to fund our operations. We currently lease back the building, and there was no disruption of manufacturing due to this transaction.
        Net cash used in investing activities was $0.5 million in 2004 compared to $1.5 million in 2003. This change is attributable to reductions in capital expenditures as our manufacturing facility became fully equipped and the liquidation of a certificate of deposit of $0.5 million that had previously been required to collateralize a letter of credit.
        Financing Activities.     Net cash provided by financing activities for the six months ended June 30, 2006 was $1.2 million compared to net cash used in financing activities of $1.0 million for the first six months of 2005. This change was primarily due to the increased usage of our revolving line of credit during 2006 to fund growth in our operations compared to the first half of 2005.
        Net cash provided by financing activities in 2005 was $3.5 million compared to $5.9 million in 2004. This change is attributable to approximately $1.4 million less in net borrowings against our revolving line of credit and an increase in net payments on capital leases and other debt of $1.0 million.
        Net cash provided by investing activities in 2004 was $5.9 million compared to net cash used in financing activities of $0.3 million in 2003. This change was primarily attributable to increased usage of our revolving line of credit to finance working capital needs as a result of our accelerating growth.
Capital Resources
        In July 2006, we amended our credit agreement with our bank. The credit agreement, as amended, provides for a revolving line of credit with borrowings of up to $25 million, a term loan with borrowings of up to $2 million, and an equipment financing line of credit with borrowings of up to $2 million. Prior to July 2006, the credit agreement provided for a revolving line of credit of $15 million and no term loan or equipment line of credit.
        Under the revolving line of credit, we may borrow up to 85% of eligible accounts receivable plus the least of (i) a percentage of eligible inventory determined from time to time by our bank,
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(ii) 80% of the appraised orderly liquidation value of eligible inventory and (iii) $7 million. Interest is payable monthly at prime plus 0.5% (prime plus 3.5% prior to July 2006). Outstanding borrowings under the revolving line of credit were $10.7 million as of June 30, 2006 and $9.5 million as of December 31, 2005. Borrowing availability as of June 30, 2006 was $2.8 million. Had the amended revolving line of credit maximum of $25 million been in effect at June 30, 2006, borrowing availability would have been $7.1 million.
        Under the new equipment financing line of credit, we may borrow up to 80% of the cost of equipment purchases up to the maximum of $2 million. Interest on equipment line of credit advances is prime plus 0.5%. Principal is due monthly through the maturity date of the credit agreement in July 2008, when all unpaid principal and interest is due.
        The term loan is amortized and paid monthly from September 2006 through July 2008. Interest is at prime plus 0.5%. Should we successfully complete an initial public offering of our stock, such as this offering, during the term of the credit agreement, we will be required to fully repay the term loan upon the closing of the initial public offering.
        Under the terms of the credit agreement, as amended, we are required to comply with certain financial and other covenants. The financial covenants require us to achieve minimum book net worth on a monthly basis, minimum net income on a quarterly basis, and limit annual capital expenditures under a defined annual cap. Also, we are required to achieve a minimum debt service coverage ratio in relation to the term loan and equipment line of credit. While we are currently in compliance with all financial covenants and expect to maintain compliance for the foreseeable future, we have in the past been in violation of one or more covenants. We were not in compliance with certain covenants as of December 31, 2005, January 31, 2006 and February 28, 2006. In April 2006, we received a waiver from our lender for all of the above covenant violations. We cannot assure you that we will not violate one or more covenants in the future. If we were to be in violation of covenants under our credit agreement, our lender could choose to accelerate payment on all outstanding loan balances. There can be no assurance that we would be able to quickly obtain equivalent or suitable replacement financing in this event. If we were not able to secure alternative sources of funding, such acceleration would have a material adverse impact on our financial condition.
        We have in the past utilized equipment leasing arrangements to finance capital expenditures. Equipment leases will continue to be a financing alternative that we may pursue in the future.
        We believe our existing cash balances, borrowing availability under our bank credit facility, and the cash expected to be generated from operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our levels of net sales, the timing and extent of expenditures to support research and development activities, the expansion of manufacturing capacity both domestically and internationally and the continued market acceptance of our products. We could be required, or may choose, to seek additional funding through public or private equity or debt financings. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt or equity financing or a combination thereof. These additional funds may not be available on terms acceptable to us, or at all.
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Contractual Obligations
        The following table outlines our principal obligations and commitments, excluding periodic interest payments, as of December 31, 2005:

 	 	Within
One Year
	 	1-3 Years
	 	4-5 Years
	 	After 5 Years
	 	Total
	
 	 	(in thousands)
	
Scheduled payments under contractual obligations:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Long-term debt	 	$	290	 	$	127	 	$	6	 	$	—	 	$	423	
Convertible notes	 	 	1,000	 	 	1,750	 	 	—	 	 	—	 	 	2,750	
Capital lease obligations	 	 	431	 	 	739	 	 	115	 	 	—	 	 	1,285	
Operating leases	 	 	216	 	 	301	 	 	256	 	 	—	 	 	773	
Purchase commitments	 	 	655	 	 	—	 	 	—	 	 	—	 	 	655	
 	 		 		 		 		 		
 	Total	 	 	2,592	 	 	2,917	 	 	377	 	 	—	 	 	5,886	

Potential cash requirements under existing commitments:	

 	

 	

 	

 	

 	
Letters of credit	 	 	500	 	 	—	 	 	—	 	 	—	 	 	500	
 	 		 		 		 		 		
 	Total	 	$	3,092	 	$	2,917	 	$	377	 	$	—	 	$	6,386	
 	 		 		 		 		 		
        We believe that funds expected to be generated from future operations will be sufficient to satisfy these contractual obligations and commercial commitments and that the ultimate payments associated with these commitments will not have a material adverse impact on our liquidity position.
        In addition, as of June 2006, we had certain commitments with one of our executive officers pursuant to an employment agreement with that officer. For further information, see "Management—Employment Agreements."
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
        In December 2005, we dismissed Deloitte & Touche LLP as our independent registered public accounting firm and engaged Corbin and Company, LLP as our independent registered public accounting firm. Our board of directors approved this change.
        Prior to the dismissal, we did not consult with Corbin and Company, LLP regarding the application of accounting principles to a specific completed or contemplated transaction or any matter that was either the subject of a disagreement or a reportable event. We also did not consult with Corbin and Company, LLP regarding the type of audit opinion that might be rendered on our consolidated financial statements.
        Deloitte & Touche LLP's report on our consolidated financial statements as of December 31, 2004, and for each of the two years in the period ended December 31, 2004 did not contain an adverse opinion or disclaimer of opinion, nor was it modified as to uncertainty, audit scope, or accounting principles. There were no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
        Our exposure to market risk for changes in interest rates relates primarily to our bank credit facility because borrowings under all lines under the facility are variable rate borrowings, generally at prime plus 0.5%. Assuming that all lines under the facility are fully drawn and holding other variables constant, each 1.0% increase in interest rates on our variable rate borrowings will result in
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an increase in annual interest expense and a decrease in our cash flows and income before taxes of approximately $0.3 million per year. We do not use derivative instruments to hedge the interest rate risk related to our credit facility.
        Upon completion of this offering, some of the proceeds may be invested in securities which may be subject to market risk for changes in interest rates. To mitigate this risk, we plan to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, which may include commercial paper, money market funds, government and non-government debt securities. Currently, we are exposed to minimal market risks.
Off-Balance Sheet Arrangements
        We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
New Accounting Pronouncements
        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 . SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 did not have a significant impact on our consolidated financial condition or results of operations.
        In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment , which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors using a fair value method and to record such expense in our consolidated financial statements. Effective January 1, 2006, we adopted SFAS No. 123(R) using the modified prospective transition method. The impact of adoption of SFAS No. 123(R) is described in Note 2 to the consolidated financial statements, which are included elsewhere in this prospectus.
        In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that we recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosures. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The adoption of this statement is not expected to have a material impact on our consolidated financial position or results of operations.
44

 
 BUSINESS
Overview
        We design and manufacture high performance memory subsystems. We sell our subsystems to OEMs in the server, high performance computing and communications markets. Within these markets, we target applications in which memory plays a key role in enabling overall system performance. Our memory subsystems are incorporated into multiple platforms at IBM, Dell, Gateway, Lenovo and Hewlett-Packard. Our subsystems are designed and manufactured to specifically address the high performance needs of these customers' systems.
        We collaborate with our OEM customers in the earliest stages of their new product design cycles. This collaboration provides us with unique insight into the OEM's system architecture and performance requirements and expands our systems expertise. In addition, we have developed a portfolio of proprietary technologies and design techniques to meet OEM needs, including efficient planar design, alternative packaging techniques and custom semiconductor logic. As a result, we are able to design application-specific memory subsystems with optimal combinations of high memory density, small form factor, high signal integrity, effective heat dissipation and low cost per bit. We also offer our OEM customers flexible order fulfillment and rapid turnaround times.
Industry Background
Memory is a Critical Element of Virtually All Electronic Systems
        Semiconductor memory is a fundamental element of electronic systems. It is used in virtually every computing, communications, consumer electronics, defense, aerospace and industrial application. Some of the most memory-intensive applications include high-end PCs, servers, workstations, storage systems, routers, and switches. Other memory-intensive applications include mobile phones, personal digital assistants, digital cameras and digital audio players. Memory is particularly important in systems requiring greater processing power and higher functionality, and comprises a significant portion of the total cost of materials. For example, we believe that memory comprises up to two-thirds of the total cost of materials for a typical blade server.
        The market for memory is large and rapidly growing. In 2005, the most common type of memory, DRAM, generated $25.2 billion of revenue, or 51% of global memory revenue, according to the market research firm Gartner Dataquest. Gartner Dataquest further estimates that worldwide DRAM shipments will grow at a compound annual growth rate, or CAGR, of 54.6%, from 238 billion megabytes in 2005, to 1.36 trillion megabytes in 2009.
        The market for servers is growing, and the amount of memory in these servers is increasing. For example, market research firm International Data Corporation, or IDC, expects server shipments to grow from 7.0 million in 2005 to 10.7 million in 2009, representing a CAGR of 10.9%, and the amount of DRAM memory in those servers is expected to increase at a higher CAGR of 26.4%. These market projections underscore the continuing importance of memory in electronic systems.
Designing Sufficient Memory into Advanced Systems Has Become Increasingly Difficult
        Memory-intensive applications continually evolve to keep pace with end user demands for higher performance, as measured by speed, functionality, or smaller physical size. OEMs develop new technologies and innovative system architectures to meet these requirements. For example, enterprise computing has migrated toward network and Internet computing models that rely upon high performance servers and storage systems. In telecommunications, the emergence of the Internet Protocol has led OEMs to develop switches and routers that offer enhanced functionality and services. Consumer electronics are also converging to offer both communications and
45

computing functionality in ever smaller form factors and at lower prices. Each successive generation of these new systems is increasingly sophisticated.
        As OEMs continue to develop new generations of higher performance electronic systems, designing the requisite amount of memory into increasingly complex system architectures has become a significant challenge. Shrinking form factors and higher performance demands require low profile, high-density memory subsystems that operate at high speeds. This poses significant challenges for system designers. For example, shrinking form factors necessitate tight spacing between memory ICs and require new methods of heat dissipation. The migration to more powerful, multi-processor architectures increases this design challenge. System designs must ensure optimal electronic signal integrity and efficient board layout to capture the performance benefits of these technological advances. OEM designs for high performance systems with powerful processors and high density memory typically employ unique system architectures. As a result, these systems require application-specific memory subsystems with distinct memory capacities and configurations.
        Servers illustrate the increasing complexity and importance of innovative memory design in high performance systems. Servers play an important role in the enterprise information technology infrastructure, as they execute a broad range of functions, including email communication, video streaming, data mining, data warehousing and web-based services. These servers require high performance microprocessors and large memory capacities to support multiple functions, concurrent users and increasingly complex applications. Strong market demand, coupled with OEM efforts to increase system performance while reducing total cost of ownership, has fueled the development of innovative server architectures such as low-profile blade servers. According to IDC, blade server shipments are expected to grow from 510,000 in 2005 to approximately 2.9 million in 2009, representing a 53.9% CAGR. Furthermore, IDC projects end-user spending on blade servers will represent 21% of the worldwide server market by 2009.
        Blade servers are characterized by small physical size and shape, which allows for dense configuration in a high performance computing cluster. These clusters occupy less space than traditional rack-mounted servers, and can achieve supercomputing performance at a fraction of the cost. In addition, blade servers are rapidly migrating to 2-way and 4-way processor systems to achieve greater computing performance, but the use of multi-processor architectures requires an accompanying increase in system memory capacity. For example, a server with a 4-way processor could require four times the memory of a typical single processor server. Blade servers' small form factors, typically with a vertical height of less than 1.75 inches, or 1-U, create significant memory subsystem design challenges. Blade servers may have up to 64 gigabytes of memory, and designing such large densities of memory into a low profile system faces numerous physical constraints. For example, high density memories concentrate heat in a tight space, yet temperature variations of as little as a few degrees can lead to systemic failure.
The Traditional Memory Supply Chain Cannot Deliver High Performance Memory Solutions
        Memory ICs are typically assembled together on a card, or module, before being incorporated into electronic systems. Memory modules save valuable motherboard space in an electronic system, allow for the use of different types and densities of memory in the same system, and facilitate subsequent upgrading of the memory to a different type or density. According to iSuppli, a market research firm, the global DRAM module market was $21.4 billion in 2005, representing 86% of the total DRAM market.
        Most DRAM memory modules sold to OEMs have traditionally been produced by the same companies that manufacture DRAM ICs. In an effort to continually reduce costs and achieve higher memory densities, DRAM manufacturers typically operate their own fabrication facilities and use
46

leading edge manufacturing processes, which require multi-billion dollar capital investments. To maximize capacity utilization and reduce unit costs, DRAM manufacturers have historically focused on the highest volume applications, such as PCs, to recoup their investments. Memory modules used in PCs employ industry standard configurations, are largely commoditized, and require limited systems expertise to develop. Therefore, DRAM manufacturers generally have not focused on developing the systems expertise necessary to produce application-specific memory subsystems that incorporate small form factors, high speed, optimal thermal characteristics and signal integrity.
        DRAM manufacturers have historically attempted to address increased demands for memory in electronic systems by developing new generations of memory ICs with increased density. For example, the density of a 1 gigabyte memory module comprised of eighteen 512 megabit ICs can be doubled to 2 gigabytes by using eighteen 1 gigabit ICs. This approach of using next-generation ICs, however, can be problematic for OEMs. When first introduced, next-generation DRAM ICs are only available in limited supply and typically command a premium price on a per-byte basis compared to current-generation DRAM ICs. Next-generation DRAM ICs can sell at prices up to ten times higher than current-generation ICs at introduction, and it may take as long as five years to achieve price parity between the generations. Thus, the increasing demand for higher density memory solutions exceeds the pace at which memory IC manufacturers are able to cost-effectively produce next-generation memory ICs and reduce the cost of current-generation memory ICs. One approach to addressing the need for high density memories in a more cost-effective manner is the stacking of memory ICs, or chip-stacking. Chip-stacking is a process in which DRAM ICs are stacked prior to assembly of the memory subsystem. For example, a 4 gigabyte memory module can be made with 36 stacks of two 512 megabit ICs. While it can be less expensive than non-stacked solutions, stacking costs can still constitute a significant portion of the cost of materials for a memory module.
        Other industry dynamics are reducing the DRAM manufacturers' focus on the high density DRAM subsystems market. In an effort to achieve greater diversification and profitability, the largest DRAM manufacturers have dedicated increasing design resources and manufacturing capacity to non-DRAM products such as flash memory and complementary metal oxide semiconductor, or CMOS, image sensors, further decreasing their desire and ability to supply high performance, application-specific memory subsystems that may sell in relatively low volumes. In addition, an increasing portion of global DRAM supply is being manufactured by integrated device manufacturers and third party foundries that lack back-end capability beyond wafer fabrication. In contrast to traditional DRAM manufacturers with fully integrated operations, these companies generally lack the internal packaging and assembly capabilities to produce modules. The most recently established DRAM manufacturers have focused on commodity-driven, mass-production business models rather than the memory module market.
A Need for High Performance Memory Subsystem Suppliers Exists Today
        Historically, many OEMs designed and manufactured their memory ICs and subsystems in-house. However, the increasing complexity of systems, proliferation of different platforms, continuing evolution of industry standards, increasing need for customization and OEM desire to reduce capital investments are driving OEMs to purchase ICs and subsystems from specialized suppliers focused on developing innovative subsystem solutions. These suppliers require extensive systems expertise to engage with the OEM customer throughout the product development cycle to produce a highly differentiated memory solution that addresses the issues and constraints specific to a particular high-end system. Since industry-standard products are inadequate, these solution providers must employ innovative technologies, such as efficient planar design, alternative packaging techniques and custom semiconductor logic design capabilities, to develop memory subsystems customized for OEMs' specific systems. OEMs also require these suppliers to meet a number of
47

additional criteria beyond innovation, such as low cost, rapid time-to-market and high product quality.
Our Solution
        We provide high performance memory subsystems to the server, high performance computing and communications markets. We utilize our innovative and proprietary technology, as well as our extensive systems expertise, to bridge the gap between industry standard approaches and the requirements of complex OEM systems. Our application-specific solutions provide customers with the following key benefits:
        Highly Differentiated Memory Solutions Through Deep Customer Engagement.     We work closely with our OEM customers, from the earliest stages of new product definition through the ramp up to mass production, to develop and deliver application-specific memory subsystems which address the full range of system architecture and performance requirements. Our close, collaborative relationships with our OEM customers give us early insight both into their current needs and into future technology trends. In addition, our in-depth systems expertise, coupled with our ability to customize solutions, enables our OEM customers to offer differentiated products that feature high levels of performance while improving reliability and, in some cases, reducing cost.
        High Performance Through Proprietary Technologies and Design Techniques.     We have developed a portfolio of proprietary technologies and design techniques to achieve optimal electronic signal strength and integrity, high memory density and improved heat dissipation. For example, our innovative printed circuit board, or PCB, designs enhance electronic signal integrity, allowing our customers to design and market products that operate at the highest commercially available speeds, such as the DDR2 specification, which is designed to operate at speeds up to 800 MHz. Another technique we utilize is to embed passive devices within the PCB, thereby freeing valuable board space to reduce form factors and improve signal integrity. Our solutions also address the system-level thermal issues encountered at high operating speeds via such innovations as planar designs and proprietary heat dissipation technologies that allow us to minimize heat concentrations within the system.
        High Quality and Reliability.     We perform a full range of product reliability testing and share the results with our customers on an on-going basis. We use advanced design tools to simulate accurately the system performance targets of our customers and to ensure that our products comply with our customers' specifications. All of our memory subsystems undergo both functional and system burn-in testing prior to delivery to our customers. We complement our test capabilities with advanced imaging technology to inspect the quality of our micro ball grid array, or microBGA, assemblies. We believe that our testing procedures significantly enhance the quality and reliability of our products.
        Rapid Order Fulfillment Capability.     We operate our manufacturing facility in a manner that maximizes our ability to meet changing customer demand. Our turn-around times are typically one week or less, and in some cases as few as two days, which allows us to match unforeseen customer demand and to provide our OEM customers with timely access to products.
        Cost-Effective Memory Solutions.     We provide high performance memory subsystems at what we believe to be the lowest cost per bit for many applications. Our portfolio of proprietary technologies and design techniques allow us to use cost-effective, current generation DRAM ICs and in some cases avoid additional costs from chip-stacking to significantly lower the cost of our memory subsystems. Additionally, the superior thermal characteristics and electronic signal integrity of our subsystems helps OEMs reduce costs through simplified system design.
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Our Strategy
        Our objective is to be the leading provider of high performance memory subsystems. Key elements of our strategy include:
        Further Sales Penetration of Existing Customers.     Our current OEM customer base has a large and diversified portfolio of system platforms that require high performance memory solutions. Today, we sell our products into a relatively small number of those platforms. As our relationships continue to develop with each of our existing customers, we will seek to provide them with memory solutions for a greater number of their existing and future platforms. A memory subsystem supplier's track record of quality and reliability is an important factor in a customer's purchase decision for each individual platform. We believe that our demonstrated ability to deliver high quality products meeting stringent customer demands will facilitate the adoption of our products into additional platforms with these OEMs. We believe that in some cases we will be able to migrate into these additional platforms with products that are already qualified for use by the customer, thereby significantly decreasing the time and expense required to bring that particular product to market with that customer.
        Establish Relationships with New Customers.     We will continue to dedicate significant sales and marketing resources to establish new relationships with industry-leading OEMs. We are particularly focused on customers for whom memory subsystem performance is a key determinant of overall system performance. Our sales team, which includes field applications engineers, engages with OEMs to understand their memory subsystem requirements, identify and deliver the optimal solution to meet those requirements, and assist with the implementation of that solution within the OEMs' overall system architecture. We believe that engaging with these prospective customers at an early stage of their system development will facilitate the adoption of our products, grow sales volumes and help us to gain additional insight into market and technology trends.
        Target New Applications and Product Opportunities.     We believe that we have established a reputation as a technology leader in the design, development and manufacture of high performance memory subsystems. To date, we have applied our technology successfully to a broad range of server products, from rack-mounted and tower servers to low-profile blade servers and other space constrained server applications. We intend to develop additional memory solutions based on our core technology capabilities for the communications, military, aerospace and industrial markets. In addition, we intend to explore the development of flash memory solutions targeting OEM applications that require high densities of non-volatile memory.
        Continue to Invest in the Development of Proprietary Technology.     We intend to actively expand our intellectual property portfolio and engineering capabilities by investing in research and development. We have filed, and intend to continue to file, patent applications covering our current and future intellectual property. One targeted area of technology development is the design of custom logic ICs that can be used in memory subsystems to provide value-added features. As new technologies are developed, we intend to expand our product offerings to incorporate the performance enhancements they enable.
        Establish International Operations and Manufacturing Capabilities.     We plan to establish a manufacturing facility in China during the first half of 2007. We believe that this international expansion will allow us to improve our support of major OEMs with manufacturing sites in China, lower our production costs and provide access to engineering talent residing in China. We have identified a specific site for our China operations and have commenced recruiting local personnel. We believe that our presence in China will help us develop products and participate more effectively in the high growth regional markets.
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Our Products
        We design and manufacture high performance memory subsystems for the server, high performance computing and communications markets. We currently sell memory subsystems with speeds up to 667 MHz, capacities up to 8 gigabytes, and form factors as small as 0.72 inches, or 18.3 millimeters, in height. Our products for the server market address a broad variety of memory capacity and configuration requirements, as well as a broad range of server types, including tower, rack-mounted, and blade servers. Our current products primarily support DDR and DDR2 DRAM technologies.
        The following table lists representative products from our major families of high performance memory subsystems:

DDR2 Registered Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
256MB	 	30 mm	 	400/533	 	RAID Memory	
1GB	 	18.3 mm	 	400/533/667	 	Blade Servers	
1GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers, Networking	
2GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers, Networking	
2GB	 	18.3 mm	 	400/533/667	 	Blade Servers, Networking	
4GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers, Workstations	
4GB	 	18.3 mm	 	400/533/667	 	Blade Servers	

DDR2 Fully Buffered Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers, Workstations	
2GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers, Workstations	
2GB	 	18.3 mm	 	400/533/667	 	Blade Servers	
4GB	 	30 mm	 	400/533/667	 	1U, 2U+ Servers	

DDR2 Unbuffered Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	30 mm	 	400/533/667	 	Workstations	
2GB	 	30 mm	 	400/533/667	 	Workstations	

DDR2 Small Outline Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	30 mm	 	400/533/667	 	Notebooks, Networking	
2GB	 	30 mm	 	400/533/667	 	Notebooks, Networking	

DDR Registered Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	1.2"	 	400	 	1U, 2U+ Servers	
1GB	 	0.72"	 	400	 	Blade Servers, Networking	
2GB	 	1.2"	 	400	 	1U, 2U+ Servers	
2GB	 	0.72"	 	400	 	Blade Servers, Networking	
4GB	 	2"	 	400	 	1U, 2U+ Servers	
4GB	 	1.2"	 	400	 	1U, 2U+ Servers	
8GB	 	1.2"	 	400	 	1U, 2U+ Servers	
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DDR Unbuffered Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	1.2"	 	400	 	1U, 2U+ Servers, Workstations	
2GB	 	1.2"	 	400	 	1U, 2U+ Servers, Workstations	

DDR Small Outline Dual In-line Memory Modules
	
Density
	 	Height
	 	Speed (MHz)
	 	Applications
	
1GB	 	1.2"	 	400	 	Notebooks, Networking	
Technology
        We have a portfolio of proprietary technologies and design techniques and have assembled an engineering team with expertise in semiconductor, PCB, memory subsystem and system design. Our technology competencies include:
        Very Low Profile Designs.     We were the first company to create a 1 gigabyte memory subsystem in a form factor of less than one inch in height. We believe our proprietary board design technology is particularly useful in the rapidly growing blade server market, where efficient use of motherboard space is critical. Our technology has allowed us to decrease the system board space required for memory, and improve thermal performance and operating speeds, by enabling our customers to use alternative methods of component layout.
        Proprietary PCB Designs.     We utilize advanced, proprietary techniques to optimize electronic signal strength and integrity within a PCB. These techniques include the use of 8- or 10-layer boards, matching conductive trace lengths, a minimized number of conductive connectors, or vias, and precise load balancing to, among other things, help reduce noise and crosstalk between adjacent traces. In addition, our proprietary designs for the precise placement of intra-substrate components allow us to assemble memory subsystems with significantly smaller physical size, enabling OEMs to develop products with smaller footprints for their customers.
        Planar Design.     Our planar solutions are designed to provide high density solutions in a more cost-effective manner than traditional chip-stacking. We believe traditional chip-stacking can represent up to 30% or more of the total cost of a memory subsystem. Our planar solutions achieve the same densities as chip-stacked modules but do so by leveraging our PCB design expertise to place ICs in two rows in the same plane rather than on top of each other. Our planar memory subsystem designs feature high memory capacity with improved thermal characteristics by dissipating heat uniformly throughout the PCB.
        Advanced Planar Designs.     We plan to extend our planar design capabilities to develop very high density memory subsystems. These advanced planar designs may allow us to build modular solutions at lower costs compared to other packaging technologies. Additionally, these advanced planar solutions may remove heat generated by memory components in a more effective manner and can be used to build memory subsystems in a number of densities and form factors.
        IC Design Expertise.     We have designed blocks of custom logic that can be implemented in a stand-alone IC or integrated with other functional blocks in other ICs. We use these custom logic blocks to effectively increase density and reduce costs by allowing the use of two current-generation, lower density DRAM ICs in lieu of a single next-generation higher density IC.
        Innovative Design Verification Tools.     We use our innovative and proprietary DRAM load simulators during the product development stage to carefully assess DRAM IC load balancing requirements in our memory subsystems. Our DRAM load simulators are mounted in a memory subsystem in place of DRAM ICs to test the electronic signal strength and integrity of the memory
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design without disrupting signal quality. This provides us with more accurate feedback than that provided by conventional means because we are able to measure the signals at the precise point of origination.
        Thermal Management Designs.     We design our memory subsystems to ensure effective heat dissipation. We use thermal cameras to obtain thermal profiles of the memory subsystem during the design phase, allowing us to rearrange components to enhance thermal characteristics and, if necessary, replace components that do not meet specifications. We use thermal simulation and modeling software to create comprehensive heat transfer models of our memory subsystems, which enables our engineers to quickly develop accurate solutions to potential thermal issues. We also develop and use proprietary heat spreaders to enhance the thermal management characteristics of our memory subsystems.
Customers
        We primarily market and sell our products to leading OEMs in the server, high performance computing and communications markets. Our memory subsystems are incorporated into multiple platforms at IBM, Dell, Gateway, Lenovo and Hewlett-Packard. Sales to IBM, Dell and Lenovo generated approximately 20%, 35% and 13%, respectively, of our net sales in 2005, and 46%, 33% and 2%, respectively, of our net sales in the first six months of 2006.
        The following chart summarizes some of our representative customers in our principal end markets for the first six months of 2006(1):

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

High Performance Computing

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

(1)
Listing does not include all representative markets or customers due to contractual confidentiality provisions.
        Our sales are made primarily pursuant to standard purchase orders that may be rescheduled or canceled on relatively short notice. Thus, we do not have a significant backlog.
Sales and Marketing
        We market and sell our products through a direct sales force and a network of independent sales representatives. Our sales activities focus primarily on developing strong relationships at the technical, marketing and executive management levels within market-leading OEMs. These OEMs design systems for a variety of applications that require a significant number of high performance memory subsystems, representing substantial opportunities for us. We have been successful in developing OEM relationships through our ability to provide high performance memory subsystems. Our direct sales group and field application engineers work closely with our OEM customers at an early stage of their design cycles to solve their design challenges and to design our products into their systems.
        We believe in the timely communication and exchange of information with our customers. We utilize well-trained, highly technical program management teams to successfully drive new product development and quickly respond to our customers' needs and expectations. Our program
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management teams provide quick response times and act as a single point-of-contact for routine issues during the sales process. Additionally, they address the long-term business and technology goals of our customers. We employ a team approach to business development whereby our sales team and independent representatives identify, qualify and prioritize customer prospects through offices in a number of locations worldwide.
        Our marketing efforts are twofold: creating awareness of the benefits of our proprietary technologies and design techniques in the development of application-specific memory subsystems, and building our brand awareness with our current and potential customers.
Manufacturing
        We currently manufacture all of our products at our facility in Irvine, California. Our advanced engineering and design capabilities, combined with our in-house manufacturing processes, allow us to assemble our memory subsystems reliably and in high volume. Our advanced, customized manufacturing facility is capable of surface mount assembly, subsystem testing, system-level burn-in testing, programming, marking, labeling and packaging. At each stage of the production cycle, including product prototyping, qualification sample production and high-volume manufacturing and delivery, we focus on providing our customers with rapid response and short manufacturing turn-around times. Manufacturing cycle times for our products are typically one week or less, and in some cases as few as two days, from receipt of order.
        We plan to expand our manufacturing capabilities by opening a new facility near Shanghai, China, which we expect will begin production in the first half of 2007. This facility will be configured in the same manner as our Irvine facility and, once operating, will significantly increase our manufacturing capacity. We believe that this facility will enable us to achieve better operating leverage through lower material and labor costs. This facility will also put our products in closer proximity to a number of our end customers allowing us to fulfill customer orders more quickly.
        We acquire components and materials such as DRAM ICs from third party suppliers and assemble them into finished subsystems. We believe that one of our key strengths is the procurement and efficient management of components for our subsystems, which benefits our customers in the form of lower costs and increased product availability. We have developed strong supplier relationships with key DRAM IC manufacturers, which we believe gives us direct and ready access to the critical components that we need for our production activities. We typically qualify our products with our customers using several manufacturers of DRAM ICs. The flexibility to choose from several DRAM IC providers allows us to minimize product cost and maximize product availability.
        We schedule production based on purchase order commitments and anticipated orders. In addition, we use advanced inventory management and material resource planning techniques to manage our supply chain. Using electronic data interchange with our suppliers, we are able to react quickly to changes in raw material availability. We release raw materials to the manufacturing floor by means of an on-line computerized system, which allows for internal quality analysis, direct access to inventory information and production floor material tracking. We have a flexible manufacturing system, and we have the capability to sell excess quantities of DRAM ICs to mitigate inventory risks. Our sales of excess inventory to distributors and other users of memory ICs generated $19.1 million, or 24%, and $7.4 million, or 11%, respectively, of our net sales for 2005 and the first six months of 2006.
        Our quality assurance engineers work with our suppliers to ensure that the raw materials we receive meet our high quality standards. These engineers also perform onsite quality control audits and use our internal test and inspection systems to verify that purchased components and materials
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meet our specifications. Our supplier quality program and incoming material quality control program are important aspects of our overall manufacturing process.
        We strive to reduce product failures to the lowest possible rate. To achieve this goal, we perform ongoing reliability testing on our memory subsystems and share the results of that testing with our customers. We believe that this improves the system design process and allows for the elimination of potential problems at the earliest possible stage. In addition, we have implemented procedures that require all of our memory subsystems to undergo functional and system burn-in testing prior to delivery to the customer. We complement our test capabilities with advanced imaging technology to inspect the quality of our microBGA assemblies.
        We are certified in ISO 9001:2000 Quality Management Systems, ISO 14001:1996 Environmental Management Standards, and OSHAS 18001:1999 Occupational Health and Safety Management Systems.
Competition
        Our products are primarily targeted for the server, high performance computing and communications markets. These markets are intensely competitive, as numerous companies vie for business opportunities at a limited number of large OEMs. Our primary competitors are memory module providers such as SimpleTech, Inc., SMART Modular Technologies, Inc., and Viking Interworks, a division of Sanmina-SCI Corporation. We also face competition from DRAM manufacturers in a limited range of applications. As we enter new markets and pursue additional applications for our products, we may face competition from a larger number of competitors.
        Many of our competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines, lower cost structures, greater brand recognition and longer standing relationships with customers and suppliers. Some of our competitors may also have a greater ability to influence industry standards than we do, as well as more extensive patent portfolios.
        Some of our customers and suppliers may have proprietary products or technologies which are competitive with our products, or could develop internal solutions or enter into strategic relationships with, or acquire, existing high-density memory module providers. Any of these actions could reduce our customers' demand for our products. Some of our significant suppliers of memory ICs may be able to manufacture competitive products at lower costs by leveraging internal efficiencies, or could choose to reduce our supply of memory ICs, adversely affecting our ability to manufacture our memory subsystems on a timely basis, if at all.
        Our ability to compete in our current target markets and in future markets will depend in large part on our ability to successfully develop, introduce and sell new and enhanced products on a timely and cost-effective basis, and to respond to changing market requirements. We believe that the principal competitive factors in the selection of high performance memory subsystems by potential customers are:
•
understanding of OEM system and business requirements;

•
timeliness of new product introductions;

•
design characteristics and performance;

•
quality and reliability;

•
track record of volume delivery;

•
credibility with the customer;
54

•
fulfillment capability and flexibility; and

•
price.
        We believe that we compete favorably with respect to these factors. We expect, however, that our current and future competitors could develop competing products that could cause a decline in sales or loss of market acceptance of our products.
Research and Development
        The market for high performance memory subsystems is characterized by rapid and continuous technology development and product innovation. We believe that the continued and timely development of new products and the enhancement of existing products are critical to maintaining our competitive position. Our research and development engineers focus on new product design and development, the development of thermal and electronic signal integrity solutions, new product testing techniques and methodologies and improvements to our manufacturing processes.
        Our engineering staff continually explores practical applications of new technologies, works with our OEM customers and provides support services throughout the product life cycle, including architecture definition, component selection, schematic design, layout, manufacturing and test engineering. An important aspect of our research and development effort is to understand the challenges presented by our OEM customers' requirements and satisfy them by utilizing our industry knowledge, proprietary technologies and technical expertise.
        We believe that to remain competitive we must continue to focus on developing advanced memory subsystem technologies to address our customers' increasingly complex memory subsystem requirements. Our total expenditures for research and development were $11.8 million, $3.8 million and $3.0 million for the years ended December 31, 2003, 2004 and 2005, respectively, and $1.9 million and $1.5 million for the six months ended June 30, 2005 and June 30, 2006, respectively. Included in total research and development expense was stock-based compensation expense of $9.7 million, $0.1 million and $(0.1) million for the years ended December 31, 2003, 2004 and 2005, respectively. Stock-based compensation expense for the six months ended June 30, 2005 and 2006 was not significant.
        We use advanced design tools to develop products that operate at high frequencies. These design tools enable real-time simulation and behavioral modeling of our designs using the input/output buffer information specification of our suppliers' components. These simulation tools help us reduce or eliminate electronic signal reflections, clock skews, signal jitter and noise, all of which can reduce system performance and reliability.
Intellectual Property
        Our high performance memory subsystems are developed in part using our proprietary intellectual property, and we believe that the strength of our intellectual property rights will be important to the success of our business. We utilize patent and trade secret protection, confidentiality agreements with customers and partners, disclosure and invention assignment agreements with employees and consultants and other contractual provisions to protect our intellectual property and other proprietary information.
        As of June 30, 2006, we had four patents issued and ten patent applications pending. Our issued patents and patent applications relate to PCB design and layout techniques, packaging techniques, and the use of custom logic in high performance memory subsystems. We intend to actively pursue the filing of additional patent applications related to our technology advancements. While we believe that our patent and other intellectual property rights are important to our success, our technical expertise and ability to introduce new products in a timely manner also will continue
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to be important factors in maintaining our competitive position. Accordingly, we believe that our business is not materially dependent upon any one claim in any of our pending patent applications.
        Despite our precautions, a third party may reverse engineer, copy or otherwise obtain and use our products, services or technology without authorization, develop similar technology independently or design around any patents issued to us. There can be no assurance that our efforts taken to prevent misappropriation or infringement of our intellectual property by third parties have been or will be successful.
Employees
        As of June 30, 2006, we had 88 full-time employees, including 49 employees in operations, 16 employees in research and development, 13 employees in sales and marketing, and 10 employees engaged in other administrative functions. Our operations department performs manufacturing, procurement and planning activities. We use contract employees in our operations department from time to time to effectively manage our manufacturing workflow. As of June 30, 2006, our operations department had 62 contract employees engaged full-time in manufacturing. We are not party to any collective bargaining agreements with any of our employees. We have never experienced a work stoppage, and we believe our employee relations are good.
Facilities
        Our corporate headquarters are located in approximately 7,000 square feet of space in Irvine, California, under a lease that expires in June 2007. We also lease approximately 8,000 square feet of space for our manufacturing facility located in Irvine, California. This lease expires in November 2010. In addition, we lease offices on a monthly basis in corporate office centers located in Austin, Texas, Raleigh, North Carolina and Dublin, Ireland. We believe that our current facilities are adequate for our current and expected operations for the next 12 months and that additional space can be obtained if needed.
Legal Proceedings
        From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. To date, no legal proceeding has had a material effect on us and, as of the date of this prospectus, we are not party to any material legal proceeding. However, we believe that protecting our intellectual property is integral to our future success and competitive advantage, and as such, we may be involved in material legal proceedings relating to our intellectual property on a regular basis in the future.
56

 
 MANAGEMENT
Executive Officers and Directors
        Our executive officers and directors, and their ages and positions, are as follows:

Name
	 	Age
	 	Position
	
Chun K. Hong	 	45	 	President, Chief Executive Officer and Chairman of the Board	
Jayesh Bhakta	 	48	 	Vice President of Engineering	
Lee Kim	 	47	 	Vice President, Chief Financial Officer and Secretary	
Christopher Lopes	 	46	 	Vice President of Sales	
Nam Ki Hong	 	43	 	Director	
Thomas F. Lagatta	 	48	 	Director	
Alan H. Portnoy	 	61	 	Director	
David M. Rickey	 	50	 	Director	
Preston Romm	 	52	 	Director	
         Chun K. Hong has been our President and Chief Executive Officer since our inception, and assumed the title of Chairman of the Board in January 2004. From September 2000 to September 2001, Mr. Hong served as President and Chief Operating Officer of Infinilink Corporation, a DSL equipment company. Mr. Hong assisted us on a part-time basis until his departure from Infinilink, at which time he assumed full-time responsibilities with us. In the third quarter of 2001, Infinilink filed for bankruptcy under Chapter 7. From July 1998 until September 2000, Mr. Hong served as Executive Vice President of Viking Components, Inc., a memory subsystems manufacturing company. From November 1997 to June 1998, he was General Manager of Sales at LG Semicon Co., Ltd., a public semiconductor manufacturing company in South Korea. From April 1992 to October 1997, Mr. Hong served as Director of Sales at LG Semicon America, Incorporated, a subsidiary of LG. From December 1983 to March 1992, Mr. Hong held various management positions at LG subsidiaries in South Korea. Mr. Hong received his B.S. in economics from Virginia Commonwealth University and his M.S. in technology management from Pepperdine University's Graduate School of Management.
         Jayesh Bhakta has been our Vice President of Engineering since he joined us full-time in January 2001. From November 2000 to January 2001, Mr. Bhakta was a staff engineer with aerospace manufacturer Hydro-Aire, Inc., a Crane Co. subsidiary. From November 1993 to October 2000, Mr. Bhakta was Chief Engineer at Viking Components. Prior to Viking Components, Mr. Bhakta was a senior design engineer and Engineering Manager with SMT Products Corp. Mr. Bhakta has represented us at the Joint Electron Device Engineering Council, or JEDEC, since he joined us, and has represented us on the board of directors of JEDEC for the last year. Mr. Bhakta holds a B.S. in electrical engineering from the University of California at Los Angeles.
         Lee Kim has been our Vice President, Chief Financial Officer and Secretary since January 2006. Since October 2003, Mr. Kim has been a partner in Tatum LLC, a national professional services firm providing senior financial executive-level services. From February 1999 to May 2003, Mr. Kim was Senior Vice President and Chief Financial Officer of Epicor Software Corporation, a publicly-traded developer of enterprise resource planning software for mid-market companies. From October 1997 to February 1999, he served as Vice President, Corporate Controller and Chief Accounting Officer of FileNet Corporation, a publicly-traded developer of enterprise content management software. From April 1993 to October 1997, Mr. Kim served as Director of Finance of Wonderware Corporation, a publicly-traded developer of supervisory control and data acquisition software. Mr. Kim began his career with Deloitte Haskins & Sells (now known as Deloitte & Touche LLP), serving in the audit practice from July 1981 to December 1987. Mr. Kim received his B.S. in Economics, majoring in accounting, from the Wharton School of the University of Pennsylvania in May 1981.
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         Christopher Lopes has been our Vice President of Sales since our inception. From November 1997 to August 2000, Mr. Lopes was an account executive, and then the Director of OEM Sales, North America, at Viking Components. From June 1996 to November 1997, Mr. Lopes was an account executive with Platinum Associates, a manufacturer's representative sales company. From August 1990 to June 1996, Mr. Lopes was an account executive with Philips Semiconductors. Mr. Lopes began his career as a design engineer with Lockheed Martin Corporation. Mr. Lopes received his B.S. in electrical engineering from California State University, Sacramento and his M.B.A. from Santa Clara University.
         Nam Ki Hong , who is the brother of our President, Chief Executive Officer and Chairman of the Board, Chun K. Hong, has served as a member of our board of directors since March 2004. Mr. Hong has served as Chairman of the board of directors of Northpoint Investment Partners, Pte. Ltd., a private investment firm based in Singapore, since September 2003. From September 2000 to November 2002, he served as Executive Director of Morgan Stanley & Co. International Ltd., Seoul Branch. From June 1998 to August 2000, he served as a First Vice President of Merrill Lynch International Inc., Seoul Branch. From September 1994 to May 1998, he served as a Vice President and portfolio manager of J.P. Morgan Investment Management Inc., based in Singapore. Prior to joining J.P. Morgan, Mr. Hong was as an equity research analyst of J. Henry Schroder Wagg & Co. Ltd., in Seoul. Mr. Hong holds a B.S.E. in chemical engineering from Princeton University and an M.B.A. from Columbia University. Mr. Hong is a Chartered Financial Analyst.
         Thomas F. Lagatta has served as a member of our board of directors since January 2006. Mr. Lagatta has served as Senior Vice President of Worldwide Sales for Broadcom Corp. since June 2006. Prior to that, he had served as the Enterprise Computing Group's Senior Vice President and General Manager since 2003. He joined Broadcom in 2002. Prior to that, Mr. Lagatta served as Vice President and General Manager of Anadigics, Inc., a semiconductor manufacturer. Before Anadigics, Mr. Lagatta served as Vice President of Business Development at Avnet, Inc. Prior to Avnet, Mr. Lagatta served in various senior management and technical positions for over 11 years at Symbios Logic, a storage systems company. Mr. Lagatta received a B.S.E.E. from Ohio State University and an M.S.E.E. from the University of Southern California.
         Alan H. Portnoy has served as a member of our board of directors since March 2004. Mr. Portnoy has served as President of Macronix America, Inc., since May 1996. From June 1995 to April 1996, he served as Managing Director for PNY Electronics, Inc., a memory module manufacturer. Mr. Portnoy was the Chief Operating Officer of LG Semicon America from 1988 to 1994, a Vice President for General Instruments Corporation from 1987 to 1988, a Senior Vice President for Silicon Systems from 1981 to 1987, and a Vice President for Macrodata Corporation from 1975 to 1980. Mr. Portnoy began his career with Fairchild Semiconductor. Mr. Portnoy presently serves on the board of Macro-Port, Inc. Mr. Portnoy received his B.S. in electrical engineering from the Rensselaer Polytechnic Institute and his M.S in Industrial Administration from Carnegie-Mellon University.
         David M. Rickey has served as a member of our board of directors since March 2004. Mr. Rickey served as Chairman of Applied Micro Circuits Corporation, or AMCC, from August 2000 to March 2005 and as the President and Chief Executive Officer from February 1996 to March 2005. From 1993 to 1995, he served as the Vice President of Operations of AMCC. During his time away from AMCC, Mr. Rickey served as the Vice President of Operations of NexGen, Inc. For eight years beginning in 1985, Mr. Rickey was employed by Northern Telecom, Inc. Mr. Rickey began his career at International Business Machines Corporation. Mr. Rickey presently serves on the board at Cytori Therapeutics, Inc. Mr. Rickey graduated Summa Cum Laude from Marietta College with a B.S. in Mathematics. He also has a B.S. in Metallurgy and Materials Science from Columbia University, and an M.S. in Material Science and Engineering from Stanford University.
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         Preston Romm has served as a member of our board of directors since March 2004. Mr. Romm has served as Vice President of Finance and Chief Financial Officer of Iomega Corporation since March 2006. Prior to that, he served as Vice President of Finance and Chief Financial Officer of Dot Hill Systems beginning in November 1999. From January 1997 to November 1999, Mr. Romm served as Vice President of Finance, Chief Financial Officer and Secretary of Verteq, Inc., a semiconductor equipment manufacturer. From November 1994 to January 1997, Mr. Romm served as Vice President of Finance and Chief Financial Officer of STM Wireless, Inc. From July 1990 to November 1994, Mr. Romm served as Vice President and Controller of MTI Technology Corporation. Mr. Romm holds a B.S. from the University of Maryland and an M.B.A. from American University.
Board of Directors
        Our board of directors currently consists of six directors. All of our directors will stand for election at each annual meeting of stockholders.
        Our board of directors has established an audit committee, a compensation committee and a nominating and governance committee. The composition and responsibilities of these committees are as follows:
        Audit Committee.     Our audit committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our audit committee reviews the qualifications, independence and performance of our independent auditor, and approves the terms of engagement of our independent auditor. The members of our audit committee are Messrs. Portnoy, Rickey and Romm. Mr. Romm serves as chairperson of the audit committee. Each member of our audit committee meets the requirements for independence under the Nasdaq Marketplace Rules and applicable rules and regulations of the Securities and Exchange Commission, and our board of directors reviews the qualifications of our audit committee members from time to time to determine whether they continue to meet these independence requirements. Mr. Romm qualifies as an "audit committee financial expert," as defined in Rule 401(h) of Regulation S-K of the Securities Exchange Act of 1934, as amended.
        Compensation Committee.     Our compensation committee discharges the responsibilities of our board of directors relating to compensation and benefits of our executive officers and directors and reviews our general policy relating to compensation and benefits. The members of our compensation committee are Messrs. Lagatta, Portnoy and Rickey. Mr. Rickey serves as chairperson of the compensation committee.
        Nominating and Governance Committee.     Our nominating and governance committee considers and makes recommendations to our board of directors regarding candidates to serve as members of our board of directors, reviews our general policy relating to selection of director candidates and members of committees of our board of directors, and reviews and makes recommendations to our board of directors regarding corporate governance principles. The members of our nominating and governance committee are Messrs. Lagatta, Rickey and Romm. Mr. Romm serves as chairperson of the nominating and governance committee.
Compensation Committee Interlocks and Insider Participation
        None of the members of our compensation committee is or has been one of our officers or employees. No member of our board of directors or compensation committee currently serves, or served during 2005, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee.
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Director Compensation
        Our non-employee directors receive annual base compensation of $30,000, paid in four quarterly installments, and compensation of $1,000 for each regularly scheduled board meeting, or committee meeting not held on the same day as a board meeting, that is attended. The chairperson of our audit committee receives an additional $5,000 per year. All of our directors, including our non-employee directors, are reimbursed for their reasonable out-of-pocket expenses incurred in attending board and board committee meetings. Our non-employee directors are also granted an option to purchase 25,000 shares of our common stock under our 2000 Equity Incentive Plan upon appointment or initial election to the board of directors, and will receive a grant of an option to purchase 10,000 shares of our common stock on August 1st of each year in which they continue to be a board member. These grants are subject to vesting over four years, contingent upon continued service as a director on the vesting date. Our employee directors do not receive cash compensation or option grants for their services as directors.
Indemnification of Directors and Officers and Limitation of Liability
        We intend to amend and restate our certificate of incorporation and bylaws prior to the completion of this offering. Our amended and restated certificate of incorporation will eliminate the personal liability of each of our directors for monetary damages resulting from any breach of his fiduciary duty as a director, except for liability:
•
for any breach of the director's duty of loyalty to us or our stockholders;

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

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

•
for any transaction from which the director derived an improper personal benefit.
        Our amended and restated bylaws will provide that:
•
we are required to indemnify our directors and officers to the fullest extent permitted by the Delaware General Corporation Law, subject to limited exceptions;

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

•
the indemnification rights conferred in the bylaws are not exclusive.
        We have entered into indemnification agreements with most of our current directors and executive officers. We intend to enter into indemnification agreements with all of our directors and executive officers prior to the completion of this offering. Subject to limited exceptions, these agreements require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to us, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. We also intend to enter into indemnification agreements with our future directors and executive officers.
        We intend to obtain directors' and officers' insurance to cover our directors, officers and some of our employees for liabilities, including liabilities under securities laws prior to the completion of this offering. We believe that these indemnification provisions and agreements and this insurance are necessary to attract and retain qualified directors and executive officers.
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        The exculpation of liability and indemnification provisions in our certificate of incorporation and indemnification agreements may discourage stockholders from bringing a lawsuit against our directors for any breach of their fiduciary duties. They may also reduce the likelihood of derivative litigation against our directors and officers, even though an action, if successful, might benefit us and other stockholders. Furthermore, a stockholder's investment may be adversely affected to the extent that we pay the costs of settlement and damage awards against directors and officers as required by these indemnification provisions. At present, there is no pending litigation or proceeding involving any of our directors, officers or employees for which indemnification is sought, and we are not aware of any threatened litigation that may result in claims for indemnification.
Code of Ethics
        We intend to adopt and post on our website, prior to the completion of this offering, a Code of Ethics that applies to all directors, officers and employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer.
Executive Compensation
        The following table presents information regarding the compensation received for the year ended December 31, 2005, by our chief executive officer and each of our other named executive officers. The compensation table excludes other compensation in the form of perquisites and other personal benefits to a named executive officer where that compensation constituted less than the lesser of $50,000 or 10% of his total annual salary and bonus for such period.
 
 Summary Compensation Table

 	 	Annual Compensation
	 	Long Term Compensation
	 	 	
Name and Principal Position
	 	Salary
	 	Bonus
	 	Other
Annual
Compensation
	 	Restricted
Stock
Awards
	 	Securities
Underlying
Options
	 	All Other
Compensation
	
Chun K. Hong
President, Chief Executive Officer and Chairman of the Board	 	$	323,733	 	$	—	 	$	—	 	$	—	 	—	 	$	—	
Jayesh Bhakta
Vice President of Engineering	 	 	153,002	 	 	—	 	 	—	 	 	—	 	—	 	 	—	
Lee Kim(1)
Vice President, Chief Financial Officer and Secretary	 	 	—	 	 	—	 	 	—	 	 	—	 	—	 	 	—	
Christopher Lopes
Vice President of Sales	 	 	202,204	 	 	—	 	 	—	 	 	—	 	—	 	 	—	
Daniel Skaggs(2)
Vice President of Finance	 	 	162,000	 	 	—	 	 	—	 	 	—	 	30,000	 	 	—	

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

(2)
Mr. Skaggs' employment terminated in February 2006.
Option Grants in 2005
        The following table presents information regarding grants of stock options that we made during 2005 to the named executive officers. We granted these options to the named executive officers under our 2000 Equity Incentive Plan. All of the options listed on the following table expire ten
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years from the date of grant and were granted at an exercise price equal to the fair market value of our common stock as determined in good faith by our board of directors on the date of grant. The percentage of total options granted to employees in 2005 is based on options to purchase a total of 691,000 shares of our common stock that were granted to employees for the year ending December 31, 2005.

 	 	Individual Grants
	
Name
	 	Number of
Securities
Underlying
Options
Granted
	 	% of Total
Options Granted
to
Employees in
Fiscal Year
	 	Exercise
Price
Per Share
	 	Expiration
Date(1)
	
Chun K. Hong	 	—	 	—	 	 	—	 	—	
Jayesh Bhakta	 	—	 	—	 	 	—	 	—	
Lee Kim	 	—	 	—	 	 	—	 	—	
Christopher Lopes	 	—	 	—	 	 	—	 	—	
Daniel Skaggs(1)	 	30,000	 	4.3	%	$	2.55	 	—	

(1)
Mr. Skaggs' employment terminated in February 2006. Mr. Skaggs did not exercise his vested options within the 90-day period following his termination in accordance with the provisions of his option grant, and his options therefore terminated as of the end of that 90-day period and are no longer outstanding.
Aggregate Option Exercises in 2005
        None of the named executive officers exercised any stock options or stock appreciation rights in fiscal year 2005. The following table presents the number of shares of our common stock subject to unexercised options held by the named executive officers at December 31, 2005, and the value of the unexercised options that were in-the-money at that date. This value is calculated based on the difference between $1.48, the estimated fair market value of our common stock at December 31, 2005, and the exercise price for the shares underlying the option, multiplied by the number of shares.

 	 	Number of Securities Underlying Unexercised Options at December 31,2005
	 	Value of Unexercised In-the-Money Options at December 31, 2005
	
Name
					
	 	Exercisable
	 	Unexercisable
	 	Exercisable
	 	Unexercisable
	
Chun K. Hong	 	—	 	—	 	 	—	 	—	
Jayesh Bhakta	 	—	 	—	 	 	—	 	—	
Lee Kim	 	—	 	—	 	 	—	 	—	
Christopher Lopes	 	—	 	—	 	 	—	 	—	
Daniel Skaggs(1)	 	68,799	 	65,000	 	$	43,262	 	—	

(1)
Mr. Skaggs' employment terminated in February 2006. Mr. Skaggs did not exercise his vested options within the 90-day period following his termination in accordance with the provisions of his option grant, and his options therefore terminated as of the end of that 90-day period and are no longer outstanding.
Recent Option Grants to Management
        In August 2006, the compensation committee of our board of directors granted options to purchase the following numbers of shares of our common stock to the following members of our management: Chun K. Hong, 500,000; Lee Kim, 100,000 (85,000 of which were granted directly to
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him and 15,000 of which were granted in the form of a warrant to a company with which he is affiliated pursuant to an agreement between that company and us); Jayesh Bhakta, 100,000; Christopher Lopes, 100,000; and Paik Ki Hong, our Vice President of Procurement, 100,000. Each of these options has an exercise price of $7.00 per share. The options granted to Chun K. Hong and Lee Kim vest quarterly over four years. The options granted to the other three employees vest upon the termination of the lock-up period included in agreements that they entered into with us in August 2006 provided that they have not terminated their employment with us prior to that time. These agreements provide that they will not sell any of their shares of common stock during the two-year period following the termination of their lock-up agreements with the underwriters other than the sale of up to 25,000 shares each quarter pursuant to a written trading plan that complies with SEC Rule 10b5-1 and is approved by us.
Employment Agreements
        We entered into an employment agreement with Lee Kim, our Vice President, Chief Financial Officer and Secretary, at the time of his hiring in January 2006. Mr. Kim's employment agreement provides for an initial base salary of $200,000. We agreed to reimburse Mr. Kim for the costs of his health and welfare plan premiums in an amount up to $750.00 per month. Our employment relationship with Mr. Kim is at-will, and either we or Mr. Kim may terminate the employment relationship on 30 days' written notice. If Mr. Kim is terminated by us for any reason other than cause within his first year of employment, he will be entitled to a severance payment equal to one months' salary; if he is terminated by us for any reason other than cause after his first year of employment, he will be entitled to a severance payment equal to four months' salary; if he is terminated by us for any reason other than cause after his second year of employment, he will be entitled to a severance payment equal to six months' salary; and for each six months of employment after his second year of employment, if he is terminated by us for any reason other than cause he will be entitled to an additional one month's salary, capped at twelve months total. If Mr. Kim is terminated by us without cause, or without 30 days' prior notice, or if Mr. Kim resigns for cause, Mr. Kim will be entitled to the applicable severance compensation described above, plus one additional month's salary, and all of Mr. Kim's cash bonuses and stock options will immediately vest and become payable and exercisable, as applicable. If Mr. Kim is terminated by us without cause, or if Mr. Kim resigns for cause, as a result of, or within six months following, a change in control of our company, he will be entitled to a payment in the amount of 12 months' salary. In conjunction with Mr. Kim's hiring, we agreed to pay a portion of any cash or equity compensation earned by him as our employee to a company with which he is affiliated.
Employee Benefit Plans
Amended and Restated 2000 Equity Incentive Plan
        We intend to amend and restate our existing 2000 Equity Incentive Plan in its entirety prior to the completion of this offering. In this prospectus we make reference to our 2000 Equity Incentive Plan, as it will be amended and restated, as the Amended and Restated 2000 Equity Incentive Plan. The Amended and Restated 2000 Equity Incentive Plan will be administered by the compensation committee of our board of directors. The compensation committee will have the authority to administer the plan, including the power to determine eligibility to receive awards, the types and number of shares of stock subject to the awards, the price and timing of awards, the acceleration or waiver of any vesting, and the imposition of performance or forfeiture restrictions. The compensation committee, however, does not have the authority to waive any performance restrictions for performance-based awards. The compensation committee may reprice or otherwise amend the terms of any award granted under the plan, prospectively or retroactively, consistent with the terms of the plan. It also may at any time offer to buy out for a cash payment an award
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previously granted, or authorize the recipient of an award to elect to cash out an award previously granted. As used in this prospectus, the term "administrator" means the compensation committee.
        Shares Reserved for Issuance.     Subject to certain adjustments, we initially will be able to issue a maximum of              shares of common stock pursuant to awards granted under the Amended and Restated 2000 Equity Incentive Plan. That maximum number will automatically increase on a fixed date each year by the least of:
•
percent of the total number of shares of common stock outstanding on the date immediately preceding the date of the increase;

•
shares; and

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

        The following types of shares issued under the Amended and Restated 2000 Equity Incentive Plan may again become available for the grant of new awards under the plan:
•
shares that are forfeited to us or repurchased by us at less than fair market value; and

•
shares tendered to us to pay the exercise price of an option.
        Participants.     Any of our employees, our non-employee directors, and any consultants and advisors to us, as determined by the administrator, may be selected to participate in the Amended and Restated 2000 Equity Incentive Plan. We may award these individuals with one or more of the following:
•
stock options;

•
stock appreciation rights;

•
restricted stock and stock unit awards;

•
performance units;

•
stock grants; and

•
performance-based awards.

        Stock Options.     Stock options may be granted under the Amended and Restated 2000 Equity Incentive Plan, including incentive stock options, as defined under Section 422 of the Code, and nonqualified stock options. The option exercise price of all stock options granted under the Amended and Restated 2000 Equity Incentive Plan will be determined by the administrator, except that any incentive stock option or any option intended to qualify as performance-based compensation under Section 162(m) of the Code will not be granted at a price that is less than 100% of the fair market value of the stock on the date of grant. Stock options may be exercised as determined by the administrator, but in no event after the tenth anniversary date of grant.
        Upon the exercise of a stock option, the purchase price must be paid in full in either cash or its equivalent. The administrator may also allow payment by tendering previously acquired shares of our common stock with a fair market value at the time of exercise equal to the exercise price, provided such shares have been held for at least six months prior to tender and broker-assisted cashless exercises and may authorize loans for the purpose of exercise as permitted under applicable law.
        Stock Appreciation Rights.     Stock appreciation rights, or SARs, entitle a participant to receive a payment equal in value to the difference between the fair market value of a share of stock on the date of exercise of the SAR over the grant price of the SAR. The administrator may pay that amount
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in cash, in shares of our common stock, or in a combination of both. The terms, methods of exercise, methods of settlement, form of consideration payable in settlement, and any other terms and conditions of any SAR will be determined by the administrator at the time of the grant of award and will be reflected in the award agreement.
         Restricted Stock and Stock Units. A restricted stock award or restricted stock unit award is the grant of shares of our common stock either currently (in the case of restricted stock) or at a future date (in the case of restricted stock units), at a price determined by the administrator (including zero), that is nontransferable and is subject to substantial risk of forfeiture until specific conditions or goals are met. Conditions may be based on continuing employment or achieving performance goals. During the period of restriction, participants holding shares of restricted stock may, if permitted by the administrator, have full voting and dividend rights with respect to those shares. The restrictions will lapse in accordance with a schedule or other conditions determined by the administrator.
         Performance Units. A performance unit award is a contingent right to receive the value of a pre-determined number of shares of our common stock if certain performance goals are met. The value of performance units will depend on the degree to which the specified performance goals are achieved, but are generally based on the value of our common stock. The administrator may, in its discretion, pay earned performance units in cash, or stock, or a combination of both.
         Stock Grants. A stock grant is an award of shares of common stock without restrictions. Stock grants may only be made in limited circumstances, such as in lieu of other earned compensation.
        Performance-Based Awards.     Grants of performance-based awards enable us to treat other awards granted under the Amended and Restated 2000 Equity Incentive Plan as "performance-based compensation" under Section 162(m) of the Code and preserve the deductibility of these awards for federal income tax purposes. Because Section 162(m) of the Code only applies to those employees who are "covered employees" as defined in Section 162(m) of the Code, only covered employees and those likely to become covered employees are eligible to receive performance-based awards. Participants are only entitled to receive payment for a performance-based award for any given performance period to the extent that pre-established performance goals set by the administrator for the period are satisfied. These pre-established performance goals must be based on one or more of the following performance criteria: pre- or after-tax net earnings, sales growth, operating earnings, operating cash flow, return on net assets, return on stockholders' equity, return on assets, return on capital, stock price growth, stockholder returns, gross or net profit margin, earnings per share, price per share and market share. These performance criteria may be measured in absolute terms or as compared to any incremental increase or as compared to results of a peer group. With regard to a particular performance period, the administrator will have the discretion to select the length of the performance period, the type of performance-based awards to be granted, and the goals that will be used to measure the performance for the period. In determining the actual size of an individual performance-based award for a performance period, the administrator may reduce or eliminate (but not increase) the award. Generally, a participant will have to be employed on the date the performance-based award is paid to be eligible for a performance-based award for that period.
        Amendment and Termination.     Our board of directors may terminate, amend, or modify the Amended and Restated 2000 Equity Incentive Plan at any time; however, stockholder approval will be obtained for any amendment to the extent necessary and desirable to comply with any applicable law, regulation or stock exchange rule. We may not make any grants under the Amended and Restated 2000 Equity Incentive Plan after             , 2016.
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        Adoption by Stockholders.     We intend to seek approval of the Amended and Restated 2000 Equity Incentive Plan by the holders of a majority of the outstanding shares of our common stock and preferred stock prior to the completion of this offering.
401(k) Plan
        We sponsor a defined contribution plan, or 401(k) Plan, intended to qualify under Section 401(a) of the Internal Revenue Code. Employees are eligible to participate in this plan provided they are employed full-time and have reached 21 years of age. Participants may make pre-tax contributions to the plan subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions and the investment earnings. Under the plan's current terms, we may match the contributions of a participant, to the extent they do not exceed 6% of the participant's compensation, on a discretionary basis. Our contributions, if any, would generally be deductible by us when made. Contributions are held in trust as required by law.
66

 
 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
        The following is a description of certain relationships and related transactions to which we have been a party, in which the amount involved in each transaction or series of related transactions exceeds $60,000, and in which any of our directors, former or current executive officers or, to our knowledge, holders of more than 5% of our capital stock had or will have a direct or indirect material interest.
Related Parties
Loans to Related Parties
        Our Vice President of Procurement, Paik Ki Hong, is the brother of Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board, and of Nam Ki Hong, one of our directors. Mr. P. K. Hong received salary and bonuses in the amount of $125,693 for the year 2005. As of December 31, 2005 and June 30, 2006, Mr. P. K. Hong owed $22,865 in outstanding principal and accrued and unpaid interest on a full-recourse promissory note issued to us by Mr. P. K. Hong as part of the exercise price of then-vested options to acquire shares granted to him pursuant to our 2000 Equity Incentive Plan. This note bears interest at a rate of 7% per annum and is due on February 17, 2008.
        In November 2000, we made loans to each of Christopher Lopes, our Vice President of Sales, and Jayesh Bhakta, our Vice President of Engineering, in connection with their respective purchases of shares of restricted stock. The original principal amount of each of these loans was $199,000, and they each accrued interest at a rate of 7% annually. As of December 31, 2003, the outstanding principal and accrued and unpaid interest on each of these loans totaled $246,299. On December 31, 2003, we forgave the entire outstanding principal amount, as well as accrued and unpaid interest due to us, on those loans. In addition, we gave each of Mr. Lopes and Mr. Bhakta a cash bonus of $165,100, which was intended to be equal to the tax liability incurred by each of these individuals with respect to the forgiveness of each of their loans.
Loans From and Guaranties by Executive Officers
        In August and October 2002, Chun K. Hong made loans to us to finance our working capital needs in exchange for two promissory notes in the original principal amount of $97,894 and $70,000, respectively. Interest on each of these notes accrued at a rate of 7% per annum and all principal and accrued interest was due in July 2004 and October 2004, respectively. We prepaid interest under these notes on a monthly basis as it accrued. As a result, the total outstanding balance of these notes on December 31, 2003 was $167,894. On that date, we offset $167,894 of prior advances made to Mr. Hong, as described below, against that outstanding balance, effectively canceling each of these notes.
        Mr. Hong has personally guarantied the repayment of $1,750,000 in aggregate principal amount of our outstanding convertible promissory notes. Messrs. Hong, Lopes and Bhakta have each personally guarantied the repayment of up to $1,000,000 of borrowings under the existing credit agreement with our bank. The guaranties of our bank debt will terminate upon the completion of this offering.
        In November 2002, Julie Skaggs, the wife of Daniel Skaggs, our former Vice President of Finance, made a loan to us to finance our working capital needs in exchange for a promissory note in the original principal amount of $100,000. Interest on this note accrued at a rate of 15% per annum and all principal and accrued interest was due in 2004. We repaid this loan in December 2003.
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Advances to Executive Officers and Other Management
        We made a series of advances in 2001 and 2002 in the aggregate amount of $152,000, $90,000, $5,000 and $81,120 to Chun K. Hong, Christopher Lopes, Jayesh Bhakta, and Paik Ki Hong, respectively. These advances accrued interest at a rate of 7% annually. As of December 31, 2003, the outstanding balances of these advances, including accrued and unpaid interest, totaled $174,340, $101,336, $5,454 and $90,244, respectively. On that same date, we offset $167,894 of the advances to Mr. C. K. Hong against the two notes owed to him, as described above, reducing the amount of his advances at year end to $6,446. On that same date, we forgave the entire remaining outstanding amounts of the advances to Messrs. C. K. Hong, Lopes, Bhakta and P. K. Hong. We also gave cash bonuses of $2,665, $82,691, $2,133 and $74,304 to Messrs. C. K. Hong, Lopes, Bhakta and P. K. Hong, respectively, which amounts were intended to be equal to the respective tax liabilities to be incurred by each of these individuals in connection with the forgiveness of each of their advances.
Other Transactions
        In August 2006, Jayesh Bhakta, Christopher Lopes, and Paik Ki Hong entered into lock-up agreements with us as part of an overall compensation package. These agreements provide that they will not sell any of their shares of common stock during the two-year period following the termination of their lock-up agreements with the underwriters other than the sale of up to 25,000 shares each quarter pursuant to a written trading plan that complies with SEC Rule 10b5-1 and is approved by us. In return, we agreed that each of them would receive a $100,000 bonus upon completion of this offering (which must be repaid to us if he terminates his employment prior to the end of the two-year lock-up period), and that each of them would be able to sell, as part of the over-allotment option in connection with this offering, if that over-allotment option is exercised by the underwriters, the number of shares of our common stock that would provide them with gross proceeds of $750,000. Upon signing these agreements, each of these employees also received an option to purchase 100,000 shares of our common stock at an exercise price of $7.00 per share as part of this compensation package.
Stock Options Granted to Directors and Executive Officers
        For more information in addition to that described under "—Other Transactions" above regarding director and executive officer compensation and the grant of stock options to directors and executive officers, please see the following subsections under "Management" above: "—Director Compensation," "—Executive Compensation," "—Option Grants in 2005" and "—Recent Option Grants to Management."
Indemnification Agreements
        We enter into indemnification agreements with all of our executive officers and directors. See the information provided in this prospectus under "Management—Indemnification of Officers and Directors and Limitation of Liability."
68

 
 PRINCIPAL AND SELLING STOCKHOLDERS
        The following table sets forth information regarding the beneficial ownership of our common stock as of July 31, 2006, and as adjusted to reflect the sale of common stock offered by us in this offering, for:
•
each named executive officer;

•
each of our current directors;

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

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

•
each stockholder that will sell shares in this offering if the underwriters' over-allotment option is exercised.
        In the following table, the percentage ownership of shares beneficially owned prior to this offering is based on 11,223,334 shares of our common stock outstanding as of July 31, 2006, and the percentage of shares beneficially owned after this offering is based on             shares of our common stock outstanding after this offering, and, in each case, assuming:
•
the conversion of all of our outstanding shares of preferred stock into 1,000,000 shares of our common stock; and

•
the conversion of $1.75 million in outstanding principal amount of our outstanding convertible promissory notes into 1,050,000 shares of our common stock.
        Beneficial ownership is determined in accordance with the rules and regulations of the Securities and Exchange Commission and does not necessarily indicate beneficial ownership for any other purpose. Under these rules, beneficial ownership includes those shares of common stock over which the stockholder has sole or shared voting or investment power. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days of July 31, 2006, are deemed outstanding for purposes of computing the percentage beneficially owned by the person holding those options or warrants, but are not deemed outstanding for purposes of computing the percentage beneficially owned by any other person.
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 	 	Shares Beneficially Owned Prior to Offering
	 	 	 	Shares Beneficially Owned After Offering(3)
	
Name of Beneficial Owner(1)
			 	Shares Being
Offered(2)
			
	 	Number
	 	Percent
			 	Number
	 	Percent
	
Directors and Executive Officers:	 	 	 	 	 	 	 	 	 	 	
Chun K. Hong(4)	 	6,000,000	 	45.2	%	 	 	 	 	 	
Christopher Lopes	 	1,000,000	 	7.5	%	 	 	 	 	 	
Jayesh Bhakta	 	1,000,000	 	7.5	%	 	 	 	 	 	
Lee Kim	 	—	 	—	 	—	 	 	 	 	
Nam Ki Hong(5)	 	115,000	 	*	 	—	 	 	 	 	
Thomas F. Lagatta	 	—	 	—	 	—	 	 	 	 	
Alan H. Portnoy(6)	 	15,000	 	*	 	—	 	 	 	 	
David M. Rickey(6)	 	15,000	 	*	 	—	 	 	 	 	
Preston Romm(6)	 	15,000	 	*	 	—	 	 	 	 	
All executive officers and directors as a group (9 persons)	 	8,160,000	 	60.7	%	 	 	 	 	 	
5% Stockholders:	 	 	 	 	 	 	 	 	 	 	
Jae Dong Lee(7)	 	1,400,000	 	10.5	%	 	 	 	 	 	
Paik Ki Hong(8)	 	1,000,000	 	7.1	%	 	 	 	 	 	
Serim Paper Manufacturing Co., Ltd(9)	 	675,000	 	5.1	%	—	 	 	 	 	
Jun S. Cho(10)	 	1,020,000	 	7.7	%	 	 	 	 	 	

*
Represents beneficial ownership of less than 1%.

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

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

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

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

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

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

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

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

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

(10)
The number of shares beneficially owned both before and after the offering includes 500,000 shares of common stock held by Mr. Cho as trustee of the Chun Ki Hong 2004 Trust, which shares were transferred to this trust by Mr. C.K. Hong in August 2004, and 500,000 shares of common stock held by Mr. Cho as trustee of the Won Kyung Cha 2004 Trust, which shares were transferred to this trust by Won Kyung Cha, the wife of Mr. C.K. Hong, in August 2004. Mr. Cho disclaims beneficial ownership of shares held for these trusts.
70

 
 
 DESCRIPTION OF CAPITAL STOCK
General
        The following information assumes the filing, prior to the completion of this offering, of our amended and restated certificate of incorporation and our amended and restated bylaws.
        Immediately following the completion of this offering, our authorized capital stock will consist of             shares of common stock, par value $0.001 per share, and              shares of undesignated preferred stock, par value $0.001 per share.
Common Stock
        As of July 31, 2006, we had outstanding 11,223,334 shares of our common stock held by 17 holders of record.
Dividend Rights
        Subject to preferences that may apply to any then outstanding shares of preferred stock, the holders of outstanding shares of our common stock are entitled to receive dividends out of assets legally available for distribution at the times and in the amounts, if any, that our board of directors may determine from time to time.
Voting Rights
        Each holder of our common stock is entitled to one vote for each share of our common stock held on all matters submitted to a vote of stockholders. We have not provided for cumulative voting for the election of directors in our certificate of incorporation. This means that the holders of a majority of the shares voted can elect all of the directors then standing for election. In addition, our certificate of incorporation and bylaws provide that all actions to be taken by our stockholders will require the approval of a majority of the shares entitled to vote at a meeting at which a quorum is present. For a description of these actions, see "—Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws."
No Preemptive, Conversion or Redemption Rights
        Our common stock is not entitled to preemptive rights and is not subject to conversion or redemption.
Right to Receive Liquidation Distributions
        Upon our liquidation, dissolution or winding-up, the holders of our common stock are entitled to share in all assets remaining after payment of all liabilities and the liquidation preferences of any then outstanding shares of preferred stock. Each outstanding share of our common stock is, and all shares of our common stock to be issued in this offering when they are paid for will be, fully paid and nonassessable.
Preferred Stock
        Immediately prior to the completion of this offering, each outstanding share of our existing series of preferred stock designated as Series A Convertible Preferred Stock will be converted into one share of common stock.
        Our board of directors is authorized, subject to limitations imposed by Delaware law, to issue up to             shares of preferred stock, in one or more series, without stockholder approval. Our board of directors is authorized to establish from time to time the number of shares to be included
71

in each series, and to fix the rights, preferences and privileges of the shares of each wholly unissued series and any of its qualifications, limitations or restrictions. Our board of directors can also increase or decrease the number of shares of any series, but not below the number of shares of that series then outstanding, without any further vote or action by the stockholders.
        The board of directors may authorize the issuance of preferred stock with voting or conversion rights that could harm the voting power or other rights of the holders of common stock. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, have the effect of delaying, deferring or preventing a change of control and might harm the market price of our common stock and the voting and other rights of the holders of common stock. We have no current plans to issue any shares of preferred stock.
Common Stock Warrants
        In January 2003, we issued a warrant to purchase an aggregate of 60,000 shares of our common stock at an exercise price of $1.25 per share to a single holder. This warrant expires in January 2013. In February 2003, we issued warrants to purchase an aggregate of 300,000 shares of our common stock at an exercise price of $1.00 per share to a total of three holders. These warrants have five-year terms and expire on February 12, 2008. In May 2006 and August 2006, we issued warrants to purchase 22,500 shares and 15,000 shares of our common stock at exercise prices of $2.55 per share and $7.00 per share, respectively, to a single holder. These warrants have a 10-year term and vest over a four-year period.
Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws
        The provisions of Delaware law and of our amended and restated certificate of incorporation and bylaws described below may have the effect of delaying, deferring or discouraging another party from acquiring control of us.
Delaware Law
        We will be subject to the provisions of Section 203 of the Delaware General Corporation Law regulating corporate takeovers. In general, those provisions prohibit a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date of the transaction in which the person became an interested stockholder, unless:
•
the transaction is approved by the board of directors before the date the interested stockholder attained that status;

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

•
on or after the date the business combination is approved by the board of directors and authorized at a meeting of stockholders by at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder.
        Section 203 defines "business combination" to include the following:
•
any merger or consolidation involving the corporation and the interested stockholder;

•
any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder;
72

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

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

•
the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation.
        In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by any of these entities or persons.
        A Delaware corporation may opt out of this provision either with an express provision in its original certificate of incorporation or in an amendment to its certificate of incorporation or bylaws approved by its stockholders. However, we have not opted out of this provision. The statute could prohibit or delay mergers or other takeover or change in control attempts and, accordingly, may discourage attempts to acquire us.
Charter and Bylaws
        Following the completion of this offering, our amended and restated certificate of incorporation and bylaws will provide that:
•
no action can be taken by stockholders except at an annual or special meeting of the stockholders called in accordance with our bylaws, and stockholders may not act by written consent;

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

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

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

•
we will indemnify officers and directors against losses that they may incur in investigations and legal proceedings resulting from their services to us, which may include services in connection with takeover defense measures.
Transfer Agent and Registrar
        The transfer agent and registrar for our common stock will be U.S. Stock Transfer Corporation and its address is 1745 Gardena Avenue, Glendale, CA 91204-2991.
Listing
        We intend to apply to have our common stock approved for trading and quotation on the Nasdaq Global Market under the proposed trading symbol "NLST."
73

 
 SHARES ELIGIBLE FOR FUTURE SALE
        Before this offering, there has not been a public market for our common stock. Future sales of substantial amounts of our common stock, including shares issued upon exercise of outstanding options and warrants, in the public markets after this offering could adversely affect market prices prevailing from time to time. As described below, only a limited number of shares currently outstanding will be available for sale immediately after this offering due to contractual and legal restrictions on resale. Nevertheless, future sales of substantial amounts of our common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market after the restrictions lapse, or the possibility of the sales, could cause the prevailing market price of our common stock to fall or impair our ability to raise equity capital in the future.
        Upon completion of this offering, we will have outstanding             shares of our common stock, assuming that there are no exercises of outstanding options after                          , 2006. Of these shares, all of the             shares sold in this offering will be freely tradable in the public market without restriction or further registration under the Securities Act, unless these shares are held by "affiliates," as that term is defined in Rule 144 under the Securities Act. For purposes of Rule 144, an "affiliate" of an issuer is a person that, directly or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the issuer. Shares purchased by an affiliate may not be resold except pursuant to an effective registration statement or an exemption from registration, including the exemption under Rule 144 of the Securities Act described below. Our shares outstanding prior to this offering are "restricted securities," as that term is defined in Rule 144 under the Securities Act. These restricted securities may be sold in the public market only if they are registered or if they qualify for an exemption from registration under Rule 144 or 701 under the Securities Act. These rules are summarized below. Subject to the lock-up agreements described below and the current information, manner of sale and volume restrictions of Rule 144 and Rule 701, these restricted securities will be available for sale in the public market as follows:

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

90 days after the date of this prospectus	
 	
shares	
 	
Shares not locked up and eligible for resale under Rule 144 and Rule 701	

180 days after the date of this prospectus	
 	
shares	
 	
Lock-up released; shares eligible for sale under Rule 144 and Rule 701	
Lock-up Agreements
        We and the selling stockholders, our executive officers and directors and substantially all of our other existing security holders have agreed, subject to limited exceptions, not to offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any of their shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock; or enter into any swap or other arrangement that transfers to another, in whole or in part, any economic consequences of ownership of our common stock (other than with respect to shares being sold by a selling stockholder in this offering) during the period ending 180 days after the date of this prospectus without the prior written consent of Thomas Weisel Partners LLC, on behalf of the underwriters. If (a) during the last 17 days of this 180-day period, we release earnings results or announce material news or a material event or (b) prior to the expiration of this 180-day period, we announce that we will release earnings results
74

during the 15-day period following the last day of the 180-day period, then in either case the above restrictions will continue to apply until 18-days after the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Thomas Weisel Partners LLC waives, in writing, such extension. These restrictions apply to shares of our capital stock which are now owned or which are acquired after the date of this prospectus by the person executing the lock-up agreement, or over which that person later acquires the power of disposition.
Rule 144
        In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year from the later of the date on which those shares of common stock were acquired from us or from an affiliate of ours, including the holding period of any prior owner other than an affiliate of ours, would be entitled to sell, within any three-month period, a number of shares that is not more than the greater of:
•
1% of the number of shares of our common stock then outstanding, which will equal approximately             shares immediately after this offering; or

•
the average weekly trading volume of our common stock on the Nasdaq Global Market during the four calendar weeks before a notice of the sale on Form 144 is filed.
        Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and the availability of current public information about us.
Rule 144(k)
        In addition, under Rule 144(k), a person who is not one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years from the later of the date these shares of our common stock were acquired from us or from an affiliate of ours, including the holding period of any prior owner other than an affiliate, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless they are subject to other restrictions on their sale, those shares may be sold immediately upon the completion of this offering.
Rule 701
        In general, under Rule 701 of the Securities Act as currently in effect, any of our employees, consultants or advisors who purchases shares from us in connection with a compensatory stock or option plan or other written agreement is eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with the manner of sale provisions, notice requirements, current public information requirements, or volume limitations of Rule 144. Based upon the number of shares of our common stock outstanding as of                          , 2006, an aggregate of approximately             shares of our common stock are eligible to be sold pursuant to Rule 701, subject to the vesting provisions that may be contained in individual option agreements.
Stock Plans
        We intend to file a registration statement on Form S-8 under the Securities Act covering all shares of our common stock subject to options outstanding or reserved for issuance under our Amended and Restated 2000 Equity Incentive Plan. We expect to file this registration statement as soon as practicable after this offering. However, none of the shares registered on Form S-8 will be eligible for resale until the expiration of any 180-day lock-up agreements to which they are subject.
75

 
 MATERIAL UNITED STATES FEDERAL TAX
CONSIDERATIONS FOR NON-UNITED STATES HOLDERS
        The following is a general discussion of certain material U.S. federal income and estate tax considerations of the ownership and disposition of our common stock by a beneficial owner thereof that is a "Non-U.S. Holder." A "Non-U.S. Holder" is a person or entity that, for U.S. federal income tax purposes, is a non-resident alien individual, a foreign corporation or a foreign estate or trust. The test for whether an individual is a resident of the U.S. for federal estate tax purposes differs from the test used for federal income tax purposes. Some individuals, therefore, may be "Non-U.S. Holders" for purposes of the federal income tax discussion below, but not for purposes of the federal estate tax discussion, and vice versa.
        This discussion is based on the U.S. Internal Revenue Code of 1986, as amended, judicial decisions and administrative regulations and interpretations in effect as of the date of this prospectus, all of which are subject to change, including changes with retroactive effect. This discussion does not address all aspects of U.S. federal income and estate taxation that may be relevant to Non-U.S. Holders in light of their particular circumstances (including, without limitation, Non-U.S. Holders who are pass-through entities or who hold their common stock through pass-through entities) and does not address any tax consequences arising under the laws of any state, local or non-U.S. jurisdiction. Prospective holders should consult their own tax advisors with respect to the federal income and estate tax consequences of holding and disposing of our common stock in light of their particular situations and any consequences to them arising under the laws of any state, local or non-U.S. jurisdiction.
Dividends
        Subject to the discussion below, distributions, if any, made to a Non-U.S. Holder of our common stock out of our current or accumulated earnings and profits generally will constitute dividends for U.S. tax purposes and will be subject to withholding tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. To obtain a reduced rate of withholding under a treaty, a Non-U.S. Holder generally will be required to provide us with a properly-executed IRS Form W-8BEN certifying the Non-U.S. Holder's entitlement to benefits under that treaty. Treasury Regulations provide special rules to determine whether, for purposes of determining the applicability of a tax treaty, dividends paid to a Non-U.S. Holder that is an entity should be treated as paid to the entity or to those holding an interest in that entity. To the extent such distributions exceed our current and accumulated earnings and profits for U.S. tax purposes, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock.
        There will be no withholding tax on dividends paid to a Non-U.S. Holder that are effectively connected with the Non-U.S. Holder's conduct of a trade or business within the United States if a properly-executed IRS Form W-8ECI, stating that the dividends are so connected, is provided to us. Instead, the effectively connected dividends will be subject to regular U.S. income tax, generally in the same manner as if the Non-U.S. Holder were a U.S. citizen or resident alien or a domestic corporation, as the case may be, unless a specific treaty exemption applies. A corporate Non-U.S. Holder receiving effectively connected dividends may also be subject to an additional "branch profits tax," which is imposed, under certain circumstances, at a rate of 30% (or such lower rate as may be specified by an applicable treaty) of the corporate Non-U.S. Holder's effectively connected earnings and profits, subject to certain adjustments. If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the U.S. Internal Revenue Service.
76

Gain on Disposition of Common Stock
        A Non-U.S. Holder generally will not be subject to U.S. federal income tax with respect to gain realized on a sale or other disposition of our common stock unless:
•
the gain is effectively connected with a trade or business of such holder in the United States and a specific treaty exemption does not apply to eliminate the tax;

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

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

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

•
we are or have been a "United States real property holding corporation" within the meaning of Code Section 897(c)(2) at any time within the shorter of the five-year period preceding such disposition or such holder's holding period.
        We believe that we are not, and do not anticipate becoming, a United States real property holding corporation. Even if we are treated as a United States real property holding corporation, gain realized by a Non-U.S. Holder on a disposition of our common stock will not be subject to U.S. federal income tax so long as: (a) the Non-U.S. Holder owned directly or indirectly, no more than five percent of our common stock at all times within the shorter of (x) the five year period preceding the disposition or (y) the holder's holding period; and (b) our common stock is regularly traded on an established securities market. There can be no assurance that our common stock will continue to qualify as being regularly traded on an established securities market.
        If you are a Non-U.S. Holder described in (i) or (ii) above, you will be required to pay tax on the net gain derived from the sale at regular graduated U.S. federal income tax rates, and corporate Non-U.S. Holders described in (i) or (ii) above may be subject to the branch profits tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. If you are an individual Non-U.S. Holder described in (iii) above, you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by U.S. source capital losses (even though you are not considered a resident of the United States).
Information Reporting Requirements and Backup Withholding
        Generally, we must report to the U.S. Internal Revenue Service the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the holder. Pursuant to tax treaties or certain other agreements, the U.S. Internal Revenue Service may make its reports available to tax authorities in the recipient's country of residence.
        Backup withholding will generally not apply to payments of dividends made by us or our paying agents to a Non-U.S. Holder if the holder has provided its federal taxpayer identification number, if any, or the required certification that it is not a U.S. person (which is generally provided by furnishing a properly-executed IRS Form W-8BEN), unless the payor otherwise has knowledge or reason to know that the payee is a U.S. person.
        Under current U.S. federal income tax law, information reporting and backup withholding will apply to the proceeds of a disposition of our common stock effected by or through a U.S. office of a broker unless the disposing holder certifies as to its non-U.S. status or otherwise establishes an exemption. Generally, U.S. information reporting and backup withholding will not apply to a
77

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

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

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

•
a foreign partnership (a) at least 50% of the capital or profits interest in which is owned by U.S. persons, or (b) that is engaged in a U.S. trade or business.
        Backup withholding will apply to a payment of disposition proceeds if the broker has actual knowledge that the holder is a U.S. person.
        Backup withholding is not an additional tax. Rather, the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund may be obtained, provided that the required information is furnished to the U.S. Internal Revenue Service.
Federal Estate Tax
        The estates of nonresident alien individuals are subject to U.S. federal estate tax on property with a U.S. situs. Because we are a U.S. corporation, our common stock will be the U.S. situs property and therefore will be included in the taxable estate of a nonresident alien decedent. This U.S. federal estate tax liability of the estate of a nonresident alien may be affected by a tax treaty between the United States and the decedent's country of residence.
         THE PRECEDING DISCUSSION OF U.S. FEDERAL TAX CONSIDERATIONS IS FOR GENERAL INFORMATION ONLY. IT IS NOT TAX ADVICE. EACH PROSPECTIVE HOLDER SHOULD CONSULT HIS, HER OR ITS OWN TAX ADVISOR REGARDING THE PARTICULAR U.S. FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES OF PURCHASING, HOLDING AND DISPOSING OF OUR COMMON STOCK.
78

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

Underwriters
	 	Number of Shares
	
Thomas Weisel Partners LLC	 	 	
Needham & Company, LLC	 	 	
WR Hambrecht + Co., LLC	 	 	
 	Total	 	 	
        The underwriting agreement provides that the obligations of the several underwriters are subject to various conditions, including approval of legal matters by counsel. The nature of the underwriters' obligations commits them to purchase and pay for all of the shares of common stock listed above if any are purchased.
        The underwriting agreement provides that we and the selling stockholders will indemnify the underwriters against liabilities specified in the underwriting agreement under the Securities Act, or will contribute to payments that the underwriters may be required to make relating to these liabilities.
        Thomas Weisel Partners LLC expects to deliver the shares of common stock to purchasers on or about                          , 2006.
Over-Allotment Option
        The selling stockholders have granted a 30-day over-allotment option to the underwriters to purchase up to a total of              additional shares of our common stock at the public offering price, less the underwriting discount, as set forth on the cover page of this prospectus. If the underwriters exercise this option in whole or in part, then each of the underwriters will be separately committed, subject to the conditions described in the underwriting agreement, to purchase the additional shares of our common stock from the selling stockholders in proportion to the underwriters' respective commitments set forth in the table above.
Determination of Offering Price
        Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined through negotiations between us and the representatives of the underwriters. In addition to prevailing market conditions, the factors to be considered in determining the initial public offering price will include:
•
the valuation multiples of publicly traded companies that the representatives believe are comparable to us;

•
our financial information;

•
our history and prospects and the outlook for our industry;

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

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

•
the above factors in relation to market values and various valuation measures of other companies engaged in activities similar to ours.
79

        We cannot assure you that an active or orderly trading market will develop for our common stock or that our common stock will trade in the public markets subsequent to this offering at or above the initial offering price.
Commissions and Discounts
        The underwriters propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus, and at this price less a concession not in excess of $                        per share of common stock to other dealers specified in a master agreement among underwriters who are members of the National Association of Securities Dealers, Inc. The underwriters may allow, and the other dealers specified may reallow, concessions not in excess of $                        per share of common stock to these other dealers. After this offering, the offering price, concessions and other selling terms may be changed by the underwriters. Our common stock is offered subject to receipt and acceptance by the underwriters and to the other conditions, including the right to reject orders in whole or in part.
        The following table summarizes the compensation to be paid to the underwriters by us and the proceeds, before expenses, payable to us and the selling stockholders:

 	 	 	 	Total
	
 	 	Per Share
	 	Without
Over-Allotment
	 	With
Over-Allotment
	
Public offering price	 	$	          	 	$	       	 	$	 	
Underwriting discount	 	 	 	 	 	 	 	 	 	
Proceeds, before expenses, to us	 	 	 	 	 	 	 	 	—	
Proceeds, before expenses, to the selling stockholders	 	 	 	 	 	—	 	 	 	
Indemnification of Underwriters
        We and the selling stockholders will indemnify the underwriters against some civil liabilities, including liabilities under the Securities Act and liabilities arising from breaches of our representations and warranties contained in the underwriting agreement. If we or the selling stockholders are unable to provide this indemnification, we and the selling stockholders will contribute to payments the underwriters may be required to make in respect of those liabilities.
No Sales of Similar Securities
        The underwriters will require all of our directors and officers and the selling stockholders to agree not to offer, sell, agree to sell, directly or indirectly, or otherwise dispose of any shares of common stock or any securities convertible into or exchangeable for shares of common stock except for the shares of common stock offered in this offering without the prior written consent of Thomas Weisel Partners LLC for a period of 180 days after the date of this prospectus. If (a) during the last 17 days of this 180-day period, we release earnings results or announce material news or a material event or (b) prior to the expiration of this 180-day period, we announce that we will release earnings results during the 15-day period following the last day of the 180-day period, then in either case the above restrictions will continue to apply until 18-days after the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Thomas Weisel Partners LLC waives, in writing, such extension.
        We have agreed that for a period of 180 days after the date of this prospectus, we will not, without the prior written consent of Thomas Weisel Partners LLC, offer, sell or otherwise dispose of any shares of common stock, except for the shares of common stock offered in this offering, the
80

shares of common stock issuable upon exercise of outstanding options on the date of this prospectus and the shares of our common stock that are issued under the Option Plans.
Nasdaq Global Market Listing
        After pricing of this offering, we expect that our common stock will be quoted on the Nasdaq Global Market under the symbol "NLST."
Short Sales, Stabilizing Transactions and Penalty Bids
        In order to facilitate this offering, persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of our common stock during and after this offering. Specifically, the underwriters may engage in the following activities in accordance with the rules of the Securities and Exchange Commission.
        Short sales.     Short sales involve the sales by the underwriters of a greater number of shares than they are required to purchase in the offering. Covered short sales are short sales made in an amount not greater than the underwriters' over-allotment option to purchase additional shares from the selling stockholders in this offering. The underwriters may close out any covered short position by either exercising their over-allotment option to purchase shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. Naked short sales are any short sales in excess of such over-allotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in this offering.
        Stabilizing transactions.     The underwriters may make bids for or purchases of the shares for the purpose of pegging, fixing or maintaining the price of the shares, so long as stabilizing bids do not exceed a specified maximum.
        Penalty bids.     If the underwriters purchase shares in the open market in a stabilizing transaction or syndicate covering transaction, they may reclaim a selling concession from the underwriters and selling group members who sold those shares as part of this offering. Stabilization and syndicate covering transactions may cause the price of the shares to be higher than it would be in the absence of these transactions. The imposition of a penalty bid might also have an effect on the price of the shares if it discourages presales of the shares.
        The transactions above may occur on the Nasdaq Global Market or otherwise. Neither we nor the underwriters make any representation or prediction as to the effect that the transactions described above may have on the price of the shares. If these transactions are commenced, they may be discontinued without notice at any time.
 
 LEGAL MATTERS
        Bingham McCutchen LLP, Orange County, California, will pass upon the validity of the issuance of the shares of our common stock offered by this prospectus. Latham & Watkins LLP, Menlo Park, California, will pass upon certain legal matters for the underwriters in connection with this offering.
81

 
 EXPERTS
        The consolidated financial statements included in this prospectus, and the related financial statement schedule included elsewhere in the registration statement, of Netlist, Inc. and subsidiaries as of December 31, 2004 and for each of the two years in the period ended December 31, 2004, have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their reports appearing herein and elsewhere in the registration statement, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing.
        The consolidated financial statements included in this prospectus, and the related financial statement schedule included elsewhere in the registration statement, of Netlist, Inc. and subsidiaries as of December 31, 2005 and for the year then ended, included in this prospectus, have been audited by Corbin & Company, LLP, an independent registered public accounting firm, as stated in their report appearing herein, and elsewhere in the registration statement, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.
 
 WHERE YOU CAN FIND ADDITIONAL INFORMATION
        We have filed with the Securities and Exchange Commission a registration statement on Form S-1, including exhibits, under the Securities Act with respect to the common stock to be sold in this offering. This prospectus, which constitutes a part of that registration statement, does not contain all of the information in that registration statement or the exhibits. Statements made in this prospectus regarding the contents of any contract, agreement or other document are only summaries. With respect to each contract, agreement or other document filed as an exhibit to the registration statement, we refer you to the exhibit for a more complete description of the matter involved. You may read and copy all or any portion of the registration statement or any reports, statements or other information filed with the Securities and Exchange Commission at the Securities and Exchange Commission's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.
        You can request copies of these documents upon payment of a duplicating fee by writing to the Securities and Exchange Commission. You may call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of its public reference room. Our filings, including the registration statement, will also be available to you on the web site maintained by the Securities and Exchange Commission at http://www.sec.gov.
        We intend to furnish our stockholders with annual reports containing consolidated financial statements audited by our independent auditors, and to make available to our stockholders quarterly reports for the first three quarters of each year containing unaudited interim consolidated financial statements.
82

 
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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

Consolidated Financial Statements	

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

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

 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Netlist, Inc.
        We have audited the accompanying consolidated balance sheet of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2005, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
        We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit on its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Netlist, Inc. and subsidiaries as of December 31, 2005, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

/s/   CORBIN & COMPANY, LLP     
Irvine, California
May 11, 2006	 	 	
F-2

 
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Netlist, Inc.
        We have audited the accompanying consolidated balance sheet of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2004, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
        We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Netlist, Inc. as of December 31, 2004, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
/s/   DELOITTE & TOUCHE LLP      
Costa Mesa, California
March 1, 2006
F-3

 
 NETLIST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except per share amounts)

 	 	December 31,
	 	 	 	
 			 	June 30,
2006
	 	
 	 	2004
	 	2005
			 	
 	 	 	 	 	 	(unaudited)
	 	
ASSETS	 	 	 	 	 	 	 	 	 	 	
Current assets:	 	 	 	 	 	 	 	 	 	 	
 	Cash and cash equivalents	 	$	759	 	$	953	 	$	27	 	
 	Accounts receivable, net of allowance for sales returns and doubtful accounts of $232 (2004), $109 (2005) and $432 (2006) (unaudited), respectively	 	 	8,813	 	 	13,140	 	 	20,274	 	
 	Inventories	 	 	7,342	 	 	6,816	 	 	9,420	 	
 	Income taxes receivable	 	 	493	 	 	259	 	 	—	 	
 	Deferred taxes	 	 	729	 	 	902	 	 	1,551	 	
 	Prepaid expenses and other current assets	 	 	295	 	 	434	 	 	225	 	
 	 		 		 		 	
 	 	Total current assets	 	 	18,431	 	 	22,504	 	 	31,497	 	
Property and equipment, net	 	 	3,372	 	 	2,437	 	 	2,229	 	
Deferred taxes	 	 	250	 	 	759	 	 	654	 	
Other assets	 	 	57	 	 	142	 	 	136	 	
 	 		 		 		 	
 	 	Total assets	 	$	22,110	 	$	25,842	 	$	34,516	 	

LIABILITIES AND STOCKHOLDERS' EQUITY	

 	

 	

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

 
 NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(in thousands, except per share amounts)

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

Net sales	
 	
$	
100,375	
 	
$	
143,659	
 	
$	
79,856	
 	
$	
36,495	
 	
$	
65,934	

Cost of sales(1)	

86,107	

133,503	

73,892	

34,319	

57,447	

Gross profit	

14,268	

10,156	

5,964	

2,176	

8,487	

Operating expenses:	

 	

 	

 	

 	

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

Total operating expenses	

26,977	

10,084	

8,023	

4,176	

5,425	

Operating income (loss)	

(12,709	
)	
 	
72	

(2,059	
)	
 	
(2,000	
)	
 	
3,062	

Other income (expense):	

 	

 	

 	

 	

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

Total other expense, net	

(879	
)	
 	
(1,386	
)	
 	
(1,200	
)	
 	
(483	
)	
 	
(944	
)	

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

(13,588	
)	
 	
(1,314	
)	
 	
(3,259	
)	
 	
(2,483	
)	
 	
2,118	

Provision (benefit) for income taxes	

2,317	

(340	
)	
 	
(912	
)	
 	
(695	
)	
 	
812	

Net income (loss)	
 	
$	
(15,905	
)	
$	
(974	
)	
$	
(2,347	
)	
$	
(1,788	
)	
$	
1,306	

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

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

 	Cost of sales	 	$	69	 	$	29	 	$	56	 	$	(9	)	$	14	
 	Research and development	 	 	9,733	 	 	80	 	 	(52	)	 	(22	)	 	22	
 	Selling, general and administrative	 	 	10,872	 	 	141	 	 	(65	)	 	(17	)	 	111	
See accompanying notes to consolidated financial statements.
F-5

 
 NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

(in thousands)

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

 
 NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)

 	 	Years Ended December 31,
	 	Six Months
Ended June 30,
	 	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	 	 	 	 	 	 	(unaudited)
	 	
Cash flows from operating activities:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Net income (loss)	 	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,306	 	
 	Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Depreciation and amortization	 	 	584	 	 	867	 	 	1,031	 	 	473	 	 	484	 	
 	 	Amortization of deferred gain on sale and leaseback transaction	 	 	—	 	 	—	 	 	—	 	 	—	 	 	(59	)	
 	 	Deferred income taxes	 	 	(345	)	 	218	 	 	(682	)	 	(164	)	 	(544	)	
 	 	Loss (gain) on disposal of assets	 	 	33	 	 	43	 	 	(11	)	 	—	 	 	15	 	
 	 	Stock-based compensation	 	 	20,674	 	 	250	 	 	(61	)	 	(48	)	 	147	 	
 	 	Interest on notes receivable from stockholders	 	 	(34	)	 	—	 	 	(1	)	 	—	 	 	—	 	
 	 	Forgiveness of notes receivable from stockholders	 	 	492	 	 	—	 	 	—	 	 	—	 	 	—	 	
 	 	Changes in operating assets and liabilities:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	Accounts receivable	 	 	(2,209	)	 	(3,570	)	 	(4,327	)	 	1,574	 	 	(7,134	)	
 	 	 	Inventories	 	 	(7,973	)	 	2,704	 	 	526	 	 	804	 	 	(2,604	)	
 	 	 	Income taxes receivable	 	 	—	 	 	(493	)	 	234	 	 	(533	)	 	259	 	
 	 	 	Prepaid expenses and other current assets	 	 	18	 	 	(116	)	 	99	 	 	(105	)	 	209	 	
 	 	 	Other assets	 	 	(38	)	 	(7	)	 	(85	)	 	(97	)	 	6	 	
 	 	 	Accounts payable	 	 	4,436	 	 	(3,032	)	 	921	 	 	566	 	 	4,598	 	
 	 	 	Income taxes payable	 	 	2,627	 	 	(2,634	)	 	—	 	 	—	 	 	894	 	
 	 	 	Accrued expenses and other current liabilities	 	 	1,299	 	 	177	 	 	95	 	 	(116	)	 	607	 	

Net cash provided by (used in) operating activities	

3,659	

(6,567	
)	
 	
(4,608	
)	
 	
566	

(1,816	
)	
 	 		 		 		 		 		 	
F-7

 
 	 	Years Ended December 31,
	 	Six Months
Ended June 30,
	 	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	 	 	 	 	 	 	(unaudited)
	 	
Cash flows from investing activities:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Acquisition of property and equipment	 	 	(2,019	)	 	(557	)	 	(484	)	 	(325	)	 	(336	)	
 	Proceeds from sale of equipment	 	 	—	 	 	61	 	 	19	 	 	—	 	 	45	 	
 	Restricted cash	 	 	504	 	 	—	 	 	—	 	 	—	 	 	—	 	
 	Proceeds from sale and leaseback of facility	 	 	—	 	 	—	 	 	1,797	 	 	—	 	 	—	 	

Net cash provided by (used in) investing activities	

(1,515	
)	
 	
(496	
)	
 	
1,332	

(325	
)	
 	
(291	
)	

Cash flows from financing activities:	

 	

 	

 	

 	

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

Net cash provided by (used in) financing activities	

(328	
)	
 	
5,915	

3,470	

(979	
)	
 	
1,181	

Net increase (decrease) in cash and cash equivalents	

1,816	

(1,148	
)	
 	
194	

(738	
)	
 	
(926	
)	

Cash and cash equivalents, beginning of period	

91	

1,907	

759	

759	

953	

Cash and cash equivalents, end of period	
 	
$	
1,907	
 	
$	
759	
 	
$	
953	
 	
$	
21	
 	
$	
27	

F-8

 
 	 	Years Ended December 31,
	 	Six Months
Ended June 30,
	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	
 	 	 	 	 	 	 	 	(unaudited)
	
Supplemental disclosure of cash flow information:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Cash paid during the period for:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Interest	 	$	794	 	$	1,061	 	$	1,169	 	$	523	 	$	897	
 	 		 		 		 		 		
 	 	Income taxes	 	$	34	 	$	3,400	 	$	2	 	$	—	 	$	—	

Supplemental disclosure of non-cash investing and financing activities:	

 	

 	

 	

 	

 	
 	Purchase of equipment through capitalized lease obligations	 	$	182	 	$	184	 	$	837	 	$	837	 	$	—	
 	 		 		 		 		 		
 	Purchase of insurance policies through notes payable	 	$	—	 	$	—	 	$	238	 	$	—	 	$	—	
 	 		 		 		 		 		
 	Deferred gain on sale and leaseback of facility	 	$	—	 	$	—	 	$	580	 	$	—	 	$	—	
 	 		 		 		 		 		
 	Estimated relative fair value of beneficial conversion feature on convertible note payable	 	$	—	 	$	—	 	$	—	 	$	—	 	$	50	
 	 		 		 		 		 		
See accompanying notes to consolidated financial statements.
F-9

 
 NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—DESCRIPTION OF BUSINESS
Description of Business
        Netlist, Inc. (the "Company") was incorporated on June 12, 2000 in Delaware. Netlist designs and manufactures high performance memory subsystems for the server, high performance computing and communications markets. The Company's solutions are targeted at applications where memory plays a key role in meeting system performance requirements.
NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
        The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Principles of Consolidation
        The consolidated financial statements include the accounts of Netlist, Inc. and its wholly owned subsidiaries, Netlist Holdings, GP, Inc., Netlist Holdings, LP, Inc., Netlist Technology Texas LP, and Netlist International. All intercompany balances and transactions have been eliminated in consolidation.
Interim Financial Information
        The interim financial information as of June 30, 2006 and for the six months ended June 30, 2006 and 2005 is unaudited and has been prepared on the same basis as the audited financial statements. In the opinion of management, such unaudited information includes all adjustments consisting only of normal recurring adjustments necessary for a fair presentation of the interim information. Operating results for the six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. All references to June 30, 2006 or to the six months ended June 30, 2005 and 2006 in the notes to the financial statements are unaudited.
Fiscal Year
        Effective January 1, 2003, the Company changed its fiscal year from a calendar year to a 52/53-week fiscal year ending on the Saturday closest to December 31. The 2003, 2004 and 2005 fiscal years ended on December 27, 2003, January 1, 2005 and December 31, 2005, respectively, and consisted of 52 weeks. For simplicity of presentation, the accompanying consolidated financial statements have been shown as ending on the last day of the calendar month.
Use of Estimates
        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management include, among others, provisions for uncollectible receivables and sales returns, valuation of inventories,
F-10

recoverability of long-lived assets and realization of deferred tax assets. Actual results could differ from these estimates.
Cash and Cash Equivalents
        Cash and cash equivalents consist of cash on hand and highly liquid investments purchased with original maturities of three months or less.
Fair Value of Financial Instruments
        The fair values of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate carrying values due to their short maturities. The fair value of the Company's debt instruments approximates their carrying values based on rates currently available to the Company.
Concentration of Credit Risk
        Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. The Company invests primarily in money market funds and high quality commercial paper instruments. Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. The Company's trade accounts receivable are primarily derived from sales to original equipment manufacturers ("OEMs") in the computer industry. The Company performs credit evaluations of its customers' financial condition and limits the amount of credit extended when deemed necessary but generally requires no collateral. The Company believes that the concentration of credit risk in its trade receivables is moderated by the Company's credit evaluation process, relatively short collection terms and the high level of credit worthiness of its customers.
Inventories
        Inventories are valued at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. At each balance sheet date, the Company evaluates its ending inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product type. Among other factors, the Company considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.
Property and Equipment
        Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which generally range from three to 40 years. Leasehold improvements are recorded at cost and amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term.
F-11

Impairment of Long-Lived Assets
        The Company evaluates long-lived assets held and used by the Company for impairment on an annual basis or whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. At December 31, 2005 and June 30, 2006 (unaudited), the Company's management believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company's products will continue, which could result in future impairment of long-lived assets.
Revenue Recognition
        The Company's revenues primarily consist of product sales of high performance memory subsystems to OEMs. Revenues also include sales of excess inventories to distributors and other users of memory ICs totaling approximately $20,412,000, $28,016,000, $19,127,000 during the years ended December 31, 2003, 2004 and 2005, respectively, and approximately $8,212,000 (unaudited) and $7,374,000 (unaudited) during the six months ended June 30, 2005 and 2006, respectively.
        The Company recognizes revenues in accordance with the Securities and Exchange Commission's Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition . Under the provisions of SAB No. 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Such conditions are typically met upon shipment and transfer of title for customers with FOB Shipping Point terms and upon receipt for customers with FOB Destination terms. Most of the Company's international shipments are made to third-party inventory warehouses, or hubs, and the Company recognizes revenue when the inventory is pulled from the hub for use in production by the customer. Customers are generally allowed limited rights of return for up to 30 days. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve.
        All amounts billed to customers related to shipping and handling are classified as revenues, while all costs incurred by the Company for shipping and handling are classified as cost of sales.
Warranties
        The Company offers warranties generally ranging from one to three years, depending on the product and negotiated terms of purchase agreements with its customers. Such warranties require the Company to repair or replace defective product returned to the Company during such warranty period at no cost to the customer. An estimate by the Company for warranty related costs is recorded by the Company at the time of sale based on its historical and estimated product return rates and expected repair or replacement costs. Such costs have historically been insignificant.
F-12

Beneficial Conversion Feature
        The convertible feature of one of the Company's convertible notes provides for a rate of conversion that is below market value (see Note 7). Such feature is normally characterized as a "beneficial conversion feature" ("BCF"). Pursuant to Emerging Issues Task Force ("EITF") Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratio and EITF No. 00-27 Application of EITF Issue No. 98-5 to Certain Convertible Instruments , the estimated relative fair value of the BCF has been recorded as a discount from the face amount of the convertible note. The Company is amortizing the discount using the effective interest method through maturity of such instrument.
Stock-Based Compensation
        The Company accounts for equity issuances to non-employees in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation , and EITF No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services . All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the third-party performance is complete or the date on which it is probable that performance will occur.
        Prior to January 1, 2006, the Company accounted for stock-based compensation issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees , and related pronouncements (see Note 12). Under this method, compensation expense was recognized over the respective vesting period based on the excess, on the date of grant, of the estimated fair value of the Company's common stock over the grant price, net of forfeitures. Deferred stock-based compensation expense was amortized on a straight-line basis over the vesting period of each grant. During the years ended December 31, 2003, 2004 and 2005, stock-based compensation expense, net of forfeitures, was approximately $20,674,000, $250,000 and $(61,000), respectively.
        Under SFAS No. 123, entities were required to recognize as expense over the vesting period the fair value of all stock-based awards on the date of the grant. Alternatively, SFAS No. 123 allowed entities to continue to apply the provisions of APB No. 25 and provide pro forma net income (loss) disclosures for employee stock option grants as if the fair value based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of APB No. 25 and provide pro forma disclosures required by SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure .
        Had compensation cost for the Company's stock-based awards to employees been determined based on the estimated fair value at the grant dates consistent with the fair value method of SFAS No. 123, the Company's net income (loss) for the years ended December 31, 2003, 2004 and 2005,
F-13

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

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

Net loss, as reported	
 	
$	
(15,905	
)	
$	
(974	
)	
$	
(2,347	
)	
$	
(1,788	
)	
Plus: stock-based employee compensation expense included in reported net loss, net of tax	 	 	20,115	 	 	185	 	 	(44	)	 	175	 	
Less: stock-based employee compensation expense determined under fair value based method, net of tax	 	 	(1,000	)	 	(470	)	 	354	 	 	(123	)	
 	 		 		 		 		 	
Pro forma net income (loss)	 	$	3,210	 	$	(1,259	)	$	(2,037	)	$	(1,736	)	
 	 		 		 		 		 	
Net income (loss) per common share as reported:	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Basic	 	$	(1.62	)	$	(0.09	)	$	(0.22	)	$	(0.17	)	
 	 		 		 		 		 	
 	Diluted	 	$	(1.62	)	$	(0.09	)	$	(0.22	)	$	(0.17	)	
 	 		 		 		 		 	
Pro forma:	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Basic	 	$	0.33	 	$	(0.12	)	$	(0.19	)	$	(0.16	)	
 	 		 		 		 		 	
 	Diluted	 	$	0.22	 	$	(0.12	)	$	(0.19	)	$	(0.16	)	
 	 		 		 		 		 	
        The fair value of options granted under the Company's equity incentive plan during the years ended December 31, 2003 and 2005, and the six months ended June 30, 2005 was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the single option approach using the following weighted-average assumptions:

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

Weighted-average risk-free rate	
 	
2.73%	
 	
n/a	
 	
4.13%	
 	
4.13%	
Expected term	 	10 years	 	n/a	 	10 years	 	10 years	
Expected stock volatility	 	80%	 	n/a	 	24%	 	24%	
Dividend yield	 	—	 	n/a	 	—	 	—	
        There were no options granted during 2004.
        Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payment , which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to
F-14

recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. SFAS No. 123(R) supersedes the Company's previous accounting under APB No. 25 for periods beginning in fiscal 2006. In March 2005, the SEC issued SAB No. 107, Share-Based Payment , relating to SFAS No. 123(R). The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).
        The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company's fiscal year 2006. The Company's consolidated financial statements as of and for the six months ended June 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, the Company's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).
        SFAS No. 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company's consolidated statement of operations. Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 as allowed under SFAS No. 123. Under this method, stock-based compensation expense had been recognized in the Company's consolidated statements of operations for option grants to employees and consultants below the fair market value of the underlying stock at the date of grant.
        Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company's consolidated statement of operations for the six months ended June 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As stock-based compensation expense recognized in the consolidated statement of operations for the six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the six months ended June 30, 2006 of approximately 8% was based on historical forfeiture experience and estimated future employee forfeitures. The estimated term of option grants for the six months ended June 30, 2006 was six years. In the Company's pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.
        Pursuant to SFAS No. 123(R), deferred stock-based compensation expense with a balance of $337,000 at December 31, 2005 was eliminated against additional paid-in capital upon the adoption of SFAS No. 123(R) on January 1, 2006. The deferred stock-based compensation expense was primarily related to stock awards granted to various employees and directors prior to the adoption of SFAS No. 123(R).
F-15

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

 	 	Six Months Ended
June 30, 2006
	 	
 	 	(unaudited)
	 	
Expected term	 	6 years	 	
Expected volatility	 	40	%	
Risk-free interest rate	 	4.50-5.00	%	
Expected dividends	 	—	 	
        A summary of option activity as of June 30, 2006 and changes during the six months then ended, is presented below (dollars and shares in thousands, except per share data):

 	 	Shares
	 	Weighted-
Average
Exercise
Price
	 	Weighted-
Average
Remaining
Contractual
Term
(Years)
	 	Aggregate
Intrinsic
Value
	
Options outstanding at January 1, 2006	 	2,190	 	$	1.26	 	 	 	 	 	
Options granted (unaudited)	 	258	 	$	2.55	 	 	 	 	 	
Options exercised (unaudited)	 	—	 	$	—	 	 	 	 	 	
Options forfeited (unaudited)	 	(193	)	$	1.82	 	 	 	 	 	
 	 		 		 	 	 	 	 	
Options outstanding at June 30, 2006 (unaudited)	 	2,255	 	$	1.35	 	7.26	 	$	12,641	
 	 		 		 		 		
Options exercisable at June 30, 2006 (unaudited)	 	1,310	 	$	0.77	 	4.15	 	$	8,107	
 	 		 		 		 		
        The weighted-average grant date fair value of options granted during the six months ended June 30, 2006 was $1.61 (unaudited) per option. The total intrinsic value of options exercised during the six months ended June 30, 2006 was zero (unaudited) as no options were exercised during the period.
F-16

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

 	 	Shares
	 	Weighted-
Average Grant
Date Fair Value
Per Share
	
Non-vested stock options at January 1, 2006	 	932	 	$	1.04	
Non-vested stock options granted (unaudited)	 	258	 	$	1.61	
Vested stock options (unaudited)	 	(118	)	$	1.08	
Forfeited/cancelled stock options (unaudited)	 	(127	)	$	2.63	
 	 		 		
Non-vested stock options at June 30, 2006 (unaudited)	 	945	 	$	1.03	
 	 		 		
        As of June 30, 2006, there was approximately $743,000 (unaudited) of total unrecognized compensation cost, net of estimated expected forfeitures, related to employee and director stock option compensation arrangements. That cost is expected to be recognized on a straight-line basis over the next 4 years. The total fair value of shares vested during the six months ended June 30, 2006 was approximately $138,000 (unaudited).
        As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company's income before provision for income taxes and net income for the six months ended June 30, 2006 were approximately $88,000 (unaudited) lower than if it had continued to account for share-based compensation under APB No. 25. Basic net income per share for the six months ended June 30, 2006 was approximately $0.01 (unaudited) lower than if the Company had continued to account for share-based compensation under APB No. 25. Diluted net income per share for the six months ended June 30, 2006 was not affected by the adoption of SFAS No. 123(R).
        The following table summarizes stock-based compensation expense related to employee and director stock options under SFAS No. 123(R) for the six months ended June 30, 2006, which was allocated as follows (in thousands):

 	 	Six Months Ended
June 30, 2006
	
 	 	(unaudited)
	
Stock-based compensation expense included in:	 	 	 	
 	Cost of sales	 	$	14	
 	Research and development	 	 	22	
 	Selling, general and administrative	 	 	102	
Income Taxes
        The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes . Under SFAS No. 109, deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at currently effective tax rates, of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the consolidated financial statements. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized.
F-17

Comprehensive Income (Loss)
        Comprehensive income (loss) includes all changes in stockholders' equity during a period from non-owner sources. For the years ended December 31, 2003, 2004, and 2005 and for the six months ended June 30, 2005 (unaudited) and 2006 (unaudited) there were no differences between the Company's net income (loss) and its comprehensive income (loss).
Net Income (Loss) Per Share
        Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average shares outstanding during the period. Diluted net income per share is calculated by dividing the net income (loss) by the weighted-average shares and dilutive potential shares outstanding during the period. Dilutive potential shares consist of dilutive shares issuable upon the exercise of outstanding stock options computed using the treasury stock method and shares issuable upon the conversion of notes payable using the "if converted" method. All potentially dilutive shares of approximately 5,071,000, 4,001,000, 3,632,000 and 3,449,000 (unaudited) during the years ended December 31, 2003, 2004 and 2005, and the six months ended June 30, 2005, respectively, have been excluded from diluted loss per share as their effect would be anti-dilutive for the periods then ended. Potentially dilutive shares of approximately 4,439,000 (unaudited) for the six months ended June 30, 2006 have been included in the diluted net income per share computation for the period then ended.
F-18

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

 	 	Years Ended December 31,
	 	Six Months Ended June 30,
	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	
 	 	 	 	 	 	 	 	(unaudited)
	
Basic income (loss) per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Net income (loss)	 	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,306	
 	 		 		 		 		 		
 	Weighted-average common shares outstanding, basic	 	 	9,831	 	 	10,671	 	 	10,673	 	 	10,672	 	 	10,988	
 	 		 		 		 		 		
 	Basic income (loss) per share	 	$	(1.62	)	$	(0.09	)	$	(0.22	)	$	(0.17	)	$	0.12	
 	 		 		 		 		 		
Diluted income (loss) per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Net income (loss)	 	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,306	
 	Convertible notes interest expense (net of tax)	 	 	—	 	 	—	 	 	—	 	 	—	 	 	141	
 	 		 		 		 		 		
 	Adjusted net income (loss) available to common stockholders	 	$	(15,905	)	$	(974	)	$	(2,347	)	$	(1,788	)	$	1,447	
 	 		 		 		 		 		
Weighted-average common shares outstanding, basic	 	 	9,831	 	 	10,671	 	 	10,673	 	 	10,672	 	 	10,988	
 	Effect of dilutive securities:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Stock options and warrants	 	 	—	 	 	—	 	 	—	 	 	—	 	 	1,968	
 	 	Convertible preferred stock	 	 	—	 	 	—	 	 	—	 	 	—	 	 	1,000	
 	 	Convertible notes payable	 	 	—	 	 	—	 	 	—	 	 	—	 	 	1,471	
 	 		 		 		 		 		
 	Weighted-average common shares outstanding, diluted	 	 	9,831	 	 	10,671	 	 	10,673	 	 	10,672	 	 	15,427	
 	 		 		 		 		 		
 	Diluted net income (loss) per share	 	$	(1.62	)	$	(0.09	)	$	(0.22	)	$	(0.17	)	$	0.09	
 	 		 		 		 		 		
New Accounting Pronouncements
        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 . SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 did not have a significant impact on the Company's consolidated financial condition or results of operations.
F-19

        In December 2004, the FASB issued SFAS No. 123(R). This statement requires companies to measure the cost of all employee stock-based compensation awards using a fair value method and to record such expense in its financial statements. The adoption of SFAS No. 123(R) also requires additional accounting and disclosures relating to the income tax and cash flow effects resulting from share-based payment arrangements. The Company adopted the provisions of SFAS No. 123(R) on January 1, 2006 using the modified prospective method. The impact of the adoption of SFAS No. 123(R) is described above.
        In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that the Company recognize in the financial statements the impact of tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The adoption of this statement is not expected to have a material impact on the Company's consolidated financial position or results of operations.
NOTE 3—INVENTORIES
        Inventories consist of the following (in thousands):

 	 	December 31,
	 	 	
 			 	June 30,
2006
	
 	 	2004
	 	2005
			
 	 	 	 	 	 	(unaudited)
	
Raw materials	 	$	4,115	 	$	2,551	 	$	4,231	
Work in process	 	 	1,345	 	 	1,027	 	 	1,771	
Finished goods	 	 	1,882	 	 	3,238	 	 	3,418	
 	 		 		 		
 	 	$	7,342	 	$	6,816	 	$	9,420	
 	 		 		 		
F-20

 
NOTE 4—PROPERTY AND EQUIPMENT
        Property and equipment consist of the following (dollars in thousands):

 	 	 	 	December 31,
	 	 	 	
 	 	Estimated Useful Lives
			 	June 30,
2006
	 	
 			 	2004
	 	2005
			 	
 	 	 	 	 	 	 	 	(unaudited)
	 	
Machinery and equipment	 	3-7 yrs.	 	$	2,608	 	$	3,595	 	$	3,529	 	
Land	 	—	 	 	600	 	 	—	 	 	—	 	
Buildings and improvements	 	40 yrs.	 	 	715	 	 	—	 	 	—	 	
Furniture and fixtures	 	5 yrs.	 	 	203	 	 	205	 	 	205	 	
Computer equipment and software	 	3-7 yrs.	 	 	944	 	 	1,241	 	 	1,400	 	
 	 	 	 		 		 		 	
 	 	 	 	 	5,070	 	 	5,041	 	 	5,134	 	
Less accumulated depreciation and amortization	 	 	 	 	(1,698	)	 	(2,604	)	 	(2,905	)	
 	 	 	 		 		 		 	
 	 	 	 	$	3,372	 	$	2,437	 	$	2,229	 	
 	 	 	 		 		 		 	
        Included in property and equipment are assets under capital leases with a cost of $1,764,000, $2,618,000 and $2,486,000 (unaudited) and accumulated amortization of $508,000, $896,000 and $1,046,000 (unaudited) at December 31, 2004 and 2005 and June 30, 2006, respectively.
NOTE 5—CREDIT AGREEMENT
        The Company has entered into an agreement (the "Credit Agreement"), as amended, with a bank which provides for a line of credit facility. As of December 31, 2005 and June 30, 2006, maximum borrowings were $15,000,000, limited to the sum of 85% of eligible accounts receivable, plus 31% of eligible inventories. Any borrowings are collateralized by a general first priority lien against all Company assets, both tangible and intangible, and the personal guarantees of three senior Company executives. Interest is payable monthly at the prime rate plus 0.50% in 2004 (5.75% at December 31, 2004) and in 2005 and 2006 at the prime rate plus 4.75% for eligible foreign accounts (12.00% and 13.00% at December 31, 2005 and June 30, 2006, respectively) and for all other advances at the prime rate plus 3.50% (10.75% and 11.75% at December 31, 2005 and June 30, 2006, respectively). Outstanding borrowings on this line of credit at December 31, 2004 and 2005 and June 30, 2006 were $5,443,000, $9,463,000 and $10,714,000 (unaudited), respectively. Borrowing availability under the line of credit was approximately $2,400,000 and $2,800,000 (unaudited) at December 31, 2005 and June 30, 2006, respectively.
        The Credit Agreement, as amended, contains certain restrictions and covenants. Under these restrictions and covenants, the Company must maintain certain levels of tangible net worth, achieve minimum monthly and quarterly profitability, and limit capital expenditures. The Company was not in compliance with certain covenants at December 31, 2005. Effective April 18, 2006, the Company executed the Fourth Amendment to Amended and Restated Credit and Security Agreement and Waiver of Defaults (the "Fourth Amendment"). The Fourth Amendment provides for, among other things, a waiver of noncompliance as of the dates above and added an additional requirement for the Company to consummate a private equity offering not later than March 31, 2007, with minimum net proceeds of $4,000,000. As of June 30, 2006, the Company was in compliance with all covenants.
F-21

        Subsequent to June 30, 2006, the Company further amended the Credit Agreement (see Note 16).
NOTE 6—LONG-TERM DEBT
        Long-term debt consists of the following (in thousands):

 	 	December 31,
	 	 	 	
 			 	June 30,
2006
	 	
 	 	2004
	 	2005
			 	
 	 	 	 	 	 	(unaudited)
	 	
Obligations under capital leases (see Note 9)	 	$	895	 	$	1,285	 	$	1,069	 	
Mortgage note payable to bank	 	 	965	 	 	—	 	 	—	 	
Notes payable to others	 	 	326	 	 	423	 	 	256	 	
 	 		 		 		 	
 	 	 	2,186	 	 	1,708	 	 	1,325	 	
Less current portion	 	 	(370	)	 	(720	)	 	(590	)	
 	 		 		 		 	
 	 	$	1,816	 	$	988	 	$	735	 	
 	 		 		 		 	
Mortgage Note Payable
        In November 2000, the Company obtained an SBA-backed 25-year mortgage note payable collateralized by its manufacturing facility in Irvine, California. This note bore interest at the prime rate plus 1.0% (6.25% at December 31, 2004), with principal and interest payments due monthly through 2025. In December 2005, the mortgage was paid in full in connection with the sale and leaseback transaction of the manufacturing facility (see Note 9).
Notes Payable to Others
        In November 2002, the Company entered into a $100,000 unsecured loan agreement with an individual, bearing interest at 7% payable annually, principal due, as amended, in June 2006. In January 2004, $4,000 of the principal amount was used to exercise certain stock options. The balance of this note was $96,000 at December 31, 2004 and 2005, and June 30, 2006. The note is currently due on demand.
        In January 2003, the Company entered into a $300,000 loan agreement with a financing company, collateralized by assets owned by an employee related to the majority stockholder. This note bears interest at 14% per annum and matures in January 2009. Principal and interest payments of approximately $6,000 are due and payable monthly. The balance of this note was $230,000, $185,000 and $160,000 (unaudited) at December 31, 2004 and 2005, and June 30, 2006, respectively.
        In August 2005, the Company entered into an agreement with a financing company in connection with financing certain insurance policies. The financing agreement required monthly principal and interest payments of approximately $25,000 through maturity on June 30, 2006. Interest was payable at 8.55% per annum. The outstanding principal balance on this financing was $142,000 at December 31, 2005. During the six months ended June 30, 2006, the balance was repaid in full (unaudited).
F-22

Capital Leases
        The Company has purchased manufacturing and computer equipment through the use of various capital leases. These leases require aggregate monthly payments of $49,360 and mature at various dates through May 2010. The interest rates on these leases vary between 4.3% and 10.4% (see Note 9).
        As of December 31, 2005, maturities of long-term debt were as follows (in thousands):

Years Ending
December 31,
	 	 	
2006	 	$	720	
2007	 	 	522	
2008	 	 	350	
2009	 	 	91	
2010	 	 	25	
 	 		
 	 	$	1,708	
 	 		
        Interest expense related to long-term debt was $156,000, $177,000, $250,000, $114,000 (unaudited) and $89,000 (unaudited) for the years ended December 31, 2003, 2004 and 2005 and for the six months ended June 30, 2005 and 2006, respectively.
NOTE 7—CONVERTIBLE NOTES PAYABLE
        In April 2001, the Company issued two convertible promissory notes, each in the original principal amount of $625,000, to Serim Paper Manufacturing Co., Ltd. ("Serim Paper") and HeungHwa Industries Co., Ltd. ("HeungHwa"), bearing interest at 7.50% per annum (collectively, the "$625,000 Notes"). In February 2003, the Company issued an additional $500,000 convertible note to Serim Paper, bearing interest at 6.50% per annum (the "$500,000 Note"). The $625,000 Notes and the $500,000 Note are guaranteed by the Company's majority stockholder and were originally convertible, at the option of the holder, into shares of a new series of preferred stock at a price equal to the lower of $2.50 per share or the per share fair market value of the new preferred stock. In the event of a public offering of the Company's common stock at a price in excess of the conversion price, the notes will automatically convert into shares of the Company's common stock at the conversion price.
        In October 2002 and April 2004, the Company exchanged the $625,000 Notes (or the applicable successor notes) for new notes with the same terms and new maturity dates. In August 2004, the Company exchanged the $500,000 Note (or the applicable successor note) for a new note with the same terms and a new maturity date. Effective October 2005, the Company exchanged the $625,000 Notes (or applicable successor notes) for new notes which provide for a conversion price of $1.667 per share (estimated fair value of the preferred stock at the effective date of exchange) with new maturity dates of April 3, 2007. Effective February 2006, the Company exchanged the $500,000 Note (or applicable successor note) for a new note which provides for a conversion price of $1.667 per share (estimated fair value of the preferred stock at the effective date of exchange) with a new maturity date of August 12, 2007.
F-23

        In December 2005, the Company issued $1,000,000 in secured convertible promissory notes (the "2005 Notes"), bearing interest at 9.96% per annum. The 2005 Notes are secured (subordinated to the Credit Agreement) by substantially all the Company's assets. The 2005 Notes are convertible, at the option of the holder, at any time after the earlier of (i) the maturity date or (ii) the consummation of a private placement offering of common stock of the Company with gross aggregate proceeds to the Company of at least $1,000,000, and prior to repayment or automatic conversion (see below). The 2005 Notes are convertible into shares of the Company's common stock at either the offering price in a private placement offering of the Company's common stock, or if no offering, at the fair value of a share of common stock as determined by the Company's Board of Directors. In the event of a merger transaction with a public company concurrent with a private placement offering with gross aggregate proceeds of at least $5,000,000, the outstanding principal and accrued but unpaid interest will automatically be converted into shares of the Company's common stock at a rate of 67.5% of the price per share at which such shares are sold in the private placement offering. In accordance with EITF No. 00-27, since the terms of the contingent conversion option do not permit the Company to compute the additional number of shares that it would need to issue upon conversion of the notes if the contingent event occurs and the conversion price is adjusted, the Company determined the value of the beneficial conversion feature as of the commitment date and will record the beneficial conversion amount as additional interest expense only if the contingent event occurs. The estimated value of the beneficial conversion feature at the commitment date was approximately $500,000.
        The 2005 Notes had an original maturity date of February 28, 2006. In March 2006, the note holders agreed to extend the maturity date to May 31, 2006. In June 2006, a note holder of $50,000 in principal agreed to extend the maturity date of its convertible note until August 31, 2006 and fix the conversion price of the note at $2.55 per share. In connection with the amendment of the $50,000 convertible note in June 2006, the Company recorded a BCF of $50,000 as a result of fixing the conversion price at a per share amount that was below the estimated fair value of the Company's common stock at the date of amendment. The BCF has been recorded as a discount from the face amount of the convertible note and will be amortized using the effective interest method through maturity of such instrument. During the six months ended June 30, 2006, amortization of the debt discount was insignificant.
        On August 4, 2006, the Company repaid the remaining $950,000 of outstanding principal on the 2005 Notes, including accrued and unpaid interest of $59,010 (unaudited) (see Note 16). As a result of the repayment, the Company will not be required to record any further beneficial conversion charge.
        As of December 31, 2005, maturities of convertible notes payable were as follows (in thousands):

Years Ending
December 31,
	 	 	
2006	 	$	1,000	
2007	 	 	1,750	
 	 		
 	 	$	2,750	
 	 		
F-24

 
NOTE 8—INCOME TAXES
        The Company's income tax provision (benefit) consists of the following (in thousands):

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	 	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	 	 	 	 	 	 	(unaudited)
	 	
Current:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Federal	 	$	1,974	 	$	(499	)	$	(232	)	$	(533	)	$	1,240	 	
 	State	 	 	688	 	 	(59	)	 	2	 	 	2	 	 	116	 	
 	 		 		 		 		 		 	
 	 	Total current	 	 	2,662	 	 	(558	)	 	(230	)	 	(531	)	 	1,356	 	
 	 		 		 		 		 		 	
Deferred:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Federal	 	 	(111	)	 	225	 	 	(319	)	 	96	 	 	(462	)	
 	State	 	 	(234	)	 	(7	)	 	(363	)	 	(260	)	 	(82	)	
 	 		 		 		 		 		 	
 	 	Total deferred	 	 	(345	)	 	218	 	 	(682	)	 	(164	)	 	(544	)	
 	 		 		 		 		 		 	
Income tax provision (benefit)	 	$	2,317	 	$	(340	)	$	(912	)	$	(695	)	$	812	 	
 	 		 		 		 		 		 	
        Deferred tax assets and liabilities are classified as current or noncurrent according to the classification of the related asset or liability. Significant components of the Company's deferred tax assets and liabilities are as follows at December 31 and June 30 (in thousands):

 	 	December 31,
	 	 	 	
 			 	June 30,
2006
	 	
 	 	2004
	 	2005
			 	
 	 	 	 	 	 	(unaudited)
	 	
Deferred tax assets:	 	 	 	 	 	 	 	 	 	 	
 	Reserves and allowances	 	$	784	 	$	1,046	 	$	1,425	 	
 	Other accruals	 	 	57	 	 	73	 	 	287	 	
 	Compensatory stock options and rights	 	 	481	 	 	503	 	 	409	 	
 	Tax credit carryforwards	 	 	132	 	 	249	 	 	342	 	
 	Deferred gain	 	 	—	 	 	241	 	 	221	 	
 	NOL carryforward	 	 	162	 	 	289	 	 	136	 	
 	 		 		 		 	
 	 	Total deferred tax assets	 	 	1,616	 	 	2,401	 	 	2,820	 	
 	 		 		 		 	
Deferred tax liabilities:	 	 	 	 	 	 	 	 	 	 	
 	State taxes, net of federal income tax benefit	 	 	(154	)	 	(278	)	 	(283	)	
 	Depreciation and amortization	 	 	(409	)	 	(304	)	 	(260	)	
 	Prepaid expenses	 	 	(74	)	 	(158	)	 	(72	)	
 	 		 		 		 	
 	 	Total deferred tax liabilities	 	 	(637	)	 	(740	)	 	(615	)	
 	 		 		 		 	
 	 	$	979	 	$	1,661	 	$	2,205	 	
 	 		 		 		 	
        The Company generated federal net operating losses ("NOL") of approximately $763,000 and $1,071,000 for the years ended December 31, 2005 and 2004, respectively. The federal NOL generated for December 31, 2005 will be carried back, and the federal NOL generated for December 31, 2004 has been carried back, to December 31, 2003 and fully utilized. In addition, the Company carried back approximately $125,000 of federal credits generated for the year ended
F-25

December 31, 2004 to the year ended December 31, 2003. At December 31, 2005, the Company had state net operating loss carryforwards of $3,854,000 which will begin to expire in 2013. In addition, the Company will carryforward approximately $249,000 of state credits. At June 30, 2006, the Company had state net operating loss carryforwards of $1,600,000 which will begin to expire in 2013. In addition, the Company will carryforward approximately $342,000 of state credits.
        A reconciliation of income taxes computed by applying the statutory U.S. income tax rate to the Company's income before income taxes to the income tax provision (benefit) is as follows:

 	 	Years Ended December 31,
	 	Six Months Ended
June 30,
	 	
 	 	2003
	 	2004
	 	2005
	 	2005
	 	2006
	 	
 	 	 	 	 	 	 	 	(unaudited)
	 	
U.S. federal statutory tax	 	(35	)%	(35	)%	(35	)%	(35	)%	35	%	
State taxes, net of federal effect	 	2	 	(4	)	(7	)	(7	)	1	 	
Research and development credits	 	(1	)	(10	)	—	 	—	 	—	 	
Benefit of lower tax rate	 	1	 	1	 	1	 	1	 	(1	)	
Stock-based compensation	 	49	 	7	 	—	 	—	 	2	 	
Loss from foreign subsidiary	 	—	 	14	 	11	 	13	 	1	 	
Other	 	1	 	1	 	3	 	—	 	—	 	
 	 		 		 		 		 		 	
Income tax provision (benefit)	 	17	%	(26	)%	(27	)%	(28	)%	38	%	
 	 		 		 		 		 		 	
NOTE 9—COMMITMENTS AND CONTINGENCIES
Leases
        The Company leases certain of its facilities under non-cancelable operating leases through November 2010. Rental expense for the years ended December 31, 2003, 2004 and 2005 and for the six months ended June 30, 2005 and 2006 totaled $145,000, $207,000, $343,000, $172,000 (unaudited) and $213,000 (unaudited), respectively. The Company also has capital leases for certain equipment.
        In December 2005, the Company sold the building containing its manufacturing facility and the related land in Irvine, California to an unrelated third party for gross proceeds of $1,900,000. Concurrent with the sale, the Company entered into an agreement to lease the property back at an initial monthly rent of $10,000, subject to annual rent increases of 3% through lease expiration in November 2010. The Company is accounting for the lease as an operating lease. In connection with the sale, the Company recognized a gain of $580,000 which was deferred and is being amortized into income ratably over the lease term. During the six months ended June 30, 2006, the Company amortized $59,000 (unaudited) of the gain which is recorded as a reduction of rent expense in the accompanying statement of operations.
F-26

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

Years Ending
December 31,
	 	Capital Leases
	 	Operating Leases
	
2006	 	$	544	 	$	216	
2007	 	 	534	 	 	173	
2008	 	 	308	 	 	128	
2009	 	 	96	 	 	132	
2010	 	 	33	 	 	124	
 	 		 		
Total minimum lease payments	 	$	1,515	 	$	773	
 	 	 	 	 		
Less amount representing interest	 	 	(230	)	 	 	
 	 		 	 	 	
Present value of future minimum lease payments (see Note 6)	 	$	1,285	 	 	 	
 	 		 	 	 	
Litigation
        The Company is subject to litigation in the ordinary course of business. The Company is not currently party to any pending litigation matters.
Other Contingent Obligations
        During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company's customers and licensees in connection with the use, sales and/or license of Company products; (ii) indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware; and (v) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company's use of the applicable premises. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments the Company could be obligated to make. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets.
        In February 2006, the Company's former Vice President of Finance (the "Former Officer") submitted his resignation. In order to secure the services of the Former Officer through an orderly transition of his responsibilities and in exchange for standard mutual releases of obligations, the Company entered into a severance agreement with the Former Officer. The agreement calls for the continuation of the Former Officer's salary through December 31, 2006. The Company will also reimburse the Former Officer for the cost of maintaining his prior medical insurance benefits
F-27

through the earlier of December 31, 2006 or the date on which he obtains medical coverage through a new employer. The total cost of the salary continuation and medical benefits to be provided under the agreement is approximately $149,000. Under terms of the agreement, the Former Officer is obligated to provide a specified minimum number of hours of service to the Company each month through the end of 2006. During the six months ended June 30, 2006, the Company paid $80,000 (unaudited) to the Former Officer in connection with the severance agreement.
NOTE 10—RELATED PARTY TRANSACTIONS
Loans to Employees for Stock
        In November 2000, the Company loaned $398,000 to two employees in connection with their purchases of shares of restricted stock. The original principal amount of each of these loans was $199,000, and both accrued interest at a rate of 7% annually. On December 31, 2003, the Company forgave the entire outstanding amount of $492,000, including both principal and accrued interest due. In addition, the Company granted each employee a cash bonus of $165,100, the amount equal to the anticipated tax liability incurred by both individuals as a result of the forgiveness of the respective loans.
        In February 2003, the Company loaned an employee $19,900 to exercise a portion of his then-vested common stock options. This full recourse note bears interest at a rate of 7% payable annually, and is due on February 17, 2008. As of December 31, 2005 and June 30, 2006 (unaudited), the amount of outstanding principal and accrued and unpaid interest on this note was approximately $23,000, and has been recorded as a reduction of stockholders' equity in the consolidated balance sheets.
        Interest income related to these loans amounted to approximately $34,000, $1,000, $1,000, $500 (unaudited) and $500 (unaudited) during the years ended December 31, 2003, 2004 and 2005 and the six months ended June 30, 2005 and 2006, respectively.
Loans From Employees
        In 2002, the Company entered into loan agreements with the majority stockholder and another employee to finance working capital needs. The loan from the majority stockholder accrued interest at a rate of 7% per annum, and the other employee note accrued interest at 15% per annum with all principal due in 2004. In December 2003, the Company repaid $100,000 due to the employee and offset the then outstanding balance of $168,000 due to the majority stockholder against outstanding balances advanced to the stockholder, as discussed below.
        Interest expense related to these notes amounted to $12,000 during the year ended December 31, 2003.
Advances to Employees
        The Company made advances in 2001 and 2002 to four employee stockholders, including the majority stockholder. These advances accrued interest at a rate of 7% per annum and were due on demand. In December 2003, the Company offset $168,000 of the advances to its majority stockholder against the two notes payable owed to him, as described above, reducing the net
F-28

amounts of his advances to $6,000. Subsequently, the Company forgave the entire remaining outstanding amounts of the advances to all four employees, totaling $203,000, and also granted the employees cash bonuses aggregating $162,000, which represent the anticipated tax liabilities to be incurred by each of these individuals in connection with the forgiveness of each of their advances.
        Interest income related to advances to employees amounted to $25,000 during the year ended December 31, 2003.
Guarantees by Executive Officers
        The Company's President, CEO and Chairman of the Board has personally guarantied the repayment of $1,750,000 in aggregate principal amount of outstanding convertible notes payable of the Company. In addition, the Company's President, CEO and Chairman of the Board, Vice President of Sales and Vice President of Engineering have each pesonally guarantied the repayment up to $1,000,000 of borrowings under the Credit Agreement. The guaranties of bank debt will terminate upon the completion of an initial public offering.
NOTE 11—STOCKHOLDERS' EQUITY
Sale of Restricted Stock
        During 2000, the Company sold 2,000,000 shares of common stock to two employees for $400,000, of which $398,000 of the purchase price was financed by the Company in the form of notes receivable, bearing interest at 7% per annum and due in 2005 but prepayable by the employees. The related shares issued were restricted and subject to repurchase by the Company at the purchase price until vested. The notes were deemed to be non-recourse for accounting purposes and the Company recognized compensation expense over the vesting period using variable accounting as prescribed under FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, as if the awards were stock options without a specific exercise price. As a result, related stock-based compensation expense fluctuated with changes in the fair market value of the Company's common stock. In December 2003, the notes receivable from the employees were forgiven and all shares were fully vested, at which time all remaining deferred compensation was expensed. In connection with these shares, the Company recognized stock-based compensation expense of $19,278,000 during fiscal 2003 based on the estimated fair market value of the Company's common stock on the date of forgiveness of $10.21, in addition to a charge of $492,000 related to the forgiveness of principal and interest on the notes (see Note 10).
Issuance of Common Stock for Option Exercises
        In 2003, options to purchase 100,000 shares of common stock were exercised for cash in the amount of $100 and a full recourse note receivable in the amount of $19,900, bearing interest at 7% per annum, with interest payable annually and principal due in 2008.
        In January 2004, options to purchase 20,000 shares of common stock were exercised by forgiving $4,000 of a $100,000 note due others (see Note 6) in lieu of cash payment for the exercise price. In addition, 1,667 common stock options were exercised for $333 in cash.
        In May 2005, options to purchase 1,667 shares of common stock were exercised for $3,251 cash.
F-29

        In March and April 2006, certain warrant holders exercised warrants to purchase 550,000 shares of common stock for $110,000 cash (unaudited).
Series A Convertible Preferred Stock ("Series A")
        The Series A stockholders are entitled to noncumulative dividends at the rate of $0.16 per share per annum, when, as and if declared by the Board of Directors, prior and in preference to the payment of any dividends on common stock. Shares of Series A are convertible, at the option of the holder, into shares of common stock, on a 1:1 basis. The conversion may occur at any time after issuance and is automatically adjusted for stock splits such that the value of the converted shares remains unchanged. Conversion is automatic immediately prior to the closing of a public offering of the Company's common stock, or at the election of the holders of a majority of the shares of Series A preferred stock. Holders of Series A are entitled to a liquidation preference, as defined, of $2.00 per share, plus any declared and unpaid dividends, prior to any distribution of assets to holders of common stock. Holders of Series A have full voting rights on an as-converted basis.
NOTE 12—STOCK OPTIONS AND WARRANTS
Common Stock Options
        In November 2000, the Company adopted the 2000 Equity Incentive Plan (the "2000 Plan"), under which direct stock awards or options to acquire shares of the Company's common stock may be granted to employees and nonemployees of the Company. The 2000 Plan is administered by the Board of Directors and permits the issuance of up to 5,500,000 shares of the Company's common stock. Options granted under the 2000 Plan vest over a rate of at least 20% per year over five years and expire 10 years from the date of grant. Shares of restricted common stock are issued upon exercise of vested options and are subject to repurchase by the Company, at its sole discretion, upon termination of service. If the termination is due to resignation or due to cause, the repurchase price will be the original exercise price of the option. If the termination is for any other reason, the repurchase price will be the estimated fair market value of a share of common stock at the date of the termination. Such restrictions and repurchase rights lapse upon a public offering of the Company's common stock. If an employee wishes to sell shares acquired through the exercise of stock options, the employee must first offer to sell the shares back to the Company at a price determined by the employee. The Company then has thirty days to accept the offer. Should the Company not accept the offer, the employee may sell the shares to a third party on terms no more favorable than offered to the Company. As of December 31, 2005, options to purchase 1,185,867 common shares were available for future grant under the 2000 Plan.
Warrants
        From time to time, the Company issues warrants to non-employees for services rendered or to be rendered in the future. Such warrants are issued outside of the 2000 Plan. As of December 31, 2005, there were warrants to purchase 910,000 shares of common stock outstanding which are fully vested and exercisable. The weighted-average exercise price of these warrants was $0.53 per share at December 31, 2005.
F-30

        A summary of changes in outstanding common stock options and warrants during the period from January 1, 2003 to December 31, 2005 is presented below (shares in thousands):

 	 	Total
Shares
	 	Weighted Average
Exercise Price
	
Outstanding—January 1, 2003	 	1,834	 	$	0.20	
 	Granted	 	1,076	 	$	1.48	
 	Exercised	 	(100	)	$	0.20	
 	Canceled	 	(60	)	$	0.20	

Outstanding—December 31, 2003	
 	
2,750	
 	
$	
0.70	
 	Granted	 	—	 	 	—	
 	Exercised	 	(22	)	$	0.20	
 	Canceled	 	(279	)	$	1.72	

Outstanding—December 31, 2004	
 	
2,449	
 	
$	
0.58	
 	Granted	 	866	 	$	2.55	
 	Exercised	 	(2	)	$	1.95	
 	Canceled	 	(213	)	$	1.98	

Outstanding—December 31, 2005	
 	
3,100	
 	
$	
1.04	
 	 		 	 	 	
        The following table summarizes information about stock options and warrants outstanding and exercisable at December 31, 2005 (shares in thousands):

 	 	Options/Warrants Outstanding
	 	Options/Warrants Exercisable
	
 	 	 	 	Weighted-
Average
Remaining
Life (Years)
	 	 			
Exercise
Price
	 	Number of
Shares
			 	Weighted-
Average
Price
	 	Number
of Shares
	 	Weighted-
Average
Price
	
$0.20	 	1,629	 	4	 	$	0.20	 	1,625	 	$	0.20	
$1.00	 	300	 	2	 	$	1.00	 	300	 	$	1.00	
$1.25	 	230	 	7	 	$	1.25	 	146	 	$	1.25	
$1.95	 	139	 	8	 	$	1.95	 	70	 	$	1.95	
$2.55	 	802	 	9	 	$	2.55	 	27	 	$	2.55	
 	 		 	 	 	 	 	 		 	 	 	
 	 	3,100	 	 	 	 	 	 	2,168	 	 	 	
 	 		 	 	 	 	 	 		 	 	 	
        During fiscal 2002, the Company issued options to purchase 1,035,000 shares of common stock to employees. Due to the difference between the exercise price and estimated fair value of common stock, $7,000 of deferred compensation expense was recorded that will be amortized to expense over the vesting period. The Company recognized compensation expense of $2,067, $400 and $400 during fiscal 2003, 2004 and 2005, respectively, related to these grants.
        During fiscal 2003, the Company issued options to purchase 696,500 shares of common stock to employees. Due to the difference between the exercise price and the estimated fair value of common stock, $2,931,000 of deferred compensation expense was recorded that will be amortized
F-31

to expense over the vesting period. During fiscal 2003, 2004 and 2005, the Company recognized compensation expense (net of forfeitures) of $349,000, $250,000 and ($64,000), related to these grants.
        During fiscal 2005, the Company issued options to purchase 831,000 shares of the Company's common stock to employees and directors. The options were granted at exercise prices which were equal to the estimated fair value of the common stock on the date of grant. Therefore, no stock-based compensation expense was recorded in the accompanying consolidated statement of operations.
        The Company has also granted stock options and warrants to non-employees for services. Options or warrants to purchase 380,000 shares of common stock were granted to non-employees in 2003. Stock-based compensation expense related to stock options granted to non-employees was recognized as services were rendered. As of December 31, 2003, all of such options and warrants were fully vested and no future services were required. In connection with the grant of stock options and warrants to non-employees, the Company recognized stock-based compensation expense of $1,044,000 during fiscal 2003.
        During 2005, the Company issued options to purchase 35,000 shares of the Company's common stock to non-employee consultants for services to be performed over a four year period. During the year ended December 31, 2005 and the six months ended June 30, 2006, the Company recognized consulting expense of $3,000 and $7,000 (unaudited), respectively, which is included in selling, general and administrative expenses.
        During the six months ended June 30, 2006, the Company granted warrants to purchase 22,500 shares of the Company's common stock to a consulting firm for services. The estimated fair value of the warrants at the date of issuance using the Black-Scholes pricing model was determined to be $11,700 and will be amortized to consulting expense over a four year vesting period. Consulting expense related to these warrants was $2,000 (unaudited) during the six months ended June 30, 2006 and is included in selling, general and administrative expenses.
        The weighted-average fair value of common stock options and warrants granted during the years ended December 31, 2003 and 2005 was $3.82 and $0.17, respectively. No common stock options or warrants were granted during 2004.
NOTE 13—401(k) PLAN
        The Company sponsors a 401(k) defined contribution plan. Employees are eligible to participate in this plan provided they are employed full-time and have reached 21 years of age. Participants may make pre-tax contributions to the plan subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions on the contributions and investment earnings. The Company may make matching contributions on the contributions of a participant on a discretionary basis. There were no Company contributions made during the three years in the period ended December 31, 2005 or the six months ended June 30, 2005 and 2006 (unaudited).
F-32

NOTE 14—MAJOR CUSTOMERS AND SUPPLIERS
        The Company's product sales have historically been concentrated in a small number of customers. The following table sets forth sales to customers comprising 10% or more of the Company's total revenues as follows:

 	 	Years Ended December 31,
	 	
 	 	2003
	 	2004
	 	2005
	 	
Customer:	 	 	 	 	 	 	 	
 	A	 	70	%	71	%	35	%	
 	B	 	—	 	—	 	13	%	
 	C	 	—	 	2	%	20	%	
 	 	Six Months Ended June 30,
	 	
 	 	2005
	 	2006
	 	
 	 	(unaudited)
	 	
Customer:	 	 	 	 	 	
 	A	 	46	%	33	%	
 	B	 	1	%	2	%	
 	C	 	22	%	46	%	
        The Company's accounts receivable are concentrated with three customers at December 31, 2004, representing 53%, 24% and 14%; and two customers at December 31, 2005, representing 39% and 17%; and one customer at June 30, 2006, representing 65% (unaudited) of aggregate gross receivables. A significant reduction in sales to, or the inability to collect receivables from, a significant customer could have a material adverse impact on the Company.
        The Company's purchases have historically been concentrated in a small number of suppliers. The following table sets forth purchases from suppliers comprising 10% or more of the Company's total purchases as follows:

 	 	Years Ended December 31,
	 	
 	 	2003
	 	2004
	 	2005
	 	
Supplier:	 	 	 	 	 	 	 	
 	A	 	54	%	33	%	37	%	
 	B	 	18	%	21	%	19	%	
 	C	 	—	 	13	%	11	%	
F-33

 
 	 	Six Months Ended June 30,
	 	
 	 	2005
	 	2006
	 	
 	 	(unaudited)
	 	
Supplier:	 	 	 	 	 	
 	A	 	8	%	21	%	
 	B	 	10	%	15	%	
 	C	 	43	%	11	%	
 	D	 	—	 	10	%	
        While the Company believes alternative suppliers could be utilized, any inability to obtain components or products in the amounts needed on a timely basis or at commercially reasonable prices could result in delays in product introductions, interruption in product shipments or increases in product costs, which could have a material adverse effect on the Company.
NOTE 15—SEGMENT AND GEOGRAPHIC INFORMATION
        The Company operates in one reportable segment: the design and manufacture of high-performance memory subsystems for the server, high-performance computing and communications markets. The Company evaluates financial performance on a Company-wide basis. All the Company's international sales relate to shipments of products to its U.S. customers' international manufacturing sites or third-party hubs and are denominated in U.S. dollars.
        As of December 31, 2005 and June 30, 2006 (unaudited), all long-lived assets are located in the United States.
NOTE 16—SUBSEQUENT EVENTS (UNAUDITED)
        Effective July 28, 2006, the Company executed the Fifth Amendment to Amended and Restated Credit and Security Agreement (the "Fifth Amendment"). The Fifth Amendment provides for, among other things, an increase in the maximum borrowings under the line of credit facility up to $25 million ($3 million of which may be in the form of letters of credit), limited to 85% of eligible accounts receivable, plus the least of (i) a percentage of eligible inventory determined from time to time by the Company's bank, (ii) 80% of the orderly liquidation value, as defined, of eligible inventories, and (iii) $7 million. Interest is payable monthly, at the Company's option, either at prime rate plus 0.50% or LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. The line of credit facility, as amended, matures on July 31, 2008.
        The Fifth Amendment also provides for a $2 million term loan to be funded in two advances as follows: (i) $1 million on the first business day following the effective date of the Fifth Amendment, and (ii) $1 million if, and only if, the Company's year to date net income at August 31, 2006 equals or exceeds $1,208,000. The term loan principal will be payable in equal monthly installments of $83,350 commencing on September 1, 2006. In addition, the Company will be required to make a principal reduction payment on the term loan in an amount equal to the lesser of (i) 10% of the Company's excess cash flow, as defined, for its year ending December 31, 2006, or (ii) $500,000. Interest will be payable monthly, at the Company's option, either at the prime rate plus 0.50% or
F-34

LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. The term loan, including all accrued and unpaid interest is due and payable on the earlier of (i) the closing of an initial public offering by the Company, or (ii) July 31, 2008.
        The Fifth Amendment also provides for equipment advances up to $2 million. Interest on the equipment advances is payable monthly, at the Company's option, either at the prime rate plus 0.50% or LIBOR plus 3%. The interest rate will be further reduced to the prime rate or LIBOR plus 2.50% concurrent with a capital raise by the Company with net proceeds of at least $15 million or achievement of annual net income of $2.5 million. Interest only payments are required on the equipment advances through January 31, 2007. Commencing February 1, 2007, the Company is required to repay the equipment advances in 42 equal monthly installments. The equipment advances, including all accrued and unpaid interest, are due on July 31, 2008.
        On August 4, 2006, the Company repaid outstanding principal of $950,000 on certain of the 2005 Notes, including accrued and unpaid interest of $59,010. The repayment was funded by proceeds from an advance on the $2 million term loan (see above).
        In August 2006, the compensation committee of the Company's board of directors granted options to purchase 885,000 shares of common stock to certain of the Company's officers. Each of these options has an exercise price of $7.00 per share. The options granted to two officers vest quarterly over four years. The options granted to the other three officers vest upon the termination of the two-year lock-up period included in agreements that they entered into with the Company in August 2006. In addition, the Company issued warrants to purchase 15,000 shares of the Company's common stock to a consulting firm for services. The warrants have an exercise price of $7.00 per share and vest at various rates over a four-year period. The warrants expire in ten years from date of issuance.
        In August 2006, the Company granted options to purchase 25,000 shares of the Company's common stock to an employee. The options have an exercise price of $7.00 per share and vest over a four-year period. The options expire in ten years from date of grant.
F-35

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

Neither we nor any of the underwriters have authorized anyone to provide information different from that contained in this prospectus. When you make a decision about whether to invest in our common stock, you should not rely upon any information other than the information in this prospectus. Neither the delivery of this prospectus nor the sale of our common stock means that information contained in this prospectus is correct after the date of this prospectus. This prospectus is not an offer to sell or solicitation of an offer to buy these shares of common stock in any circumstances in which the offer or solicitation is unlawful.
Through and including                           , 2006 (the 25 th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligations to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 
 PART II

INFORMATION NOT REQUIRED IN THE PROSPECTUS
  Item 13.    Other Expenses of Issuance and Distribution
        Expenses of the Registrant in connection with the issuance and distribution of the securities being registered, other than the underwriting discount and commissions, are estimated as follows:

Securities and Exchange Commission Registration Fee	 	$	6,152.50	
National Association of Securities Dealers Fees	 	$	6,250.00	
*Nasdaq Global Market Listing Fees	 	 	 	
*Printing and Engraving Expenses	 	 	 	
*Legal Fees and Expenses	 	 	 	
*Accountant's Fees and Expenses	 	 	 	
*Expenses of Qualification Under State Securities Laws, including Attorneys' Fees	 	 	 	
*Transfer Agent and Registrar's Fees	 	 	 	
*Miscellaneous Costs	 	 	 	
 	*Total	 	 	 	

*
To be provided by amendment.
 
 Item 14.    Indemnification of Directors and Officers
        Netlist, Inc. is incorporated under the laws of the State of Delaware. Section 145 of the Delaware General Corporation Law provides that a corporation may indemnify any persons who were, are or are threatened to be made, parties to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was an officer, director, employee or agent of such corporation, or is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise. The indemnity may include expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such person acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to, the corporation's best interests and, with respect to any criminal action or proceeding, had no reasonable cause to believe that his or her conduct was unlawful.
        Section 145 of the Delaware General Corporation Law further authorizes a corporation to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or enterprise, against any liability asserted against him or her and incurred by him or her in any such capacity, arising out of his or her status as such, whether or not the corporation would otherwise have the power to indemnify him or her under Section 145 of the Delaware Corporation Law.
        Netlist, Inc.'s current certificate of incorporation, as amended, eliminates the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liabilities arising (a) from any breach of the director's duty of loyalty to the corporation or its stockholders; (b) from acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (c) under Section 174 of the Delaware General Corporation Law; or (d) from any transaction from which the director derived an improper personal benefit. Our amended and restated certificate of incorporation, which we intend to file
II-1

prior to the completion of this offering, will provide for the same elimination of personal liability. In addition, the amended and restated bylaws we intend to adopt prior to the completion of this offering will provide for indemnification of directors, officers, employees and agents to the fullest extent permitted by Delaware law and authorize us to purchase and maintain insurance to protect itself and any director, officer, employee or agent of our company or another business entity against any expense, liability, or loss, regardless of whether we would have the power to indemnify such person under our bylaws or Delaware law.
        We have entered into indemnification agreements with each of our current directors and executive officers. These agreements will require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to us, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. We also intend to enter into indemnification agreements with our future directors and executive officers.
 
 Item 15.    Recent Sales of Unregistered Securities
        We have issued and sold the following unregistered securities since the beginning of fiscal year 2003:
        Between December 30, 2002 and June 30, 2006, we granted options to purchase 1,840,000 shares of our common stock at exercise prices ranging from $1.25 to $2.55 per share to employees, directors, consultants and advisors under our 2000 Equity Incentive Plan. In August 2006, we granted options to purchase 910,000 shares of our common stock to members of our management, and 50,000 shares of our common stock to non-employee directors, each at an exercise price of $7.00 per share under our 2000 Equity Incentive Plan.
        In April 2001, we issued and sold two promissory notes convertible into shares of our common stock, each in the original principal amount of $625,000, to Serim Paper Manufacturing Co., Ltd. and HeungHwa Industries Co., Ltd. In October 2002 and April 2004, we exchanged these two notes (or the applicable successor notes) for new notes of like tenor. In October 2005, we exchanged the applicable successor notes for new notes of like tenor with an extended maturity date and a change in conversion price from $2.50 to $1.67. In April 2001 we issued warrants for the purchase of an aggregate of 550,000 shares of our common stock, each at a strike price of $0.20 per share, to seven individuals related to Serim Paper and HeungHwa. All of these warrants were exercised in full in 2006.
        In January 2003, we issued a warrant to purchase 60,000 shares of our common stock at an exercise price of $1.25 per share to Logic One Sales, Inc., as partial compensation for services provided to us by Logic One as one of our manufacturer's representatives. This warrant expires in January 2013.
        In February 2003, we issued a promissory note convertible into shares of our common stock to Serim Paper in the original principal amount of $500,000. In August 2004, we exchanged this note for a new note of like tenor. In February 2006, we exchanged the applicable successor note for new notes of like tenor with an extended maturity date and a change in conversion price from $2.50 to $1.67. In February 2003, we issued warrants for the purchase of an aggregate of 300,000 shares of our common stock, each at a strike price of $1.00 per share, to three individuals related to Serim Paper.
        In December 2005, we issued promissory notes convertible into shares of our common stock to six accredited investors in the aggregate principal amount of $1,000,000. In August 2006, we used $1 million in proceeds of our term loan to repay $950,000 in principal amount, and unpaid interest, on these convertible promissory notes.
II-2

        In May 2006, we issued a warrant to purchase 22,500 shares of our common stock at an exercise price of $2.55 per share to Tatum, LLC, as partial consideration for services provided to us by Tatum, LLC in connection with the hiring of our Vice President and Chief Financial Officer, Lee Kim. This warrant has a 10-year term. The warrant becomes exercisable with respect to 5,625 of the underlying shares on May 3, 2007, and an additional 468 of the underlying shares become available for exercise on each month thereafter, such that on May 3, 2010, all 22,500 shares underlying this warrant will be available for exercise.
        In August 2006, we issued a warrant to purchase 15,000 shares of our common stock at an exercise price of $7.00 per share to Tatum, LLC in connection with a grant of options to Lee Kim pursuant to an agreement between Tatum, LLC and us. This warrant has a 10-year term and vests in equal quarterly installments such that in August 2010 this warrant will be exercisable for all 15,000 underlying shares.
        The issuances of the securities in the transactions described above were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering, where the purchasers represented their intention to acquire the securities for investment only and not with a view to public distribution and received or had access to adequate information about us, or were deemed to be exempt from registration under the Securities Act under Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan or a written contract relating to compensation.
        Appropriate legends were affixed to the stock certificates and warrants issued in the above transactions. Similar legends were imposed in connection with any subsequent exercises, as applicable, of any of the securities described above. No underwriters were employed in any of the transactions described above.
 
 Item 16.    Exhibits and Financial Statement Schedules
(a)
Exhibits

1.1	 	Underwriting Agreement, dated as of                      , 2006, among Netlist, Inc. and                          .*	
3.1	 	Restated Certificate of Incorporation of Netlist, Inc. (to be adopted and filed in connection with the offering contemplated by this registration statement).*	
3.2	 	Amended and Restated Bylaws of Netlist, Inc. (to be adopted in connection with the offering contemplated by this registration statement).*	
5.1	 	Opinion of Bingham McCutchen LLP.*	
10.1	 	Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, among Netlist, Inc., Netlist Technology Texas, L.P. ("Netlist Texas"), and Wells Fargo Business Credit, Inc. ("Wells Fargo").	
10.2	 	First Amendment to Amended and Restated Credit and Security Agreement, dated as of June 30, 2004, among Netlist, Inc., Netlist Texas and Wells Fargo.	
10.3	 	Second Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of December 20, 2005, among Netlist, Inc., Netlist Texas and Wells Fargo.	
10.4	 	Third Amendment to Amended and Restated Credit and Security Agreement, dated as of February 14, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.	
10.5	 	Fourth Amendment to Amended and Restated Credit and Security Agreement and Waiver of Defaults, dated as of April 18, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.	

II-3

 
10.6	 	Fifth Amendment to Amended and Restated Credit and Security Agreement, dated as of July 28, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.	
10.7	 	Amended and Restated 2000 Equity Incentive Plan of Netlist, Inc.*	
10.8	 	Letter agreement regarding employment, dated January 11, 2006, between Netlist, Inc. and Lee Kim.	
10.9	 	Full-time Permanent Engagement Resources Agreement, dated as of January 10, 2006, between Netlist, Inc. and Tatum, LLC.	
10.10	 	Master Sales and Supply Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.	
10.11	 	Management Fee Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.	
10.12	 	Form of Indemnity Agreement for officers and directors.	
14.1	 	Code of Ethics (to be adopted in connection with the offering contemplated by this registration statement).*	
16.1	 	Letter regarding change in certifying accountant.	
21.1	 	Subsidiaries of Netlist, Inc.	
23.1	 	Consent of Corbin & Company, LLP.	
23.2	 	Consent of Deloitte & Touche LLP.	
23.3	 	Consent of Bingham McCutchen LLP (included in Exhibit 5.1).*	
24.1	 	Power of Attorney of Netlist, Inc. (included on the signature page in Part II hereof).	

*
To be filed by amendment.

(b)
Financial Statement Schedules
        The following financial statement schedule is included in this registration statement:

Reports of Independent Registered Public Accounting Firm on Financial Statement Schedule	 	S-1	

Schedule II - Valuation and Qualifying Accounts	
 	
S-3	
        All other schedules for which provision is made in the applicable accounting regulations of the Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the consolidated financial statements, and therefore have been omitted.
 
 Item 17.    Undertakings.
        Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, and controlling persons of the Registrant pursuant to the foregoing provisions described in Item 14 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate
II-4

jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.
        The undersigned registrant hereby undertakes:
        (1)   To provide to the Underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser.
        (2)   For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4), or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.
        (3)   For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
II-5

        Pursuant to the requirements of the Securities Act of 1933, as amended, Netlist, Inc. has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on this 18th day of August, 2006.

 	 	NETLIST, INC.	

 	
By:	
/s/   CHUN K. HONG       

Chun K. Hong
 President, Chief Executive Officer and
Chairman of the Board	
 
 POWER OF ATTORNEY
        Each person whose signature appears below constitutes and appoints Chun K. Hong and Lee Kim, jointly and severally, each in his own capacity, his true and lawful attorneys-in-fact, with full power of substitution, for him and his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such said attorneys-in-fact and agents with full power and authority to do so and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
        Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated:

Signature
	 	Title
	 	Date

 	

 	
 	
/s/   CHUN K. HONG       

Chun K. Hong	 	President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)	 	August 18, 2006	

/s/   LEE KIM       

Lee Kim	
 	
Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)	
 	
August 18, 2006	

/s/   NAM KI HONG       

Nam Ki Hong	
 	
Director	
 	
August 18, 2006	

/s/   THOMAS F. LAGATTA       

Thomas F. Lagatta	
 	
Director	
 	
August 18, 2006	

/s/   ALAN H. PORTNOY       

Alan H. Portnoy	
 	
Director	
 	
August 18, 2006	

/s/   DAVID M. RICKEY       

David M. Rickey	
 	
Director	
 	
August 18, 2006	

/s/   PRESTON ROMM       

Preston Romm	
 	
Director	
 	
August 18, 2006	
II-6

 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
of Netlist, Inc.
        We have audited the consolidated financial statements of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2005, and for the year then ended, and have issued our report thereon dated May 11, 2006 (appearing in the prospectus, which is part of this registration statement). Our audit also included the consolidated financial statement schedule listed in Item 16(b) of the accompanying index of this registration statement. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/   CORBIN & COMPANY, LLP      
Irvine, California
May 11, 2006
S-1

 
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Netlist, Inc.:
        We have audited the consolidated financial statements of Netlist, Inc. and subsidiaries (the "Company") as of December 31, 2004, and for each of the two years in the period ended December 31, 2004, and have issued our report thereon dated March 1, 2006 (appearing in the prospectus, which is part of this registration statement). Our audits also included the consolidated financial statement schedule listed in Item 16(b) of this registration statement. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/   DELOITTE & TOUCHE LLP     
Costa Mesa, California
March 1, 2006
S-2

 
 
 Netlist, Inc.

Schedule II Valuation and Qualifying Accounts (in thousands)

 	 	Balance At
Beginning of
Period
	 	Charged to
Cost and
Expenses
	 	(Deductions)
	 	Balance at
End of
Period
	
Allowance for sales returns and doubtful accounts:	 	 	 	 	 	 	 	 	 	 	 	 	
Year Ended December 31, 2003	 	$	61	 	$	452	 	$	(377	)	$	136	
Year Ended December 31, 2004	 	 	136	 	 	200	 	 	(104	)	 	232	
Year Ended December 31, 2005	 	$	232	 	$	19	 	$	(142	)	$	109	
S-3

QuickLinks
 TABLE OF CONTENTS
 PROSPECTUS SUMMARY
Netlist, Inc.
The Offering
 Summary Consolidated Financial Data
 RISK FACTORS
 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
USE OF PROCEEDS
DIVIDEND POLICY
 CAPITALIZATION
DILUTION
 SELECTED CONSOLIDATED FINANCIAL DATA
 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 BUSINESS
 MANAGEMENT
Summary Compensation Table
 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 PRINCIPAL AND SELLING STOCKHOLDERS
DESCRIPTION OF CAPITAL STOCK
 SHARES ELIGIBLE FOR FUTURE SALE
MATERIAL UNITED STATES FEDERAL TAX CONSIDERATIONS FOR NON-UNITED STATES HOLDERS
 UNDERWRITING
LEGAL MATTERS
EXPERTS
WHERE YOU CAN FIND ADDITIONAL INFORMATION
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 NETLIST, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except per share amounts)
 NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Operations (in thousands, except per share amounts)
 NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (in thousands)
 NETLIST, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands)
 NETLIST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
Item 14. Indemnification of Directors and Officers
Item 15. Recent Sales of Unregistered Securities
Item 16. Exhibits and Financial Statement Schedules
Item 17. Undertakings.
 POWER OF ATTORNEY
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Netlist, Inc. Schedule II Valuation and Qualifying Accounts (in thousands)
 
QuickLinks -- Click here to rapidly navigate through this document
Exhibit 10.1
EXECUTION COPY

  
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
AMONG
NETLIST, INC.
AND
NETLIST TECHNOLOGY TEXAS LP, AS BORROWERS
AND
WELLS FARGO BUSINESS CREDIT, INC.
AS LENDER
as of
December 27, 2003

 
 TABLE OF CONTENTS

 	 	 	 	 	Page
	
ARTICLE I    DEFINITIONS	 	1	
 	Section 1.1	 	Definitions	 	1	
 	Section 1.2	 	Other Definitional Terms; Rules of Interpretation	 	11	
ARTICLE II    AMOUNT AND TERMS OF THE CREDIT FACILITY	 	11	
 	Section 2.1	 	Revolving Advances	 	11	
 	Section 2.2	 	Procedures for Requesting Advances	 	11	
 	Section 2.3	 	Intentionally Omitted	 	12	
 	Section 2.4	 	Capital Adequacy; Funding Exceptions	 	12	
 	Section 2.5	 	Letters of Credit	 	13	
 	Section 2.6	 	Special Account	 	13	
 	Section 2.7	 	Payment of Amounts Drawn Under Letters of Credit; Obligation of Reimbursement	 	13	
 	Section 2.8	 	Obligations Absolute	 	14	
 	Section 2.9	 	Intentionally Omitted	 	14	
 	Section 2.10	 	Inventory Appraisals	 	14	
 	Section 2.11	 	Intentionally Omitted	 	15	
 	Section 2.12	 	Interest; Applicable Margin; Minimum Interest Charge; Default Interest; Participations; Clearance Days; Usury	 	15	
 	Section 2.13	 	Fees	 	16	
 	Section 2.14	 	Time for Interest Payments; Payment on Non-Banking Days; Computation of Interest and Fees	 	18	
 	Section 2.15	 	Lockbox; Collateral Account; Application of Payments	 	18	
 	Section 2.16	 	Voluntary Prepayment; Termination of the Credit Facility by the Borrowers	 	18	
 	Section 2.17	 	Mandatory Prepayment	 	19	
 	Section 2.18	 	Revolving Advances to Pay Obligations	 	19	
 	Section 2.19	 	Use of Proceeds	 	19	
 	Section 2.20	 	Liability Records	 	19	
ARTICLE III    SECURITY INTEREST; OCCUPANCY; SETOFF	 	19	
 	Section 3.1	 	Grant of Security Interest	 	19	
 	Section 3.2	 	Notification of Account Debtors and Other Obligors	 	19	
 	Section 3.3	 	Assignment of Insurance	 	19	
 	Section 3.4	 	Occupancy	 	20	
 	Section 3.5	 	License	 	20	
 	Section 3.6	 	Financing Statement	 	20	
 	Section 3.7	 	Setoff	 	21	
 	Section 3.8	 	Power of Attorney	 	21	
ARTICLE IV    CONDITIONS OF LENDING	 	22	
 	Section 4.1	 	Conditions Precedent to the Initial Advances and Letter of Credit	 	22	
 	Section 4.2	 	Conditions Precedent to All Advances and Letters of Credit	 	23	
ARTICLE V    REPRESENTATIONS AND WARRANTIES	 	23	
 	Section 5.1	 	Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number	 	23	
 	Section 5.2	 	Capitalization	 	24	
 	Section 5.3	 	Authorization of Borrowing; No Conflict as to Law or Agreements	 	24	
 	Section 5.4	 	Legal Agreements	 	24	
 	Section 5.5	 	Subsidiaries	 	24	

i

 
 	Section 5.6	 	Financial Condition; No Adverse Change	 	24	
 	Section 5.7	 	Litigation	 	25	
 	Section 5.8	 	Regulation U	 	25	
 	Section 5.9	 	Taxes	 	25	
 	Section 5.10	 	Titles and Liens	 	25	
 	Section 5.11	 	Intellectual Property Rights	 	25	
 	Section 5.12	 	Plans	 	26	
 	Section 5.13	 	Default	 	26	
 	Section 5.14	 	Environmental Matters	 	26	
 	Section 5.15	 	Submissions to Lender	 	27	
 	Section 5.16	 	Financing Statements	 	27	
 	Section 5.17	 	Rights to Payment	 	27	
 	Section 5.18	 	Eligible Accounts; Eligible Foreign Accounts	 	27	
 	Section 5.19	 	Eligible Inventory	 	27	
 	Section 5.20	 	Equipment	 	27	
 	Section 5.21	 	Fraudulent Transfer	 	27	
ARTICLE VI    COVENANTS	 	28	
 	Section 6.1	 	Reporting Requirements	 	28	
 	Section 6.2	 	Financial Covenants	 	31	
 	Section 6.3	 	Permitted Liens; Financing Statements	 	31	
 	Section 6.4	 	Indebtedness	 	32	
 	Section 6.5	 	Guaranties	 	32	
 	Section 6.6	 	Investments and Subsidiaries	 	32	
 	Section 6.7	 	Dividends and Distributions	 	33	
 	Section 6.8	 	Salaries	 	33	
 	Section 6.9	 	Intentionally Omitted	 	33	
 	Section 6.10	 	Books and Records; Inspection and Examination	 	33	
 	Section 6.11	 	Account Verification	 	33	
 	Section 6.12	 	Compliance with Laws	 	33	
 	Section 6.13	 	Payment of Taxes and Other Claims	 	33	
 	Section 6.14	 	Maintenance of Properties	 	34	
 	Section 6.15	 	Insurance	 	34	
 	Section 6.16	 	Preservation of Existence	 	34	
 	Section 6.17	 	Delivery of Instruments, etc	 	34	
 	Section 6.18	 	Sale or Transfer of Assets; Suspension of Business Operations	 	34	
 	Section 6.19	 	Consolidation and Merger; Asset Acquisitions	 	35	
 	Section 6.20	 	Sale and Leaseback	 	35	
 	Section 6.21	 	Restrictions on Nature of Business	 	35	
 	Section 6.22	 	Accounting	 	35	
 	Section 6.23	 	Discounts, etc	 	35	
 	Section 6.24	 	Plans	 	35	
 	Section 6.25	 	Place of Business	 	35	
 	Section 6.26	 	Change in Name, Trade Name, Trade Style or FEIN	 	35	
 	Section 6.27	 	Transactions With Affiliates	 	35	
 	Section 6.28	 	Performance by the Lender	 	35	
ARTICLE VII    EVENTS OF DEFAULT, RIGHTS AND REMEDIES	 	36	
 	Section 7.1	 	Events of Default	 	36	
 	Section 7.2	 	Rights and Remedies	 	39	
 	Section 7.3	 	Disclaimer of Warranties	 	40	
 	Section 7.4	 	Compliance With Laws	 	41	
 	 	 	 	 	 	
ii

 
 	Section 7.5	 	No Marshalling	 	41	
 	Section 7.6	 	Borrowers to Cooperate	 	41	
 	Section 7.7	 	Application of Proceeds	 	41	
 	Section 7.8	 	Remedies Cumulative	 	41	
 	Section 7.9	 	Lender Not Liable For The Collateral	 	41	
ARTICLE VIII    MISCELLANEOUS	 	41	
 	Section 8.1	 	No Waiver	 	41	
 	Section 8.2	 	Amendments, Etc	 	41	
 	Section 8.3	 	Addresses for Notices; Requests for Accounting	 	42	
 	Section 8.4	 	Intentionally Omitted	 	42	
 	Section 8.5	 	Further Documents	 	42	
 	Section 8.6	 	Costs and Expenses	 	42	
 	Section 8.7	 	Indemnity	 	42	
 	Section 8.8	 	Participants	 	43	
 	Section 8.9	 	Advertising and Promotion	 	43	
 	Section 8.10	 	Execution in Counterparts; Telefacsimile Execution	 	43	
 	Section 8.11	 	Retention of Borrowers' Records	 	43	
 	Section 8.12	 	Binding Effect; Assignment; Complete Agreement; Exchanging Information	 	43	
 	Section 8.13	 	Severability of Provisions	 	44	
 	Section 8.14	 	Revival and Reinstatement of Obligations	 	44	
 	Section 8.15	 	Headings	 	44	
 	Section 8.16	 	Governing Law; Jurisdiction, Venue; Waiver of Jury Trial	 	44	
ARTICLE IX    JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT	 	44	
 	Section 9.1	 	Joint and Several Liability	 	44	
 	Section 9.2	 	Primary Obligation; Waiver of Marshalling	 	45	
 	Section 9.3	 	Financial Condition of Borrowers	 	45	
 	Section 9.4	 	Continuing Liability	 	45	
 	Section 9.5	 	Additional Waivers	 	45	
 	Section 9.6	 	Settlement or Releases	 	47	
 	Section 9.7	 	No Election	 	48	
 	Section 9.8	 	Indefeasible Payment	 	48	
 	Section 9.9	 	Single Loan Account	 	48	
 	Section 9.10	 	Apportionment of Proceeds of Advances	 	48	
 	Section 9.11	 	Lender Held Harmless	 	49	
 	Section 9.12	 	Borrowers' Integrated Operations	 	49	
iii

 
 AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
Dated as of December 27, 2003
        NETLIST, INC., a Delaware corporation ("Netlist"), NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP"), and WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), are entering into this Agreement with reference to the following facts:
        WHEREAS, Netlist and the Lender previously entered into that certain Credit and Security Agreement, dated as of July 2, 2003, as amended by that certain First Amendment to Credit and Security Agreement, dated as of October 30, 2003, and a second amendment which is also entitled the First Amendment to Credit and Security Agreement, dated as of December 5, 2003 (as so amended, the "Prior Agreement").
        WHEREAS, Netlist has requested that its Subsidiary, NTTLP, be a co-borrower and the Lender has agreed with such request, subject to the terms and conditions of this Agreement.
        WHEREAS, the parties hereto hereby agree to enter into this Agreement in order to amend and restate in its entirety, and continue the Obligations incurred under, the Prior Agreement.
        NOW THEREFORE, the parties hereto hereby agree as follows:
 
 ARTICLE I

DEFINITIONS
        Section 1.1     Definitions.     For all purposes of this Agreement, except as otherwise expressly provided, the following terms shall have the meanings assigned to them in this Section or in the Section referenced after such term:
        "Account Debtor" means any Person who is or who may become obligated under, with respect to, or on account of, an Account, chattel paper, or a General Intangible.
        "Accounts" means all of each Borrower's now owned or hereafter acquired right, title, and interest with respect to "accounts" (as that term is defined in the UCC), and any and all supporting obligations in respect thereof.
        "Advance" means a Revolving Advance.
        "Affiliate" means, as applied to any Person, any other Person who, directly or indirectly, controls, is controlled by, or is under common control with, such Person. For purposes of this definition, "control" means the possession, directly or indirectly, of the power to direct the management and policies of a Person, whether through the ownership of stock, by contract, or otherwise; provided , however , that, in any event: (a) any Person which owns directly or indirectly 10% or more of the securities having ordinary voting power for the election of directors or other members of the governing body of a Person or 10% or more of the partnership or other ownership interests of a Person (other than as a limited partner of such Person) shall be deemed to control such Person, (b) each director (or comparable manager) of a Person shall be deemed to be an Affiliate of such Person, and (c) each partnership or joint venture in which a Person is a partner or joint venturer shall be deemed to be an Affiliate of such Person.
        "Agreement" means this Amended and Restated Credit and Security Agreement.
        "Applicable Margin" means fifty (50) basis points; provided that (1) if the condition(s) described in the table below are fulfilled to the satisfaction of the Lender, and (2) if no Default Period is then
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continuing, then the Applicable Margin shall mean the margin set forth in the table below opposite the applicable condition, effective the first day of the month following the fulfillment of such condition:

Condition
	 	Applicable Margin
	
Receipt of Netlist's 12/31/03 audited financial statements evidencing Net Income during such fiscal year of not less than $2,500,000	 	Twenty-five (25) basis points	
Receipt of Netlist's 12/31/04 audited and consolidated financial statements evidencing Net Income during such fiscal year of not less than $2,500,000	 	Zero (0) basis points	
        "Approved Buyer" means an Account Debtor under an Eligible Foreign Account that is (i) not located in a country that is unacceptable to the Lender in its sole discretion, and (ii) otherwise acceptable to the Lender in its sole discretion. Unacceptable countries are determined by the Lender from time to time, in its sole discretion. As of September 30, 2003, the unacceptable countries are listed on Schedule 1 attached hereto.
        "Availability" means the difference of (i) the Borrowing Base and (ii) the sum of (A) the outstanding principal balance of the Revolving Note and (B) the L/C Amount.
        "Banking Day" means a day on which the Federal Reserve Bank of New York is open for Business.
        "Bankruptcy Code" means the United States Bankruptcy Code, as in effect from time to time.
        "Base Rate" means the rate of interest publicly announced from time to time by Wells Fargo Bank National Association at its principal office in San Francisco as its "prime rate", with the understanding that the "prime rate" is one of Wells Fargo's base rates (not necessarily the lowest of such rates) and serves as the basis upon which effective rates of interest are calculated for loans making reference thereto.
        "Book Net Worth" means the aggregate of the common and preferred stockholders' equity in the Borrowers, prepared on a consolidating and consolidated basis including any Subsidiaries, determined in accordance with GAAP.
        "Borrowers" means Netlist and NTTLP (each, a "Borrower").
        "Borrowing Base" means at any time the lesser of:
        (a)   the Maximum Line; or
        (b)   the sum of following:
          (i)  85% of Eligible Accounts less the amount, if any, of the Dilution Reserve; plus
         (ii)  30 days following the Lender's receipt of the FREP Activation Notice, the lesser of (A) 85% of Eligible Foreign Accounts, or (B) $1,500,000, less the amount, if any, of the Dilution Reserve; plus
        (iii)  the lowest of (A) the Inventory Advance Rate times the Eligible Inventory, or (B) $5,000,000, or (C) 50% of Eligible Accounts; provided, however, that Advances against Eligible Inventory shall not be available until completion of an appraisal of the Inventory conducted by the Lender, or the Lender's representative. The Borrower shall provide the Lender with not less than 60 days' prior written notice of the Borrower's request to have the Inventory appraised for purposes hereof.
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        Notwithstanding the foregoing, the Lender may reduce the advance rates or create additional reserves against the Eligible Accounts, the Eligible Foreign Accounts and/or the Eligible Inventory, in its sole and absolute discretion, without declaring an Event of Default if it reasonably determines that there has occurred a Material Adverse Effect.
        "Capital Expenditures" means for a period, any expenditure of money during such period for the purchase or construction of assets, or for improvements or additions thereto, which are capitalized on the Borrowers' balance sheet.
        "Change of Control" means the occurrence of any of the following events:
        (a)   any Person or "group" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934) is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Securities Exchange Act of 1934, except that a Person will be deemed to have "beneficial ownership" of all securities that such Person has the right to acquire, whether such right is exercisable immediately or only after the passage of time), directly or indirectly, of more than ten percent of the voting power of all classes of voting stock of the Borrowers.
        (b)   During any consecutive two-year period, individuals who at the beginning of such period constituted the board of Directors of the Borrowers (together with any new Directors whose election to such board of Directors, or whose nomination for election by the owners of such Borrower, was approved by a vote of 66 2 / 3 % of the Directors then still in office who were either Directors at the beginning of such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority of the board of Directors of the Borrowers then in office.
        (c)   Chun "Chuck" K. Hong shall cease to actively manage the Borrowers' day-to-day business activities
        "Collateral" means all of each Borrower's Accounts, chattel paper, deposit accounts, documents, Equipment, General Intangibles, goods, instruments, Inventory, Investment Property, letter-of-credit rights, letters of credit, all sums on deposit in any Collateral Account, and any items in any Lockbox; together with (i) all substitutions and replacements for and products of any of the foregoing; (ii) in the case of all goods, all accessions; (iii) all accessories, attachments, parts, equipment and repairs now or hereafter attached or affixed to or used in connection with any goods; (iv) all warehouse receipts, bills of lading and other documents of title now or hereafter covering such goods; (v) all collateral subject to the Lien of any Security Document; (vi) any money, or other assets of either Borrower that now or hereafter come into the possession, custody, or control of the Lender; (vii) all sums on deposit in the Special Account; and (viii) proceeds of any and all of the foregoing.
        "Collateral Account" means the "Lender Account" as defined in the Lockbox and Collection Account Agreement.
        "Commitment" means the Lender's commitment to make Advances to, and to cause the Issuer to issue Letters of Credit for the account of, the Borrowers pursuant to Article II.
        "Constituent Documents" means with respect to any Person, as applicable, such Person's certificate of incorporation, articles of incorporation, by-laws, certificate of formation, articles of organization, limited liability company agreement, management agreement, operating agreement, shareholder agreement, partnership agreement or similar document or agreement governing such Person's existence, organization or management or concerning disposition of ownership interests of such Person or voting rights among such Person's owners.
        "Credit Facility" means the credit facility being made available to the Borrowers by the Lender under Article II.
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        "Daily Balance" means, with respect to each day during the term of this Agreement, the amount of an Obligation owed at the end of such day.
        "Default" means an event that, with giving of notice or passage of time or both, would constitute an Event of Default.
        "Default Period" means any period of time beginning on the day a Default or Event of Default occurs and ending on the date the Lender notifies the Borrower in writing that such Default or Event of Default has been cured or waived.
        "Default Rate" means an annual interest rate equal to three percent (3%) over the initial Floating Rate, which interest rate shall change when and as the Base Rate changes.
        "Dilution" means, as of any date of determination, a percentage, based upon the experience of the calendar year-to-date period ending on the date of determination, that is the result of dividing the Dollar amount of (a) bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts during such period, by (b) Borrower's sales during such period (excluding extraordinary items) plus the Dollar amount of clause (a).
        "Dilution Reserve" means, as of any date of determination, an amount sufficient to reduce the advance rate against Eligible Accounts and/or the Eligible Foreign Accounts by one percentage point for each percentage point by which Dilution is in excess of 4%.
        "Director" means a director if the Borrower is a corporation, a manager if the Borrower is a limited liability company, or a general partner if the Borrower is a partnership.
        "Dollars" or "$" means lawful currency of the United States of America.
        "ERISA" means the Employee Retirement Income Security Act of 1974.
        "ERISA Affiliate" means any trade or business (whether or not incorporated) that is a member of a group which includes the Borrowers and which is treated as a single employer under Section 414 of the IRC.
        "Eligible Accounts" means those Accounts created by either Borrower in the ordinary course of its business, that arise out of such Borrower's sale of goods or rendition of services, that comply with each of the representations and warranties respecting Eligible Accounts made by the Borrowers in the Loan Documents, and that are not excluded as ineligible by virtue of one or more of the criteria set forth below; provided , however , that such criteria may be fixed and revised from time to time by the Lender in the Lender's sole and absolute discretion to address the results of any audit performed by the Lender from time to time after the Closing Date. In determining the amount to be included, Eligible Accounts shall be calculated net of customer deposits and unapplied cash remitted to the Borrower. Eligible Accounts shall not include the following:
        (i)    That portion of Accounts unpaid 90 days or more after the invoice date;
        (ii)   That portion of Accounts that is disputed or subject to a claim of offset or a contra account;
        (iii)  That portion of Accounts not yet earned by the final delivery of goods or rendition of services, as applicable, by the Borrower to the customer, including progress billings;
        (iv)  Accounts constituting proceeds of copyrightable material unless such copyrightable material shall have been registered with the United States Copyright Office and shall be covered by a duly executed copyright security agreement, in form and substance satisfactory to the Lender, and filed in the United States Copyright Office;
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        (v)   Accounts owed by an Account Debtor that is not Solvent, the subject of an Insolvency Proceeding or has gone out of business;
        (vi)  Accounts owed by an Owner, Subsidiary, Affiliate, Officer or employee of the Borrower;
        (vii) Accounts not subject to a duly perfected security interest in the Lender's favor or which are subject to any Lien other than a Permitted Lien;
        (viii) That portion of Accounts that has been restructured, extended, amended or modified;
        (ix)  That portion of Accounts that constitutes advertising, finance charges, service charges or sales or excise taxes;
        (x)   Accounts owed by an Account Debtor (or an Affiliate of such Account Debtor), regardless of whether otherwise eligible, to the extent that the balance of such Accounts exceeds 15% of the aggregate amount of all Accounts (except in the case of Dell Computer Corporation (excluding Dell Computer-Ireland), in which case such percentage shall be 65% through June 30, 2004, and 50% thereafter);
        (xi)  Accounts owed by an Account Debtor (or an Affiliate of such Account Debtor), regardless of whether otherwise eligible, if 15% or more of the total amount due under Accounts from such Account Debtor is ineligible under clauses (i), (ii)or (x) above;
        (xii) Accounts arising in a transaction wherein goods are placed on consignment or are sold pursuant to a guaranteed sale, a sale or return, a sale on approval, a bill and hold, or any other terms by reason of which the payment by the Account Debtor may be conditional;
        (xiii) Accounts that are not payable in Dollars;
        (xiv) Accounts with respect to which the Account Debtor either (i) does not maintain its chief executive office in the United States, or (ii) is not organized under the laws of the United States or any state thereof, or (iii) is the government of any foreign country or sovereign state, or of any state, province, municipality, or other political subdivision thereof, or of any department, agency, public corporation, or other instrumentality thereof, unless (y) the Account is supported by an irrevocable letter of credit satisfactory to the Lender (as to form, substance, and issuer or domestic confirming bank) that has been delivered to Lender and is directly drawable by the Lender, or (z) the Account is covered by credit insurance in form, substance, and amount, and by an insurer, satisfactory to the Lender;
        (xv) Accounts with respect to which the Account Debtor is either (i) the United States or any department, agency, or instrumentality of the United States (exclusive, however, of Accounts with respect to which the Borrower has complied, to the reasonable satisfaction of the Lender, with the Assignment of Claims Act, 31 USC § 3727), or (ii) any state of the United States (exclusive, however, of (y) Accounts owed by any state that does not have a statutory counterpart to the Assignment of Claims Act, or (z) Accounts owed by any state that does have a statutory counterpart to the Assignment of Claims Act as to which the Borrower has complied to the Lender's satisfaction);
        (xvi) Accounts with respect to which the Account Debtor is located in the states of New Jersey, Minnesota, or West Virginia (or any other state that requires a creditor to file a business activity report or similar document in order to bring suit or otherwise enforce its remedies against such Account Debtor in the courts or through any judicial process of such state), unless the applicable Borrower has qualified to do business in New Jersey, Minnesota, West Virginia, or such other states, or has filed a business activities report with the applicable division of taxation, the department of revenue, or with such other state offices, as appropriate, for the then-current year, or is exempt from such filing requirement; and
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        (xvii) Accounts, or portions thereof, of poor quality credit or otherwise deemed ineligible by the Lender in its sole discretion.
        "Eligible Foreign Account" means an Account that would be an Eligible Account except that the Account Debtor either (i) does not maintain its chief executive office in the United States, or (ii) is not organized under the laws of the United States or any state thereof, or (iii) is the government of any foreign country or sovereign state, or of any state, province, municipality, or other political subdivision thereof, or of any department, agency, public corporation, or other instrumentality thereof, but excluding any Accounts having the following characteristics:
        (i)    Eligible Accounts more than 180 days past shipment date as shown on a bill of lading or airbill;
        (ii)   That portion of Eligible Accounts owed by any one Account Debtor that would permit Revolving Advances supported by such Account Debtor's Eligibility Accounts to exceed the following at any one time:
        (a)   $500,000 for Approved Buyers that are rated BBB-minus or better by Standard and Poors,
        (b)   $500,000 for Approved Buyers that are controlled by entities rated BBB-minus or better by Standard and Poors, and
        (c)   $300,000 for all other Approved Buyers,
        (iii)  Eligible Accounts denominated in any currency other than United States dollars, Canadian dollars, Swiss francs, Japanese yen, United Kingdom pounds sterling or European Euros;
        (iv)  Eligible Accounts with respect to which the Borrower has not instructed the Account Debtor to pay the Account to the Collateral Account or lockbox;
        (v)   Eligible Accounts that are not covered by the Lender's credit insurance policy; and
        (vi)  Eligible Accounts otherwise deemed unacceptable to the Lender in its sole discretion.
        "Eligible Inventory" means Inventory consisting of raw chips and first quality finished goods consisting of custom memory products held for sale in the ordinary course of either Borrower's business, that complies with each of the representations and warranties respecting Eligible Inventory made by the Borrowers in this Agreement and the Loan Documents, and that is not excluded as ineligible by virtue of the one or more of the criteria set forth below; provided , however , that such criteria may be fixed and revised from time to time by the Lender in the Lender's sole and absolute discretion to address the results of any audit or appraisal performed by the Lender from time to time after the Closing Date. In determining the amount to be so included, Inventory shall be valued at the lower of cost or market on a basis consistent with the Borrowers' historical accounting practices. The following shall not be included in Eligible Inventory:
        (i)    Inventory that is: in-transit; located at any warehouse, job site or other premises not approved by the Lender in writing; located outside of the states, or localities, as applicable, in which the Lender has filed financing statements to perfect a first priority security interest in such Inventory; covered by any negotiable or non-negotiable warehouse receipt, bill of lading or other document of title; on consignment from any Person; on consignment to any Person or subject to any bailment unless such consignee or bailee has executed an agreement with the Lender;
        (ii)   Supplies, packaging, maintenance parts or sample Inventory;
        (iii)  Work-in-process Inventory;
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        (iv)  Inventory that is damaged, obsolete, slow moving or not currently saleable in the normal course of the Borrowers' operations;
        (v)   Inventory that the applicable Borrower has returned, has attempted to return, is in the process of returning or intends to return to the vendor thereof;
        (vi)  Inventory that is perishable or live;
        (vii) Inventory manufactured by either Borrower pursuant to a license unless the applicable licensor has agreed in writing to permit the Lender to exercise its rights and remedies against such Inventory;
        (viii) Inventory that is not subject to a valid and perfected first priority Lien in favor of the Lender or is subject to any Lien other than a Permitted Lien;
        (ix)  Inventory the applicable Borrower does not have good, valid, and marketable title thereto; and
        (x)   Inventory otherwise deemed ineligible by the Lender in its sole discretion.
        "Environmental Law" means any federal, state, local or other governmental statute, regulation, law or ordinance dealing with the protection of human health and the environment.
        "Equipment" means all of each Borrower's equipment, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all present and future machinery, vehicles, furniture, fixtures, manufacturing equipment, shop equipment, office and recordkeeping equipment, parts, tools, supplies, and including specifically the goods described in any equipment schedule or list herewith or hereafter furnished to the Lender by either Borrower.
        "Event of Default" has the meaning specified in Section 7.1.
        "FEIN" means Federal Employer Identification Number.
        "Financial Covenants" means the covenants set forth in Section 6.2.
        "Floating Rate" means an annual interest rate equal to the sum of the Base Rate plus the Applicable Margin, which interest rate shall, in each case, change when and as the Base Rate changes.
        "FREP Activation Notice" means a written notice from the Borrowers to the Lender of the Borrowers' request to obtain Advances against Eligible Foreign Accounts pursuant to the terms and conditions of this Agreement.
        "Funding Date" has the meaning given in Section 2.1.
        "GAAP" means generally accepted accounting principles, applied on a basis consistent with the accounting practices applied in the financial statements described in Section 5.6.
        "General Intangibles" means all of each Borrower's general intangibles, as such term is defined in the UCC, whether now owned or hereafter acquired, including all present and future Intellectual Property Rights, customer or supplier lists and contracts, manuals, operating instructions, permits, franchises, the right to use such Borrower's name, and the goodwill of such Borrower's business.
        "General Partner" means Netlist Holdings GP, Inc., a Texas corporation.
        "Governmental Authority" means any federal, state, local, or other governmental or administrative body, instrumentality, department, or agency or any court, tribunal, administrative hearing body, arbitration panel, commission, or other similar dispute-resolving panel or body.
        "Guarantor(s)" means Chun K. Hong, Christopher Lopes, Jayesh Bhakta, the General Partner and the Limited Partner and any other Person now or hereafter guarantying the Obligations.
        "Guaranty" means each certain Continuing Guaranty by a Guarantor in favor of the Lender.
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         "Hazardous Substances" means pollutants, contaminants, hazardous substances, hazardous wastes, petroleum and fractions thereof, and all other chemicals, wastes, substances and materials listed in, regulated by or identified in any Environmental Law.
        "Indebtedness" means of a Person as of a given date, all items of indebtedness or liability which in accordance with GAAP would be included in determining total liabilities as shown on the liabilities side of a balance sheet for such Person and shall also include the aggregate payments required to be made by such Person at any time under any lease that is considered a capitalized lease under GAAP.
        "IRC" means the Internal Revenue Code of 1986.
        "Infringe" means when used with respect to Intellectual Property Rights means any infringement or other violation of Intellectual Property Rights.
        "Insolvency Proceeding" means any proceeding commenced by or against any Person under any provision of the Bankruptcy Code or under any other state or federal bankruptcy or insolvency law, assignments for the benefit of creditors, formal or informal moratoria, compositions, extensions generally with creditors, or proceedings seeking reorganization, arrangement, or other similar relief.
        "Intellectual Property Rights" means all actual or prospective rights arising in connection with any intellectual property or other proprietary rights, including all rights arising in connection with copyrights, patents, service marks, trade dress, trade secrets, trademarks, trade names or mask works.
        "Inventory" means all of each Borrower's inventory, as such term is defined in the UCC, whether now owned or hereafter acquired, whether consisting of whole goods, spare parts or components, supplies or materials, whether acquired, held or furnished for sale, for lease or under service contracts or for manufacture or processing, and wherever located.
        "Inventory Advance Rate" means the lesser of (i) seventy percent (70%) of the appraised orderly liquidation recovery rate for Inventory or (ii) forty percent (40%).
        "Investment Property" means all of each Borrower's investment property, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all securities, security entitlements, securities accounts, commodity contracts, commodity accounts, stocks, bonds, mutual fund shares, money market shares and U.S. Government securities.
        "Issuer" means the issuer of any Letter of Credit.
        "L/C Amount" means the sum of (i) the aggregate face amount of any issued and outstanding Letters of Credit and (ii) the unpaid amount of the Obligation of Reimbursement.
        "L/C Application" means an application and agreement for letters of credit in a form acceptable to the Issuer and the Lender.
        "Letter of Credit" has the meaning specified in Section 2.5.
        "Licensed Intellectual Property" has the meaning given in Section 5.11(c).
        "Lien" means any security interest, mortgage, deed of trust, pledge, lien, charge, encumbrance, title retention agreement or analogous instrument or device, including the interest of each lessor under any capitalized lease and the interest of any bondsman under any payment or performance bond, in, of or on any assets or properties of a Person, whether now owned or hereafter acquired and whether arising by agreement or operation of law.
        "Limited Partner" means Netlist Holdings LP, Inc., a Delaware corporation.
        "Loan Account" has the meaning given in Section 9.9.
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        "Loan Documents" means this Agreement, the Note, each Guaranty, the Security Documents, the Subordination Agreements and any L/C Application.
        "Lockbox" means as defined in the Lockbox and Collection Account Agreement.
        "Lockbox and Collection Account Agreement" means each Lockbox and Collection Account Agreement by and among Borrowers, Wells Fargo Bank, N.A., and the Lender.
        "Material Adverse Effect" means any of the following:
          (i)  a material adverse effect on the business, operations, results of operations, prospects, assets, liabilities or financial condition of either Borrower or any Guarantor;
         (ii)  a material adverse effect on the ability of either Borrower or any Guarantor to perform its obligations under the Loan Documents;
        (iii)  a material adverse effect on the ability of the Lender to enforce the Obligations or to realize the intended benefits of the Security Documents, including a material adverse effect on the validity or enforceability of any Loan Document or of any rights against any Guarantor, or on the status, existence, perfection, priority (subject to Permitted Liens) or enforceability of any Lien securing payment or performance of the Obligations; or
        (iv)  any claim against either Borrower or any Guarantor or threat of litigation which if determined adversely to such Borrower or such Guarantor would cause such Borrower or such Guarantor to be liable to pay an amount exceeding $100,000 or would be an event described in clauses (i), (ii) and (iii) above.
        "Maturity Date" means July 2, 2006.
        "Maximum Line" means $15,000,000, unless reduced pursuant to Section 2.16, in which case it means such lesser amount.
        "Minimum Interest Charge" has the meaning given in Section 2.12(c).
        "Multiemployer Plan" means a multiemployer plan (as defined in Section 4001(a)(3) of ERISA) to which the Borrower or any ERISA Affiliate contributes or is obligated to contribute.
        "Net Income" and "Net Loss" mean fiscal year-to-date after-tax net income, or loss, as applicable, prepared on a consolidating and consolidated basis to include any Subsidiaries, from continuing operations as determined in accordance with GAAP.
        "Note" means the Revolving Note.
        "Obligation of Reimbursement" has the meaning given in Section 2.7(a).
        "Obligations" means the Note, the Obligation of Reimbursement and each and every other debt, liability and obligation of every type and description which either Borrower may now or at any time hereafter owe to the Lender, whether such debt, liability or obligation now exists or is hereafter created or incurred, whether it arises in a transaction involving the Lender alone or in a transaction involving other creditors of the Borrower, and whether it is direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or sole, joint, several or joint and several, and including all indebtedness of either Borrower arising under any Credit Document or guaranty between either Borrower and the Lender, whether now in effect or hereafter entered into.
        "Officer" means with respect to either Borrower, an officer if such Borrower is a corporation, or a partner if such Borrower is a partnership.
        "Owned Intellectual Property" has the meaning given in Section 5.11(a).
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        "Owner" means with respect to each Borrower, each Person having legal or beneficial title to an ownership interest in such Borrower or a right to acquire such an interest.
        "Pension Plan" means a pension plan (as defined in Section 3(2) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate and covered by Title IV of ERISA.
        "Permitted Lien" has the meaning given in Section 6.3(a).
        "Person" means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof.
        "Plan" means an employee benefit plan (as defined in Section 3(3) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate.
        "Premises" means all premises where the Borrower conducts its business and has any rights of possession, including the premises legally described in Exhibit D attached hereto.
        "Reportable Event" means a reportable event (as defined in Section 4043 of ERISA), other than an event for which the 30-day notice requirement under ERISA has been waived in regulations issued by the Pension Benefit Guaranty Corporation.
        "Revolving Advance" has the meaning given in Section 2.1.
        "Revolving Note" means the Borrowers' second replacement revolving promissory note, payable to the order of the Lender in substantially the form of Exhibit A hereto.
        "Security Agreements" means (i) the Security Agreement, dated as of the date hereof, executed by the General Partner in the Lender's favor, (ii) the Security Agreement, dated as of the date hereof, executed by the Limited Partner in the Lender's favor, and (iii) any other security agreement accepted by the Lender from time to time.
        "Security Documents" means this Agreement, the Lockbox and Collection Account Agreement, the Security Agreements and any other document delivered to the Lender from time to time to secure the Obligations.
        "Security Interest" has the meaning given in Section 3.1.
        "Solvent" means, with respect to any Person on a particular date, that such Person is not insolvent (as such term is defined in the Uniform Fraudulent Transfer Act).
        "Special Account" means a specified cash collateral account maintained by a financial institution acceptable to the Lender in connection with Letters of Credit, as contemplated by Section 2.6.
        "Subordinated Indebtedness" has the meaning given to such term in either Subordination Agreement.
        "Subordination Agreements" means (i) the Subordination Agreement, dated as of July 2, 2003, executed by Serim Paper Manufacturing Co., Ltd. in the Lender's favor and acknowledged by Netlist, (ii) the Subordination Agreement, dated as of July 2, 2003, executed by HeungHwa Industry Co. Ltd. in the Lender's favor and acknowledged by Netlist, and (iii) any other subordination agreement accepted by the Lender from time to time.
        "Subsidiary" means any corporation of which more than 50% of the outstanding shares of capital stock having general voting power under ordinary circumstances to elect a majority of the board of Directors of such corporation, irrespective of whether or not at the time stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency, is at the time directly or indirectly owned by the Borrower, by the Borrower and one or more other Subsidiaries, or by one or more other Subsidiaries.
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        "Termination Date" means the earliest of (i) the Maturity Date, (ii) the date the Borrowers terminate the Credit Facility, or (iii) the date the Lender demands payment of the Obligations after an Event of Default pursuant to Section 7.2.
        "UCC" means the Uniform Commercial Code as in effect in the state designated in Section 8.15 as the state whose laws shall govern this Agreement, or in any other state whose laws are held to govern this Agreement or any portion hereof.
        Section 1.2     Other Definitional Terms; Rules of Interpretation.     The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. All accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. All terms defined in the UCC and not otherwise defined herein have the meanings assigned to them in the UCC. References to Articles, Sections, subsections, Exhibits, Schedules and the like, are to Articles, Sections and subsections of, or Exhibits or Schedules attached to, this Agreement unless otherwise expressly provided. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". Unless the context in which used herein otherwise clearly requires, "or" has the inclusive meaning represented by the phrase "and/or". Defined terms include in the singular number the plural and in the plural number the singular. Reference to any agreement (including the Loan Documents), document or instrument means such agreement, document or instrument as amended or modified and in effect from time to time in accordance with the terms thereof (and, if applicable, in accordance with the terms hereof and the other Loan Documents), except where otherwise explicitly provided, and reference to any promissory note includes any promissory note which is an extension or renewal thereof or a substitute or replacement therefor. Reference to any law, rule, regulation, order, decree, requirement, policy, guideline, directive or interpretation means as amended, modified, codified, replaced or reenacted, in whole or in part, and in effect on the determination date, including rules and regulations promulgated thereunder.
ARTICLE II
AMOUNT AND TERMS OF THE CREDIT FACILITY
        Section 2.1     Revolving Advances.     The Lender agrees, on the terms and subject to the conditions herein set forth, to make advances to the Borrowers from time to time from the date all of the conditions set forth in Section 4.1 are satisfied (the "Funding Date") to the Termination Date (the "Revolving Advances"). The Lender shall have no obligation to make a Revolving Advance to the extent the amount of the requested Revolving Advance exceeds Availability. The Borrowers' obligation to pay the Revolving Advances shall be evidenced by the Revolving Note and shall be secured by the Collateral. Within the limits set forth in this Section 2.1, the Borrowers may borrow, prepay pursuant to Section 2.16 and reborrow.
        Section 2.2     Procedures for Requesting Advances.     The Borrowers shall comply with the following procedures in requesting Revolving Advances:
        (a)     Time for Requests.     The Borrowers shall request each Advance not later than 10:00 a.m., Pacific time on the Banking Day which is the date the Advance is to be made. Each such request shall be effective upon receipt by the Lender, shall be in writing or by telephone, telecopy transmission or email, to be confirmed in writing by the Borrowers if so requested by the Lender, shall be by (i) an Officer of the Borrowers; or (ii) a person designated as the Borrowers' agent by an Officer of the Borrowers in a writing delivered to the Lender; or (iii) a person whom the Lender reasonably believes to be an Officer of the Borrowers or such a designated agent. The Borrowers shall repay all Advances even if the Lender does not receive such confirmation and even if the person requesting an Advance was not in fact authorized to do so. Any request for an
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Advance, whether written or telephonic, shall be deemed to be a representation by the Borrowers that the conditions set forth in Section 4.2 have been satisfied as of the time of the request.
        (b)     Disbursement.     Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall disburse the proceeds of the requested Advance by crediting the same to the Borrowers' demand deposit account maintained with Wells Fargo Bank, N.A., unless the Lender and the Borrowers shall agree in writing to another manner of disbursement.
        Section 2.3     Intentionally Omitted.     
        Section 2.4     Capital Adequacy; Funding Exceptions.     
        (a)   If the Lender determines at any time that its Return has been reduced as a result of any Rule Change, such Lender may so notify the Borrowers and require the Borrowers, beginning fifteen (15) days after such notice, to pay it the amount necessary to restore its Return to what it would have been had there been no Rule Change. For purposes of this Section 2.4:
          (i)  "Capital Adequacy Rule" means any law, rule, regulation, guideline, directive, requirement or request regarding capital adequacy, or the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency, whether or not having the force of law, that applies to any Related Lender, including rules requiring financial institutions to maintain total capital in amounts based upon percentages of outstanding loans, binding loan commitments and letters of credit.
         (ii)  "L/C Rule" means any law, rule, regulation, guideline, directive, requirement or request regarding letters of credit, or the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency, whether or not having the force of law, that applies to any Related Lender, including those that impose taxes, duties or other similar charges, or mandate reserves, special deposits or similar requirements against assets of, deposits with or for the account of, or credit extended by any Related Lender, on letters of credit.
        (iii)  "Related Lender" includes (but is not limited to) the Lender, any parent of the Lender, any assignee of any interest of the Lender hereunder and any participant in the Credit Facility.
        (iv)  "Return", for any period, means the percentage determined by dividing (i) the sum of interest and ongoing fees earned by the Lender under this Agreement during such period, by (ii) the average capital such Lender is required to maintain during such period as a result of its being a party to this Agreement, as determined by such Lender based upon its total capital requirements and a reasonable attribution formula that takes account of the Capital Adequacy Rules and L/C Rules then in effect, costs of issuing or maintaining any Advance or Letter of Credit and amounts received or receivable under this Agreement or the Notes with respect to any Advance or Letter of Credit. Return may be calculated for each calendar quarter and for the shorter period between the end of a calendar quarter and the date of termination in whole of this Agreement.
         (v)  "Rule Change" means any change in any Capital Adequacy Rule or L/C Rule occurring after the date of this Agreement, or any change in the interpretation or administration thereof by any governmental or regulatory authority, but the term does not include any changes that at the Funding Date are scheduled to take place under the existing Capital Adequacy Rules or L/C Rules or any increases in the capital that the Lender is required to maintain to the extent that the increases are required due to a regulatory authority's assessment of that Lender's financial condition.
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        (b)   The initial notice sent by the Lender shall be sent as promptly as practicable after such Lender learns that its Return has been reduced, shall include a demand for payment of the amount necessary to restore such Lender's Return for the quarter in which the notice is sent, and shall state in reasonable detail the cause for the reduction in its Return and its calculation of the amount of such reduction. Thereafter, such Lender may send a new notice during each calendar quarter setting forth the calculation of the reduced Return for that quarter and including a demand for payment of the amount necessary to restore its Return for that quarter. The Lender's calculation in any such notice shall be conclusive and binding absent demonstrable error.
        Section 2.5     Letters of Credit.     
        (a)   The Lender agrees, on the terms and subject to the conditions herein set forth, to cause an Issuer to issue, from the Funding Date to the Termination Date, one or more irrevocable standby or documentary letters of credit (each, a "Letter of Credit") for either Borrower's account by guaranteeing payment of such Borrower's obligations or being a co-applicant. The Lender shall have no obligation to cause an Issuer to issue any Letter of Credit if the face amount of the Letter of Credit to be issued would exceed the lesser of:
          (i)  $500,000 less the L/C Amount, or
         (ii)  Availability.
Each Letter of Credit, if any, shall be issued pursuant to a separate L/C Application entered into between the Borrower and the Lender for the benefit of the Issuer, completed in a manner satisfactory to the Lender and the Issuer. The terms and conditions set forth in each such L/C Application shall supplement the terms and conditions hereof, but if the terms of any such L/C Application and the terms of this Agreement are inconsistent, the terms hereof shall control.
        (b)   No Letter of Credit shall be issued with an expiry date later than the Termination Date in effect as of the date of issuance.
        (c)   Any request to cause an Issuer to issue a Letter of Credit shall be deemed to be a representation by the Borrowers that the conditions set forth in Section 4.2 have been satisfied as of the date of the request.
        Section 2.6     Special Account.     If the Credit Facility is terminated for any reason while any Letter of Credit is outstanding, the Borrowers shall thereupon pay the Lender in immediately available funds for deposit in the Special Account an amount equal to the L/C Amount. The Special Account shall be an interest bearing account maintained for the Lender by any financial institution acceptable to the Lender. Any interest earned on amounts deposited in the Special Account shall be credited to the Special Account. The Lender may apply amounts on deposit in the Special Account at any time or from time to time to the Obligations in the Lender's sole discretion. The Borrowers may not withdraw any amounts on deposit in the Special Account as long as the Lender maintains a security interest therein. The Lender agrees to transfer any balance in the Special Account to the Borrowers when the Lender is required to release its security interest in the Special Account under applicable law.
        Section 2.7     Payment of Amounts Drawn Under Letters of Credit; Obligation of Reimbursement.     Each Borrower acknowledges that the Lender, as co-applicant, will be liable to the Issuer for reimbursement of any and all draws under Letters of Credit and for all other amounts required to be paid under the applicable L/C Application. Accordingly, the Borrowers shall pay to the Lender any and all amounts required to be paid under the applicable L/C Application, when and as required to be paid thereby, and the amounts designated below, when and as designated:
        (a)   The Borrowers shall pay to the Lender on the day a draft is honored under any Letter of Credit a sum equal to all amounts drawn under such Letter of Credit plus any and all reasonable charges and expenses that the Issuer or the Lender may pay or incur relative to such draw and the
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applicable L/C Application, plus interest on all such amounts, charges and expenses as set forth below (the Borrowers' obligation to pay all such amounts is herein referred to as the "Obligation of Reimbursement").
        (b)   Whenever a draft is submitted under a Letter of Credit, each Borrower authorizes the Lender to make a Revolving Advance in the amount of the Obligation of Reimbursement and to apply the proceeds of such Revolving Advance thereto. Such Revolving Advance shall be repayable in accordance with and be treated in all other respects as a Revolving Advance hereunder.
        (c)   If a draft is submitted under a Letter of Credit when the Borrowers are unable, because a Default Period exists or for any other reason, to obtain a Revolving Advance to pay the Obligation of Reimbursement, the Borrowers shall pay to the Lender on demand and in immediately available funds, the amount of the Obligation of Reimbursement together with interest, accrued from the date of the draft until payment in full at the Default Rate. Notwithstanding the Borrowers' inability to obtain a Revolving Advance for any reason, the Lender is irrevocably authorized, in its sole discretion, to make a Revolving Advance in an amount sufficient to discharge the Obligation of Reimbursement and all accrued but unpaid interest thereon.
        (d)   The Borrowers' obligation to pay any Revolving Advance made under this Section 2.7, shall be evidenced by the Revolving Note and shall bear interest as provided in Section 2.12.
        Section 2.8     Obligations Absolute.     The Borrowers' obligations arising under Section 2.7 shall be absolute, unconditional and irrevocable, and shall be paid strictly in accordance with the terms of Section 2.7, under all circumstances whatsoever, including (without limitation) the following circumstances:
        (a)   any lack of validity or enforceability of any Letter of Credit or any other agreement or instrument relating to any Letter of Credit (collectively the "Related Documents");
        (b)   any amendment or waiver of or any consent to departure from all or any of the Related Documents;
        (c)   the existence of any claim, setoff, defense or other right which the Borrowers may have at any time, against any beneficiary or any transferee of any Letter of Credit (or any persons or entities for whom any such beneficiary or any such transferee may be acting), or other person or entity, whether in connection with this Agreement, the transactions contemplated herein or in the Related Documents or any unrelated transactions;
        (d)   any statement or any other document presented under any Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect whatsoever;
        (e)   payment by or on behalf of the Issuer under any Letter of Credit against presentation of a draft or certificate which does not strictly comply with the terms of such Letter of Credit; or
        (f)    any other circumstance or happening whatsoever, whether or not similar to any of the foregoing.
        Section 2.9     Intentionally Omitted.     
        Section 2.10     Inventory Appraisals.     The Lender may from time to time (and will, no less than four times each year) obtain at the Borrowers' expense an appraisal of Inventory by an appraiser acceptable to the Lender in its sole discretion.
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        Section 2.11     Intentionally Omitted.     
        Section 2.12     Interest; Applicable Margin; Minimum Interest Charge; Default Interest; Participations; Clearance Days; Usury.     
        (a)     Notes.     Except as set forth in Subsections (d) and (g), the outstanding principal balance of the Note shall bear interest at the Floating Rate.
        (b)     Applicable Margin.     Reductions and increases in the Applicable Margin will be made within five calendar days following receipt of the Netlist's consolidated financial statements and compliance certificates required under Section 6.1. Notwithstanding the foregoing, (i) if the Borrowers fail to deliver any financial statements or compliance certificates when required under Section 6.1, the Lender may, by notice to the Borrowers, increase the Applicable Margin to fifty (50) basis points until such time as the Lender has received all such financial statements and compliance certificates, and (ii) no reduction in the Applicable Margin will be made if a Default Period exists at the time that such reduction would otherwise be made.
        (c)     Minimum Interest Charge.     Notwithstanding the interest payable pursuant to Subsection (a), the Borrowers shall pay to the Lender interest of not less than $30,000 per calendar quarter beginning October 1, 2003, and increasing to $37,500 per calendar quarter beginning January 1, 2004 (the "Minimum Interest Charge") during the term of this Agreement, and the Borrowers shall pay any deficiency between the Minimum Interest Charge and the amount of interest otherwise calculated under Subsection (a) on the first day of each month and on the Termination Date.
        (d)     Default Interest Rate.     Upon notice to the Borrowers from the Lender from time to time, the principal of the Advances outstanding from time to time shall bear interest at the Default Rate, effective as of the first day of the month during which any Default Period begins through the last day of such Default Period. The Lender's election to charge the Default Rate shall be in its sole discretion and shall not be a waiver of any of its other rights and remedies. The Lender's election to charge interest at the Default Rate for less than the entire period during which the Default Rate may be charged shall not be a waiver of its right to later charge the Default Rate for the entire such period.
        (e)     Clearance Days.     Notwithstanding Section 2.15(b)(ii), interest at the interest rate applicable under this Section 2.12 shall accrue on the amount of all payments (even if in the form of immediately available federal funds) for one (1) day for clearance.
        (f)     Participations.     If any Person shall acquire a participation in the Advances or the Obligation of Reimbursement, the Borrowers shall be obligated to the Lender to pay the full amount of all interest calculated under this Section 2.12, along with all other fees, charges and other amounts due under this Agreement, regardless if such Person elects to accept interest with respect to its participation at a lower rate than that calculated under this Section 2.12, or otherwise elects to accept less than its prorata share of such fees, charges and other amounts due under this Agreement.
        (g)     Usury.     In any event no rate change shall be put into effect which would result in a rate greater than the highest rate permitted by law. Notwithstanding anything to the contrary contained in any Loan Document, all agreements which either now are or which shall become agreements between the Borrowers and the Lender are hereby limited so that in no contingency or event whatsoever shall the total liability for payments in the nature of interest, additional interest and other charges exceed the applicable limits imposed by any applicable usury laws. If any payments in the nature of interest, additional interest and other charges made under any Loan Document are held to be in excess of the limits imposed by any applicable usury laws, it is agreed that any such amount held to be in excess shall be considered payment of principal hereunder, and the
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indebtedness evidenced hereby shall be reduced by such amount so that the total liability for payments in the nature of interest, additional interest and other charges shall not exceed the applicable limits imposed by any applicable usury laws, in compliance with the desires of the Borrowers and the Lender. This provision shall never be superseded or waived and shall control every other provision of the Loan Documents and all agreements between the Borrowers and the Lender, or their successors and assigns.
        Section 2.13     Fees.     
        (a)     Origination Fee.     The Borrowers have paid the Lender a fully earned and non-refundable origination fee of $25,000 upon the execution of the Prior Agreement.
        (b)     Audit Fees.     The Borrowers shall pay the Lender, on demand, audit fees in connection with any audits or inspections conducted by or on behalf of the Lender of any Collateral or the Borrowers' operations or business at the rates established from time to time by the Lender as its audit fees (which fees are currently $90 per hour per auditor), together with all actual out-of-pocket costs and expenses incurred in conducting any such audit or inspection.
        (c)     Letter of Credit Fees.     The Borrowers shall pay to the Lender a fee with respect to each Letter of Credit, if any, accruing on a daily basis and computed at the annual rate of one percent (1.0%), of the aggregate amount that may then be drawn under it assuming compliance with all conditions for drawing (the "Aggregate Face Amount"), from and including the date of issuance of such Letter of Credit until such date as such Letter of Credit shall terminate by its terms or be returned to the Lender, due and payable monthly in arrears on the first day of each month and on the Termination Date; provided , however that during Default Periods, in the Lender's sole discretion and without waiving any of its other rights and remedies, such fee shall increase to four percent (4.0%) of the Aggregate Face Amount. The foregoing fee shall be in addition to any and all fees, commissions and charges of the Issuer with respect to or in connection with such Letter of Credit.
        (d)     Letter of Credit Administrative Fees.     The Borrowers shall pay to the Lender, on written demand, the administrative fees charged by the Issuer in connection with the honoring of drafts under any Letter of Credit, amendments thereto, transfers thereof and all other activity with respect to the Letters of Credit at the then-current rates published by the Issuer for such services rendered on behalf of customers of the Issuer generally.
        (e)     Termination Fees.     If the Credit Facility is terminated (i) by the Lender during a Default Period that begins before a Maturity Date, or (ii) by the Borrowers (A) as of a date other than a Maturity Date or (B) as of a Maturity Date but without the Lender having received written notice of such termination at least 90 days before such Maturity Date, the Borrowers shall pay to the Lender a fee in an amount equal to a percentage of the Maximum Line (or the reduction of the Maximum Line, as the case may be) as follows: (A) three percent (3.0%) if the termination or reduction occurs on or before the first anniversary of the Funding Date; (B) two percent (2.0%) if the termination or reduction occurs after the first anniversary of the Funding Date but on or before the second anniversary of the Funding Date; and (C) one percent (1.0%) if the termination or reduction occurs after the second anniversary of the Funding Date.
        (f)    Intentionally Omitted.
        (g)   Waiver of Termination Fee.
          (i)  The Borrowers will not be required to pay the termination fee otherwise due under subsection (e) if such termination or prepayment is made because of refinancing by an affiliate of the Lender.
         (ii)  If at any time after the first anniversary of the Funding Date the Borrowers shall receive a written, bona fide letter of intent, commitment letter or similar offer ("Commitment
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Letter") to provide financing to refinance the Obligations, the Borrowers shall immediately provide the Lender with a copy of such Commitment Letter and such other information with respect to the offeror (including name, address and contact person) as the Lender may reasonably request. Upon the date of receipt by the Lender of a Commitment Letter, the Lender shall have the exclusive right to provide to the Borrowers the financing arrangements at the terms described in such Commitment Letter for a period of 45 days following the date of such receipt by the Lender. If the Lender does not deliver to the Borrowers a written offer to provide the financing arrangements at the terms described in a Commitment Letter within such 45 day period, then, provided that no Event of Default is then continuing, the Borrowers may obtain the financing arrangements from the offeror thereof only at the terms described in such Commitment Letter for a period of 30 days following the expiration of such 45 day period without being required to pay the termination fees otherwise due under subsection (e).
        (h)     Unused Line Fee.     On the first day of each calendar quarter during the term of this Agreement, an unused line fee in an amount equal to 0.25% per annum times the result of (a) the Maximum Line, less (b) the sum of (i) the average Daily Balance of Advances that were outstanding during the immediately preceding calendar quarter, plus (ii) the average Daily Balance of the L/C Amount during the immediately preceding calendar quarter.
        (i)     Other Fees.     The Lender may from time to time, upon five (5) days prior notice to the Borrowers during a Default Period, charge additional fees for Revolving Advances made and Letters of Credit issued in excess of Availability, for late delivery of reports, in lieu of imposing interest at the Default Rate, and for other reasons. The Borrowers' request for a Revolving Advance or the issuance of a Letter of Credit at any time after such notice is given and such five (5) day period has elapsed shall constitute the Borrowers' agreement to pay the fees described in such notice.
        (j)     Foreign Receivable Subline Fee.     The Borrowers will pay a monthly fee, in advance, in the amount of $2,187.50, which monthly fee shall be due on the first day of each month, commencing on the first such day following receipt by the Lender of the FREP Activation Notice and continuing on the first day of each succeeding month for so long as the Lender is obligated to make Advances against Eligible Foreign Accounts hereunder. The Foreign Receivable Subline Fee shall be fully earned when paid and non-refundable.
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         Section 2.14     Time for Interest Payments; Payment on Non-Banking Days; Computation of Interest and Fees.     
        (a)     Time For Interest Payments.     Interest shall be due and payable in arrears on the last day of each month and on the Termination Date.
        (b)     Payment on Non-Banking Days.     Whenever any payment to be made hereunder shall be stated to be due on a day which is not a Banking Day, such payment may be made on the next succeeding Banking Day, and such extension of time shall in such case be included in the computation of interest on the Advances or the fees hereunder, as the case may be.
        (c)     Computation of Interest and Fees.     Interest accruing on the outstanding principal balance of the Advances and fees hereunder outstanding from time to time shall be computed on the basis of actual number of days elapsed in a year of 360 days.
        Section 2.15     Lockbox; Collateral Account; Application of Payments.     
        (a)   Lockbox and Collateral Account.
          (i)  The Borrowers shall instruct all Account Debtors to pay all Accounts directly to the Lockbox. If, notwithstanding such instructions, either Borrower receives any payments on Accounts, such Borrower shall deposit such payments into the Collateral Account. The Borrowers shall also deposit all other cash proceeds of Collateral directly to the Collateral Account. Until so deposited, the Borrowers shall hold all such payments and cash proceeds in trust for and as the property of the Lender and shall not commingle such property with any of its other funds or property. All deposits in the Collateral Account shall constitute proceeds of Collateral and shall not constitute payment of the Obligations.
         (ii)  All items deposited in the Collateral Account shall be subject to final payment. If any such item is returned uncollected, the Borrowers will immediately pay the Lender, or, for items deposited in the Collateral Account, the bank maintaining such account, the amount of that item, or such bank at its discretion may charge any uncollected item to the Borrowers' commercial account or other account. The Borrowers shall be liable as an endorser on all items deposited in the Collateral Account, whether or not in fact endorsed by the Borrowers.
        (b)   Application of Payments.
          (i)  The Borrowers may, from time to time, in accordance with the Lockbox and Collection Account Agreement, cause funds in the Collateral Account to be transferred to the Lender's general account for payment of the Obligations. Except as provided in the preceding sentence, amounts deposited in the Collateral Account shall not be subject to withdrawal by the Borrowers, except after full payment and discharge of all Obligations.
         (ii)  All payments to the Lender shall be made in immediately available funds and shall be applied to the Obligations upon receipt by the Lender. Funds received from the Collateral Account shall be deemed to be immediately available. The Lender may hold all payments not constituting immediately available funds for three (3) additional days before applying them to the Obligations. Subject to Section 7.7 of this Agreement, all payments with respect to the Obligations may be applied, and in the Lender's sole discretion reversed and re-applied, to the Obligations, in such order and manner as the Lender shall determine in its sole discretion.
        Section 2.16     Voluntary Prepayment; Termination of the Credit Facility by the Borrowers.     Except as otherwise provided herein, the Borrowers may prepay the Advances in whole at any time or from time to time in part. The Borrowers may terminate the Credit Facility at any time if it (i) gives the Lender at least 30 days' prior written notice and (ii) pays the Lender termination and prepayment fees in accordance with Section 2.13(e). Subject to termination of the Credit Facility and payment and
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performance of all Obligations, the Lender shall, at the Borrowers' expense, release or terminate the Security Interest and the Security Documents to which the Borrowers are entitled by law.
        Section 2.17     Mandatory Prepayment.     Without notice or demand, if the sum of the outstanding principal balance of the Revolving Advances plus the L/C Amount shall at any time exceed the Borrowing Base, the Borrowers shall (i) first, immediately prepay the Revolving Advances to the extent necessary to eliminate such excess; and (ii) if prepayment in full of the Revolving Advances is insufficient to eliminate such excess, pay to the Lender in immediately available funds for deposit in the Special Account an amount equal to the remaining excess. Any payment received by the Lender under this Section 2.17 or under Section 2.16 may be applied to the Obligations, in such order and in such amounts as the Lender, in its discretion, may from time to time determine.
        Section 2.18     Revolving Advances to Pay Obligations.     Notwithstanding anything in Section 2.1, the Lender may, in its discretion at any time or from time to time, without the Borrowers' request and even if the conditions set forth in Section 4.2 would not be satisfied, make a Revolving Advance in an amount equal to the portion of the Obligations from time to time due and payable.
        Section 2.19     Use of Proceeds.     The Borrowers shall use the proceeds of Advances and each Letter of Credit for ordinary working capital purposes.
        Section 2.20     Liability Records.     The Lender may maintain from time to time, at its discretion, records as to the Obligations. All entries made on any such record shall be presumed correct until the Borrowers establish the contrary. Upon the Lender's demand, the Borrowers will admit and certify in writing the exact principal balance of the Obligations that the Borrowers then assert to be outstanding. Any billing statement or accounting rendered by the Lender shall be conclusive and fully binding on the Borrowers unless the Borrowers give the Lender specific written notice of exception within 30 days after receipt.
ARTICLE III
SECURITY INTEREST; OCCUPANCY; SETOFF
        Section 3.1     Grant of Security Interest.     Each Borrower hereby pledges, assigns and grants to the Lender a lien and security interest (collectively referred to as the "Security Interest") in the Collateral, as security for the payment and performance of the Obligations. Upon request by the Lender, each Borrower will grant the Lender a security interest in all commercial tort claims it may have against any Person.
        Section 3.2     Notification of Account Debtors and Other Obligors.     The Lender may at any time (whether or not a Default Period then exists) notify any Account Debtor or other person obligated to pay the amount due that such right to payment has been assigned or transferred to the Lender for security and shall be paid directly to the Lender. The Borrowers will join in giving such notice if the Lender so requests. At any time after the Borrowers or the Lender gives such notice to an Account Debtor or other obligor, the Lender may, but need not, in the Lender's name or in the Borrowers' name, demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such right to payment, or grant any extension to, make any compromise or settlement with or otherwise agree to waive, modify, amend or change the obligations (including collateral obligations) of any such Account Debtor or other obligor.
        Section 3.3     Assignment of Insurance.     As additional security for the payment and performance of the Obligations, each Borrower hereby assigns to the Lender any and all monies (including proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of such Borrower with respect to, any and all policies of insurance now or at any time hereafter covering the Collateral or any evidence thereof or any business records or valuable papers pertaining thereto,
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and each Borrower hereby directs the issuer of any such policy to pay all such monies directly to the Lender. At any time, whether or not a Default Period then exists, the Lender may (but need not), in the Lender's name or in the Borrowers' name, execute and deliver proof of claim, receive all such monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy.
        Section 3.4     Occupancy.     
        (a)   Each Borrower hereby irrevocably grants to the Lender the right to take exclusive possession of the Premises at any time during a Default Period.
        (b)   The Lender may use the Premises only to hold, process, manufacture, sell, use, store, liquidate, realize upon or otherwise dispose of goods that are Collateral and for other purposes that the Lender may in good faith deem to be related or incidental purposes.
        (c)   The Lender's right to hold the Premises shall cease and terminate upon the earlier of (i) payment in full and discharge of all Obligations and termination of the Credit Facility, and (ii) final sale or disposition of all goods constituting Collateral and delivery of all such goods to purchasers.
        (d)   The Lender shall not be obligated to pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises; provided , however , that if the Lender does pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises, the Borrowers shall reimburse the Lender promptly for the full amount thereof. In addition, the Borrowers will pay, or reimburse the Lender for, all taxes, fees, duties, imposts, charges and expenses at any time incurred by or imposed upon the Lender by reason of the execution, delivery, existence, recordation, performance or enforcement of this Agreement or the provisions of this Section 3.4.
        Section 3.5     License.     Without limiting the generality of any other Security Document, each Borrower hereby grants to the Lender a non-exclusive, worldwide and royalty-free license to use or otherwise exploit all Intellectual Property Rights of such Borrower for the purpose of: (a) completing the manufacture of any in-process materials during any Default Period so that such materials become saleable Inventory, all in accordance with the same quality standards previously adopted by such Borrower for its own manufacturing and subject to such Borrower's reasonable exercise of quality control; and (b) selling, leasing or otherwise disposing of any or all Collateral during any Default Period.
        Section 3.6     Financing Statement.     Each Borrower authorizes the Lender to file from time to time where permitted by law, such financing statements against collateral described as "all personal property" or describing specific items of collateral including commercial tort claims as the Lender deems necessary or useful to perfect the Security Interest. A carbon, photographic or other reproduction of this Agreement or of any financing statements signed by either Borrower is sufficient
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as a financing statement and may be filed as a financing statement in any state to perfect the security interests granted hereby. For this purpose, the following information is set forth:
Name and address of Debtors:
Netlist, Inc.
3 Goddard
Irvine, CA 92618
FEIN 95-4812784
Organizational Identification No. 3242099
Netlist Technology Texas, L.P.
9430 Research Blvd. Echelon IV, Suite 400
Austin, TX 78759
FEIN 54-2133194
Organizational Identification No.
Name and address of Secured Party:
Wells Fargo Business Credit, Inc.
245 S. Los Robles Avenue, Suite 700
Pasadena, CA 91101
FEIN 41-1237652
        Section 3.7     Setoff.     The Lender may at any time or from time to time, at its sole discretion and without demand and without notice to anyone, setoff any liability owed to the Borrowers by the Lender, whether or not due, against any Obligation, whether or not due. In addition, each other Person holding a participating interest in any Obligations shall have the right to appropriate or setoff any deposit or other liability then owed by such Person to the Borrowers, whether or not due, and apply the same to the payment of said participating interest, as fully as if such Person had lent directly to the Borrowers the amount of such participating interest.
        Section 3.8     Power of Attorney.     Each Borrower hereby irrevocably makes, constitutes, and appoints the Lender (and any of the Lender's officers, employees, or agents designated by the Lender) as such Borrower's true and lawful attorney, with power to (a) if the Borrower refuses to, or fails timely to execute and deliver any of the documents required to be described in Section 8.5, sign the name of the Borrower on any of the documents described in Section 8.5, (b) at any time that an Event of Default has occurred and is continuing, sign the Borrower's name on any invoice or bill of lading relating to the Collateral, drafts against Account Debtors, or notices to Account Debtors, (c) send requests for verification of Accounts, (d) endorse the Borrower's name on any collection item that may come into the Lender's possession, (e) at any time that an Event of Default has occurred and is continuing, make, settle, and adjust all claims under Borrower's policies of insurance and make all determinations and decisions with respect to such policies of insurance, (f) at any time that an Event of Default has occurred and is continuing, settle and adjust disputes and claims respecting the Accounts, chattel paper, or General Intangibles directly with Account Debtors, for amounts and upon terms that the Lender determines to be reasonable, and the Lender may cause to be executed and delivered any documents and releases that the Lender determines to be necessary, and (g) notify the United States Postal Service to change the address for delivery of the Borrower's mail to any address designated by the Lender, otherwise intercept the Borrower's mail, and receive, open and dispose of the Borrower's mail, applying all Collateral as permitted under this Agreement and holding all other mail for the Borrower's account or forwarding such mail to the Borrower's last known address. The appointment of the Lender as each Borrower's attorney, and each and every one of its rights and powers, being coupled with an interest, is irrevocable until all of the Obligations have been fully and finally repaid and performed and the Lender's obligations to extend credit hereunder are terminated.
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ARTICLE IV
CONDITIONS OF LENDING
        Section 4.1     Conditions Precedent to the Initial Advances and Letter of Credit.     The Lender's obligation to make the initial Advances or to cause any Letters of Credit to be issued shall be subject to the condition precedent that the Lender shall have received all of the following, each in form and substance satisfactory to the Lender:
        (a)   This Agreement, duly executed by the Borrowers.
        (b)   The Note, duly executed by the Borrowers.
        (c)   A true and correct copy of any and all agreements pursuant to which the Borrowers' property is in the possession of any Person other than the Borrowers, together with, in the case of any goods held by such Person for resale, (i) a consignee's acknowledgment and waiver of Liens, (ii) UCC financing statements sufficient to protect the Borrowers and the Lender's interests in such goods, and (iii) UCC searches showing that no other secured party has filed a financing statement against such Person and covering property similar to the Borrowers other than the Borrowers, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrowers and the Lender sufficient to protect the Borrowers' and the Lender's interests in the Borrowers' goods from any claim by such secured party.
        (d)   An acknowledgment and waiver of Liens from each warehouse in which the Borrowers are storing Inventory.
        (e)   A true and correct copy of any and all agreements pursuant to which the Borrowers' property is in the possession of any Person other than the Borrowers, together with, (i) an acknowledgment and waiver of Liens from each subcontractor who has possession of the Borrowers' goods from time to time, (ii) UCC financing statements sufficient to protect the Borrowers' and the Lender's interests in such goods, and (iii) UCC searches showing that no other secured party has filed a financing statement covering such Person's property other than the Borrowers, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrowers and the Lender sufficient to protect the Borrowers' and the Lender's interests in the Borrowers' goods from any claim by such secured party.
        (f)    The Lockbox and Collection Account Agreement, duly executed by NTTLP.
        (g)   Control agreements in form and substance satisfactory to the Lender, each duly executed by NTTLP, the General Partner and the Limited Partner and each bank at which each of NTTLP, the General Partner and the Limited Partner maintains deposit accounts.
        (h)   The Guaranties, duly executed by the General Partner and the Limited Partner.
        (i)    The Security Agreements duly executed by the General Partner and the Limited Partner.
        (j)    The acknowledgements, in form and substance satisfactory to the Lender, dated as of the date hereof duly executed by Serim Paper Manufacturing Co., Ltd, HeungHwa Industry Co. Ltd, Chun K. Hong, Christopher Lopes and Jayesh Bhakta.
        (k)   Current searches of appropriate filing offices showing that (i) no Liens have been filed and remain in effect against the Borrowers except Permitted Liens or Liens held by Persons who have agreed in writing that upon receipt of proceeds of the initial Advances, they will satisfy, release or terminate such Liens in a manner satisfactory to the Lender, and (ii) the Lender has duly filed all financing statements necessary to perfect the Security Interest, to the extent the Security Interest is capable of being perfected by filing.
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        (l)    A certificate of the NTTLP's Secretary or Assistant Secretary certifying that attached to such certificate are (i) the resolutions of the General Partner's Directors and, if required, Owners, authorizing the execution, delivery and performance of the Loan Documents, (ii) true, correct and complete copies of the General Partners' and NTTLP's Constituent Documents, and (iii) examples of the signatures of the General Partner's Officers or agents authorized to execute and deliver the Loan Documents and other instruments, agreements and certificates, including Advance requests, on NTTLP's behalf.
        (m)  A current certificate issued by the Secretary of State of Texas, certifying that NTTLP is in compliance with all applicable organizational requirements of the State of Texas.
        (n)   Evidence that NTTLP is duly licensed or qualified to transact business in the State of California and all other jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary.
        (o)   A certificate of an Officer of NTTLP confirming, in his personal capacity, the representations and warranties set forth in Article V.
        (p)   Certificates of the insurance required hereunder, with all hazard insurance containing a lender's loss payable endorsement in the Lender's favor and with all liability insurance naming the Lender as an additional insured.
        (q)   Payment of the fees and commissions due under Section 2.13 through the date of the initial Advance or Letter of Credit and expenses incurred by the Lender through such date and required to be paid by the Borrowers under Section 8.6, including all legal expenses incurred through the date of this Agreement.
        (r)   Such other documents as the Lender in its sole discretion may require.
        Section 4.2     Conditions Precedent to All Advances and Letters of Credit.     The Lender's obligation to make each Advance and to cause each Letter of Credit to be issued shall be subject to the further conditions precedent that:
        (a)    the representations and warranties contained in Article V are correct on and as of the date of such Advance or issuance of a Letter of Credit as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date;
        (b)    no event has occurred and is continuing, or would result from such Advance or issuance of a Letter of Credit which constitutes a Default or an Event of Default; and
        (c)    no injunction, writ, restraining order, or other order of any nature prohibiting, directly or indirectly, the extending of such credit shall have been issued and remain in force by any Governmental Authority against the Borrowers, the Lender, or any of their Affiliates.
ARTICLE V
REPRESENTATIONS AND WARRANTIES
        Each Borrower represents and warrants to the Lender as follows:
        Section 5.1     Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number.     
        (a)   Netlist is a corporation, duly organized, validly existing and in good standing under the laws of the State of Delaware and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. Netlist has all requisite power and authority to conduct its business, to own its properties and to execute and deliver, and to perform
23

all of its obligations under, the Loan Documents. During its existence, Netlist has done business solely under the names set forth in Schedule 5.1 and all of Netlist's records relating to its business or the Collateral are kept at that location. Netlist's chief executive office and principal place of business is located at the address set forth in Schedule 5.1. All Inventory and Equipment is located at that location or at one of the other locations listed in Schedule 5.1. Netlist's federal employer identification number is correctly set forth in Section 3.6.
        (b)   NTTLP is a limited partnership, duly organized, validly existing and in good standing under the laws of the State of Texas and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. NTTLP has all requisite power and authority to conduct its business, to own its properties and to execute and deliver, and to perform all of its obligations under, the Loan Documents. During its existence, NTTLP has done business solely under the names set forth in Schedule 5.1 and all of NTTLP's records relating to its business or the Collateral are kept at that location. NTTLP's chief executive office and principal place of business is located at the address set forth in Schedule 5.1. All Inventory and Equipment is located at that location or at one of the other locations listed in Schedule 5.1. NTTLP's federal employer identification number is correctly set forth in Section 3.6.
        Section 5.2     Capitalization.     Schedule 5.2 constitutes a correct and complete list of all ownership interests of the Borrower and rights to acquire ownership interests including the record holder, number of interests and percentage interests on a fully diluted basis, and an organizational chart showing the ownership structure of all Subsidiaries of the Borrower.
        Section 5.3     Authorization of Borrowing; No Conflict as to Law or Agreements.     The execution, delivery and performance by the Borrower of the Loan Documents and the borrowings from time to time hereunder have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of the Borrower's Owners; (ii) require any authorization, consent or approval by, or registration, declaration or filing with, or notice to, any Governmental Authority, or any third Person, except such authorization, consent, approval, registration, declaration, filing or notice as has been obtained, accomplished or given prior to the date hereof; (iii) violate any provision of any law, rule or regulation (including Regulation X of the Board of Governors of the Federal Reserve System) or of any order, writ, injunction or decree presently in effect having applicability to the Borrower or of the Borrower's Constituent Documents; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected; or (v) result in, or require, the creation or imposition of any Lien (other than the Security Interest) upon or with respect to any of the properties now owned or hereafter acquired by the Borrower.
        Section 5.4     Legal Agreements.     This Agreement constitutes and, upon due execution by the Borrower, the other Loan Documents will constitute the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms, except as enforcement may be limited by equitable principles or by bankruptcy, insolvency, reorganization, moratorium, or similar laws relating to or limiting creditors' rights generally.
        Section 5.5     Subsidiaries.     Except as set forth in Schedule 5.5 hereto, the Borrower has no Subsidiaries.
        Section 5.6     Financial Condition; No Adverse Change.     Netlist has furnished to the Lender its audited financial statements for its fiscal year ended December 31, 2001 and unaudited financial statements for the fiscal-year-to-date period ended May 31, 2003, and those statements fairly present Netlist's financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with generally accepted accounting principles. Since the date of the most recent financial statements, there has been no material adverse change in
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Netlist's business, properties or condition (financial or otherwise) which has had a Material Adverse Effect.
        Section 5.7     Litigation.     There are no actions, suits or proceedings pending or, to the Borrower's knowledge, threatened against or affecting the Borrower or any of its Affiliates or the properties of the Borrower or any of its Affiliates before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which, if determined adversely to the Borrower or any of its Affiliates, would have a Material Adverse Effect.
        Section 5.8     Regulation U.     The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock.
        Section 5.9     Taxes.     The Borrower and its Affiliates have paid or caused to be paid to the proper authorities when due all federal, state and local taxes required to be withheld by each of them. The Borrower and its Affiliates have filed all federal, state and local tax returns which to the knowledge of the Officers of the Borrower or any Affiliate, as the case may be, are required to be filed, and the Borrower and its Affiliates have paid or caused to be paid to the respective taxing authorities all taxes as shown on said returns or on any assessment received by any of them to the extent such taxes have become due.
        Section 5.10     Titles and Liens.     The Borrower has good and absolute title to all Collateral free and clear of all Liens other than Permitted Liens. No financing statement naming the Borrower as debtor is on file in any office except to perfect only Permitted Liens.
        Section 5.11     Intellectual Property Rights.     
        (a)     Owned Intellectual Property.     Schedule 5.11 is a complete list of all patents, applications for patents, trademarks, applications for trademarks, service marks, applications for service marks, mask works, trade dress and copyrights for which the Borrower is the registered owner (the "Owned Intellectual Property"). Except as disclosed on Schedule 5.11, (i) the Borrower owns the Owned Intellectual Property free and clear of all restrictions (including covenants not to sue a third party), court orders, injunctions, decrees, writs or Liens, whether by written agreement or otherwise, (ii) no Person other than the Borrower owns or has been granted any right in the Owned Intellectual Property, (iii) all Owned Intellectual Property is valid, subsisting and enforceable and (iv) the Borrower has taken all commercially reasonable action necessary to maintain and protect the Owned Intellectual Property.
        (b)     Agreements with Employees and Contractors.     The Borrower has entered into a legally enforceable agreement with each of its employees and subcontractors obligating each such Person to assign to the Borrower, without any additional compensation, any Intellectual Property Rights created, discovered or invented by such Person in the course of such Person's employment or engagement with the Borrower (except to the extent prohibited by law), and further requiring such Person to cooperate with the Borrower, without any additional compensation, in connection with securing and enforcing any Intellectual Property Rights therein; provided, however, that the foregoing shall not apply with respect to employees and subcontractors whose job descriptions are of the type such that no such assignments are reasonably foreseeable.
        (c)     Intellectual Property Rights Licensed from Others.     Schedule 5.11 is a complete list of all agreements under which the Borrower has licensed Intellectual Property Rights from another Person ("Licensed Intellectual Property") other than readily available, non-negotiated licenses of computer software and other intellectual property used solely for performing accounting, word processing and similar administrative tasks ("Off-the-shelf Software") and a summary of any
25

ongoing payments the Borrower is obligated to make with respect thereto. Except as disclosed on Schedule 5.11 and in written agreements copies of which have been given to the Lender, the Borrower's licenses to use the Licensed Intellectual Property are free and clear of all restrictions, Liens, court orders, injunctions, decrees, or writs, whether by written agreement or otherwise. Except as disclosed on Schedule 5.11, the Borrower is not obligated or under any liability whatsoever to make any payments of a material nature by way of royalties, fees or otherwise to any owner of, licensor of, or other claimant to, any Intellectual Property Rights.
        (d)     Other Intellectual Property Needed for Business.     Except for Off-the-shelf Software and as disclosed on Schedule 5.11, the Owned Intellectual Property and the Licensed Intellectual Property constitute all Intellectual Property Rights used or necessary to conduct the Borrower's business as it is presently conducted or as the Borrower reasonably foresees conducting it.
        (e)     Infringement.     Except as disclosed on Schedule 5.11, the Borrower has no knowledge of, and has not received any written claim or notice alleging, any Infringement of another Person's Intellectual Property Rights (including any written claim that the Borrower must license or refrain from using the Intellectual Property Rights of any third party) nor, to the Borrower's knowledge, is there any threatened claim or any reasonable basis for any such claim.
        Section 5.12     Plans.     Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate (i) maintains or has maintained any Pension Plan, (ii) contributes or has contributed to any Multiemployer Plan or (iii) provides or has provided post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required under Section 601 of ERISA, Section 4980B of the IRC or applicable state law). Neither the Borrower nor any ERISA Affiliate has received any notice or has any knowledge to the effect that it is not in full compliance with any of the requirements of ERISA, the IRC or applicable state law with respect to any Plan. No Reportable Event exists in connection with any Pension Plan. Each Plan which is intended to qualify under the IRC is so qualified, and no fact or circumstance exists which may have an adverse effect on the Plan's tax-qualified status. Neither the Borrower nor any ERISA Affiliate has (i) any accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the IRC) under any Plan, whether or not waived, (ii) any liability under Section 4201 or 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan or (iii) any liability or knowledge of any facts or circumstances which could result in any liability to the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Labor or any participant in connection with any Plan (other than routine claims for benefits under the Plan).
        Section 5.13     Default.     The Borrower is in compliance with all provisions of all agreements, instruments, decrees and orders to which it is a party or by which it or its property is bound or affected, the breach or default of which could have a Material Adverse Effect.
        Section 5.14     Environmental Matters.     
        (a)   To the Borrower's best knowledge, there are not present in, on or under the Premises any Hazardous Substances in such form or quantity as to create any material liability or obligation for either the Borrower or the Lender under common law of any jurisdiction or under any Environmental Law, and no Hazardous Substances have ever been stored, buried, spilled, leaked, discharged, emitted or released in, on or under the Premises in such a way as to create any such material liability.
        (b)   To the Borrower's best knowledge, the Borrower has not disposed of Hazardous Substances in such a manner as to create any material liability under any Environmental Law.
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        (c)   There are not and there never have been any requests, claims, notices, investigations, demands, administrative proceedings, hearings or litigation, relating in any way to the Premises or the Borrower, alleging material liability under, violation of, or noncompliance with any Environmental Law or any license, permit or other authorization issued pursuant thereto. To the Borrower's best knowledge, no such matter is threatened or impending.
        (d)   To the Borrower's best knowledge, the Borrower's businesses are and have in the past always been conducted in accordance with all Environmental Laws and all licenses, permits and other authorizations required pursuant to any Environmental Law and necessary for the lawful and efficient operation of such businesses are in the Borrower's possession and are in full force and effect. No permit required under any Environmental Law is scheduled to expire within 12 months and there is no threat that any such permit will be withdrawn, terminated, limited or materially changed.
        (e)   To the Borrower's best knowledge, the Premises are not and never have been listed on the National Priorities List, the Comprehensive Environmental Response, Compensation and Liability Information System or any similar federal, state or local list, schedule, log, inventory or database.
        (f)    The Borrower has delivered to Lender all environmental assessments, audits, reports, permits, licenses and other documents describing or relating in any way to the Premises or Borrower's businesses.
        Section 5.15     Submissions to Lender.     All financial and other information provided to the Lender by or on behalf of the Borrower in connection with the Borrower's request for the credit facilities contemplated hereby is (i) true and correct in all material respects, (ii) does not omit any material fact necessary to make such information not misleading and, (iii) as to projections, valuations or proforma financial statements, present a good faith opinion as to such projections, valuations and proforma condition and results.
        Section 5.16     Financing Statements.     The Borrower has authorized the filing of financing statements sufficient when filed to perfect the Security Interest and the other security interests created by the Security Documents. When such financing statements are filed in the offices noted therein, the Lender will have a valid and perfected security interest in all Collateral which is capable of being perfected by filing financing statements. None of the Collateral is or will become a fixture on real estate, unless a sufficient fixture filing is in effect with respect thereto.
        Section 5.17     Rights to Payment.     Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral is (or, in the case of all future Collateral, will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, setoff or counterclaim, of the Account Debtor or other obligor named therein or in the Borrower's records pertaining thereto as being obligated to pay such obligation.
        Section 5.18     Eligible Accounts; Eligible Foreign Accounts.     Each Account included in the Borrowing Base is an "Eligible Account" or an "Eligible Foreign Account" as defined herein, and conforms to the definitions thereof.
        Section 5.19     Eligible Inventory.     All Inventory included in the Borrowing Base is "Eligible Inventory," as defined herein, and conforms to the definition thereof.
        Section 5.20     Equipment.     All of the Equipment is used or held for use in the Borrower's business and is fit for such purposes.
        Section 5.21     Fraudulent Transfer.     The Borrower is Solvent. No transfer of property is being made by the Borrower and no obligation is being incurred by the Borrower in connection with the
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transactions contemplated by this Agreement or the other Loan Documents with the intent to hinder, delay, or defraud either present or future creditors of the Borrower.
ARTICLE VI
COVENANTS
        So long as the Obligations shall remain unpaid, or the Credit Facility shall remain outstanding, each Borrower will comply with the following requirements, unless the Lender shall otherwise consent in writing:
        Section 6.1     Reporting Requirements.     The Borrower will deliver, or cause to be delivered, to the Lender each of the following, which shall be in form and detail acceptable to the Lender:
        (a)     Annual Financial Statements.     As soon as available, and in any event within 90 days after the end of each fiscal year of the Borrowers, the Borrowers will deliver, or cause to be delivered, to the Lender, Netlist's audited and consolidated financial statements with the unqualified opinion of independent certified public accountants selected by the Borrowers and acceptable to the Lender, which annual financial statements shall include Netlist's balance sheet as at the end of such fiscal year and the related statements of Netlist's income, retained earnings and cash flows for the fiscal year then ended, prepared on a consolidating and consolidated basis to include any Subsidiaries, and prepared, if the Lender so requests, on a consolidating and consolidated basis to include any Affiliates, all in reasonable detail and prepared in accordance with GAAP, together with (i) copies of all management letters prepared by such accountants; (ii) a report signed by such accountants stating that in making the investigations necessary for said opinion they obtained no knowledge, except as specifically stated, of any Default or Event of Default and all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrowers are in compliance with the Financial Covenants; and (iii) a certificate of Netlist's chief financial officer stating that such financial statements have been prepared in accordance with GAAP, fairly represent Netlist's financial position and the results of its operations, and whether or not such officer has knowledge of the occurrence of any Default or Event of Default and, if so, stating in reasonable detail the facts with respect thereto.
        (b)     Monthly Financial Statements.     As soon as available and in any event within 20 days after the end of each month, the Borrowers will deliver to the Lender an unaudited/internal balance sheet and statements of income and retained earnings of Netlist as at the end of and for such month and for the year to date period then ended, prepared, on a consolidating and consolidated basis to include any Subsidiaries, in reasonable detail and stating in comparative form the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments and fairly represent the Borrower's financial position and the results of its operations; and accompanied by a certificate of the Borrower's chief financial Officer, substantially in the form of Exhibit C hereto stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end audit adjustments, (ii) whether or not such officer has knowledge of the occurrence of any Default or Event of Default not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the Financial Covenants.
        (c)     Collateral Reports.     The Borrower will deliver to the Lender the following documents at the following times in form satisfactory to Lender:

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Daily	
 	
(a)    a report of cash collections, sales assignments, credit memos/adjustments and deposits, copies of all invoices over $100,000, and a calculation of the Borrowing Base as of such date, and	

 	
(b)    notice of all returns, disputes, or claims.	

Weekly	
 	
(c)    A copy of Dell Computers rolling 16 week forecast needs.	

Monthly (not later than the 15th day of each month)	
 	
(d)    a detailed calculation of the Borrowing Base (including detail regarding those Accounts that are not Eligible Accounts or Eligible Foreign Accounts, and Inventory that is not Eligible Inventory),	

 	
(e)    a certified detailed listing and aging, by total, of the Accounts, together with a reconciliation to the detailed calculation of the Borrowing Base previously provided to Lender,	

 	
(f)    a summary aging, by vendor, of Borrower's accounts payable and any book overdraft, together with a reconciliation to the Borrower's general ledger and monthly financial statements delivered pursuant to Section 6.1(b),	

 	
(g)    an Inventory stock status report, by type and by location,	

 	
(h)    an Inventory slow moving report, and	

 	
(i)    an Inventory certification and perpetual report by location, including Inventory turnover by item number, together with a reconciliation to the Borrower's general ledger and monthly financial statements delivered pursuant to Section 6.1(b).	

Semi-Annually	
 	
(j)    a detailed list of Borrower's customers	

Upon request by Lender	
 	
(k)    copies of invoices in connection with the Accounts, credit memos, remittance advices, deposit slips, shipping and delivery documents in connection with the Accounts and, for Inventory and Equipment acquired by Borrower, purchase orders and invoices, and	

 	
(l)    such other reports as to the Collateral, or the financial condition of Borrower, as Lender may request.	
        (d)     Projections.     At least 30 days before the beginning of each fiscal year of the Borrowers, the Borrower will deliver to the Lender the projected consolidated balance sheets and income statements for each month of such year, each in reasonable detail, representing Netlist's good faith projections and certified by Netlist's chief financial Officer as being the most accurate projections available and identical to the projections used by the Borrowers for internal planning purposes, together with a statement of underlying assumptions and such supporting schedules and information as the Lender may in its discretion require.
        (e)     Litigation.     Immediately after the commencement thereof, the Borrower will deliver to the Lender notice in writing of all litigation and of all proceedings before any governmental or regulatory agency affecting the Borrower (i) of the type described in Section 5.14(c) or (ii) which seek a monetary recovery against the Borrower in excess of $100,000.
        (f)     Defaults.     As promptly as practicable (but in any event not later than five business days) after an Officer of the Borrower obtains knowledge of the occurrence of any Default or Event of Default, the Borrower will deliver to the Lender notice of such occurrence, together with a detailed statement by a responsible Officer of the Borrower of the steps being taken by the Borrower to cure the effect thereof.
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        (g)     Plans.     As soon as possible, and in any event within 30 days after the Borrower knows or has reason to know that any Reportable Event with respect to any Pension Plan has occurred, the Borrower will deliver to the Lender a statement of the Borrower's chief financial Officer setting forth details as to such Reportable Event and the action which the Borrower proposes to take with respect thereto, together with a copy of the notice of such Reportable Event to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event within 10 days after the Borrower fails to make any quarterly contribution required with respect to any Pension Plan under Section 412(m) of the IRC, the Borrower will deliver to the Lender a statement of the Borrower's chief financial Officer setting forth details as to such failure and the action which the Borrower proposes to take with respect thereto, together with a copy of any notice of such failure required to be provided to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event with 10 days after the Borrower knows or has reason to know that it has or is reasonably expected to have any liability under Section 4201 or 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan, the Borrower will deliver to the Lender a statement of the Borrower's chief financial Officer setting forth details as to such liability and the action which Borrower proposes to take with respect thereto.
        (h)     Disputes.     Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of (i) any disputes or claims by the Borrower's customers exceeding $100,000 individually or $1,000,000 in the aggregate with the other Borrower during any fiscal year; (ii) credit memos; (iii) any goods returned to or recovered by the Borrower.
        (i)     Officers and Directors.     Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of any change in the persons constituting the Borrower's Officers and Directors.
        (j)     Collateral.     Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of any loss of or material damage to any Collateral or of any substantial adverse change in any Collateral or the prospect of payment thereof.
        (k)     Commercial Tort Claims.     Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of any commercial tort claims it may bring against any person, including the name and address of each defendant, a summary of the facts, an estimate of the Borrower's damages, copies of any complaint or demand letter submitted by the Borrower, and such other information as the Lender may request.
        (l)     Intellectual Property.     
          (i)  The Borrower will give the Lender 30 days prior written notice of its intent to acquire material Intellectual Property Rights; except for transfers permitted under Section 6.18, the Borrower will give the Lender 30 days prior written notice of its intent to dispose of material Intellectual Property Rights; and upon request, shall provide the Lender with copies of all applicable documents and agreements.
         (ii)  Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of (A) any Infringement of its Intellectual Property Rights by others, (B) claims that the Borrower is Infringing another Person's Intellectual Property Rights and (C) any threatened cancellation, termination or material limitation of its Intellectual Property Rights.
        (iii)  Promptly upon receipt, the Borrower will give the Lender copies of all registrations and filings with respect to its Intellectual Property Rights.
        (m)     Reports to Owners.     Promptly upon their distribution, the Borrower will deliver to the Lender copies of all financial statements, reports and proxy statements which the Borrower shall have sent to its Owners.
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        (n)     SEC Filings.     Promptly after the sending or filing thereof, the Borrower will deliver to the Lender copies of all regular and periodic reports which the Borrower shall file with the Securities and Exchange Commission or any national securities exchange.
        (o)     Tax Returns.     Within 30 days of the date of filing, and in any event by not later November 30 of each year, copies of the Borrower's state and federal tax returns and all schedules thereto; and as soon as possible, and in any event by not later than April 20 of each year, copies of the state and federal tax returns and all schedules thereto and an updated personal financial statement of each owner of the Borrower and each Guarantor.
        (p)     Violations of Law.     Promptly upon knowledge thereof, the Borrower will deliver to the Lender notice of the Borrower's violation of any law, rule or regulation, the non-compliance with which could materially and adversely affect the Borrower's business or its financial condition.
        (q)     Other Reports.     From time to time, with reasonable promptness, the Borrower will deliver to the Lender any and all receivables schedules, collection reports, deposit records, equipment schedules, copies of invoices to Account Debtors, shipment documents and delivery receipts for goods sold, and such other material, reports, records or information as the Lender may request.
        Section 6.2     Financial Covenants.     
        (a)     Minimum Book Net Worth.     Borrowers will maintain at all times the sum of Netlist's Book Net Worth plus Subordinated Indebtedness, determined as at the end of each month, at an amount not less than the amount set forth in the table below opposite the applicable test date:

Test Date
	 	Minimum Book Net Worth Plus
Subordinated Indebtedness
	
12/31/03 and each month end thereafter	 	$	5,583,000	
        (b)     Minimum Net Income.     Netlist will achieve during each period described below minimum year to date Net Income of not less than the amount set forth opposite in the table below opposite such period:

Year to Date Period Ending
	 	Minimum Year to Date
Consolidated Net Income
	
12/31/03	 	$	3,833,000	
        (c)     Capital Expenditures.     The Borrower will not incur or contract to incur Capital Expenditures of more than $1,300,000 in the aggregate during the fiscal year ending December 27, 2003.
        (d)     Minimum Monthly Net Income.     Netlist will achieve minimum Net Income of not less than zero ($0) as at the end of each month.
        Section 6.3     Permitted Liens; Financing Statements.     
        (a)   The Borrower will not create, incur or suffer to exist any Lien upon or of any of its assets, now owned or hereafter acquired, to secure any indebtedness; excluding, however, from the operation of the foregoing, the following (collectively, "Permitted Liens"):
          (i)  in the case of any of the Borrower's property which is not Collateral, covenants, restrictions, rights, easements and minor irregularities in title which do not materially interfere with the Borrower's business or operations as presently conducted;
         (ii)  Liens in existence on the date hereof and listed in Schedule 6.3 hereto, securing indebtedness for borrowed money permitted under Section 6.4;
        (iii)  the Security Interest and Liens created by the Security Documents; and
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        (iv)  purchase money Liens relating to the acquisition of machinery and equipment of the Borrower not exceeding the lesser of cost or fair market value thereof, not exceeding $150,000 for any one purchase or $1,300,000 in the aggregate during any fiscal year, and so long as no Default Period is then in existence and none would exist immediately after such acquisition.
        (b)   The Borrower will not amend any financing statements in favor of the Lender except as permitted by law. Any authorization by the Lender to any Person to amend financing statements in favor of the Lender shall be in writing.
        Section 6.4     Indebtedness.     The Borrower will not incur, create, assume or permit to exist any Indebtedness or liability on account of deposits or advances or any Indebtedness for borrowed money or letters of credit issued on the Borrower's behalf, or any other Indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:
        (a)   Indebtedness arising hereunder;
        (b)   Indebtedness of the Borrower in existence on the date hereof and listed in Schedule 6.4 hereto;
        (c)   Indebtedness relating to Permitted Liens; and
        (d)   Indebtedness consisting of intercompany transactions in the ordinary course of business between the Borrowers.
        Section 6.5     Guaranties.     The Borrower will not assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any obligations of any other Person, except:
        (a)   the endorsement of negotiable instruments by the Borrower for deposit or collection or similar transactions in the ordinary course of business; and
        (b)   guaranties, endorsements and other direct or contingent liabilities in connection with the obligations of other Persons, in existence on the date hereof and listed in Schedule 6.4 hereto.
        Section 6.6     Investments and Subsidiaries.     The Borrower will not purchase or hold beneficially any stock or other securities or evidences of indebtedness of, make or permit to exist any loans or advances to, or make any investment or acquire any interest whatsoever in, any other Person, including any partnership or joint venture, except:
        (a)   investments in direct obligations of the United States of America or any agency or instrumentality thereof whose obligations constitute full faith and credit obligations of the United States of America having a maturity of one year or less, commercial paper issued by U.S. corporations rated "A-1" or "A-2" by Standard & Poors Corporation or "P-1" or "P-2" by Moody's Investors Service or certificates of deposit or bankers' acceptances having a maturity of one year or less issued by members of the Federal Reserve System having deposits in excess of $100,000,000 (which certificates of deposit or bankers' acceptances are fully insured by the Federal Deposit Insurance Corporation);
        (b)   travel advances or loans to the Borrower's Officers and employees not exceeding at any one time an aggregate of $2,500;
        (c)   advances in the form of progress payments, prepaid rent not exceeding three months or security deposits;
        (d)   current investments in the Subsidiaries in existence on the date hereof and listed in Schedule 5.5 hereto; and
        (e)   Indebtedness consisting of intercompany transactions in the ordinary course of business between the Borrowers.
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        Section 6.7     Dividends and Distributions.     The Borrower will not declare or pay any dividends (other than dividends payable solely in stock of the Borrower) or distributions on any class of its stock or partnership interests, as the case may be, or make any payment on account of the purchase, redemption or other retirement of any shares of such stock or such partnership interests or make any distribution in respect thereof, either directly or indirectly.
        Section 6.8     Salaries.     The Borrower will not pay excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation; or increase the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families.
        Section 6.9     Intentionally Omitted.     
        Section 6.10     Books and Records; Inspection and Examination.     The Borrower will keep accurate books of record and account for itself pertaining to the Collateral and pertaining to the Borrower's business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender's request, will permit any officer, employee, attorney or accountant for the Lender to audit, review, make extracts from or copy any and all company and financial books and records of the Borrower at all times during ordinary business hours, to send and discuss with Account Debtors and other obligors requests for verification of amounts owed to the Borrower, and to discuss the Borrower's affairs with any of its Directors, Officers, employees or agents. The Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to Lender, at the Borrower's expense, all financial information, books and records, work papers, management reports and other information in their possession regarding the Borrower. The Borrower will permit the Lender, or its employees, accountants, attorneys or agents, to examine and inspect any Collateral or any other property of the Borrower at any time during ordinary business hours.
        Section 6.11     Account Verification.     The Lender may at any time and from time to time send or require the Borrower to send requests for verification of accounts or notices of assignment to Account Debtors and other obligors. The Lender may also at any time and from time to time telephone Account Debtors and other obligors to verify accounts.
        Section 6.12     Compliance with Laws.     
        (a)   The Borrower will (i) comply with the requirements of applicable laws and regulations, the non-compliance with which would materially and adversely affect its business or its financial condition and (ii) use and keep the Collateral, and require that others use and keep the Collateral, only for lawful purposes, without violation of any federal, state or local law, statute or ordinance.
        (b)   Without limiting the foregoing undertakings, the Borrower specifically agrees that it will comply with all applicable Environmental Laws and obtain and comply with all permits, licenses and similar approvals required by any Environmental Laws, and will not generate, use, transport, treat, store or dispose of any Hazardous Substances in such a manner as to create any material liability or obligation under the common law of any jurisdiction or any Environmental Law.
        Section 6.13     Payment of Taxes and Other Claims.     The Borrower will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a Lien upon any properties of the Borrower; provided, that the Borrower shall not be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made.
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        Section 6.14     Maintenance of Properties.     
        (a)   The Borrower will keep and maintain the Collateral and all of its other properties necessary or useful in its business in good condition, repair and working order (normal wear and tear excepted) and will from time to time replace or repair any worn, defective or broken parts; provided, however, that nothing in this Section 6.14 shall prevent the Borrower from discontinuing the operation and maintenance of any of its properties if such discontinuance is, in the Borrower's judgment, desirable in the conduct of the Borrower's business and not disadvantageous in any material respect to the Lender. The Borrower will take all commercially reasonable steps necessary to protect and maintain its Intellectual Property Rights.
        (b)   The Borrower will defend the Collateral against all Liens, claims or demands of all Persons (other than the Lender) claiming the Collateral or any interest therein. The Borrower will keep all Collateral free and clear of all Liens except Permitted Liens. The Borrower will take all commercially reasonable steps necessary to prosecute any Person Infringing its Intellectual Property Rights and to defend itself against any Person accusing it of Infringing any Person's Intellectual Property Rights.
        Section 6.15     Insurance.     The Borrower will obtain and at all times maintain insurance with insurers believed by the Borrower to be responsible and reputable, in such amounts and against such risks as may from time to time be required by the Lender, but in all events in such amounts and against such risks as is usually carried by companies engaged in similar business and owning similar properties in the same general areas in which the Borrower operates. Without limiting the generality of the foregoing, the Borrower will at all times keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (for Collateral consisting of motor vehicles) and such other risks and in such amounts as the Lender may reasonably request, with any loss payable to the Lender to the extent of its interest, and all policies of such insurance shall contain a lender's loss payable endorsement for the Lender's benefit. All policies of liability insurance required hereunder shall name the Lender as an additional insured.
        Section 6.16     Preservation of Existence.     The Borrower will preserve and maintain its existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business and shall conduct its business in an orderly, efficient and regular manner.
        Section 6.17     Delivery of Instruments, etc.     Upon request by the Lender, the Borrower will promptly deliver to the Lender in pledge all instruments, documents and chattel paper constituting Collateral, duly endorsed or assigned by the Borrower.
        Section 6.18     Sale or Transfer of Assets; Suspension of Business Operations.     The Borrower will not sell, lease, assign, transfer or otherwise dispose of (i) the stock of any Subsidiary, (ii) all or a substantial part of its assets, or (iii) any Collateral or any interest therein (whether in one transaction or in a series of transactions) to any Person other than (x) another Borrower, (y) the sale of Inventory in the ordinary course of business, and (z) dispositions of obsolete, worn or nonfunctional equipment. The Borrower will not liquidate, dissolve or suspend business operations. The Borrower will not transfer any part of its ownership interest in any Intellectual Property Rights and will not permit any agreement under which it has licensed Licensed Intellectual Property to lapse, except that the Borrower may transfer such rights or permit such agreements to lapse if it shall have reasonably determined that the applicable Intellectual Property Rights are no longer useful in its business. If the Borrower transfers any Intellectual Property Rights for value, the Borrower will pay over the proceeds to the Lender for application to the Obligations. The Borrower will not license any other Person to use any of the Borrower's Intellectual Property Rights, except that the Borrower may grant licenses in the ordinary course of its business in connection with sales of Inventory or provision of services to its customers.
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        Section 6.19     Consolidation and Merger; Asset Acquisitions.     The Borrower will not consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person.
        Section 6.20     Sale and Leaseback.     The Borrower will not enter into any arrangement, directly or indirectly, with any other Person whereby the Borrower shall sell or transfer any real or personal property, whether now owned or hereafter acquired, and then or thereafter rent or lease as lessee such property or any part thereof or any other property which the Borrower intends to use for substantially the same purpose or purposes as the property being sold or transferred.
        Section 6.21     Restrictions on Nature of Business.     The Borrower will not engage in any line of business materially different from that presently engaged in by the Borrower and will not purchase, lease or otherwise acquire assets not related to its business.
        Section 6.22     Accounting.     The Borrower will not adopt any material change in accounting principles other than as required by GAAP. The Borrower will not adopt, permit or consent to any change in its fiscal year.
        Section 6.23     Discounts, etc.     After notice from the Lender, the Borrower will not grant any discount, credit or allowance to any customer of the Borrower or accept any return of goods sold. The Borrower will not at any time modify, amend, subordinate, cancel or terminate the obligation of any Account Debtor or other obligor of the Borrower.
        Section 6.24     Plans.     Unless disclosed to the Lender pursuant to Section 5.12, neither the Borrower nor any ERISA Affiliate will (i) adopt, create, assume or become a party to any Pension Plan, (ii) incur any obligation to contribute to any Multiemployer Plan, (iii) incur any obligation to provide post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required by law) or (iv) amend any Plan in a manner that would materially increase its funding obligations.
        Section 6.25     Place of Business.     The Borrower will not transfer its chief executive office or principal place of business, or move, relocate, close or sell any business location. The Borrower will not permit any tangible Collateral or any records pertaining to the Collateral to be located in any state or area in which, in the event of such location, a financing statement covering such Collateral would be required to be, but has not in fact been, filed in order to perfect the Security Interest. The Borrower will not change its jurisdiction of organization.
        Section 6.26     Change in Name, Trade Name, Trade Style or FEIN.     Borrower shall not change its legal name, trade names, trade styles or FEIN, or add any new trade names or trade styles from those listed on Schedule 5.1; provided, however , that Borrower may amend Schedule 5.1 so long as (i) such amendment occurs by written notice to Secured Party not less than 30 days prior to the date on which such new name, trade name, trade style or FEIN becomes effective, and (ii) at the time of such written notification, Borrower executes and delivers any financing statement amendments or fixture filing amendments necessary to continue perfected Lender security interest in the Collateral.
        Section 6.27     Transactions With Affiliates.     The Borrower will not directly or indirectly enter into or permit to exist any transaction with any Affiliate of the Borrower except for transactions that are in the ordinary course of the Borrower's business, upon fair and reasonable terms, that are fully disclosed to the Lender, and that are no less favorable to the Borrower than would be obtained in an arm's length transaction with a non-Affiliate.
        Section 6.28     Performance by the Lender.     If the Borrower at any time fails to perform or observe any of the foregoing covenants contained in this Article VI or elsewhere herein, and if such failure shall continue for a period of ten calendar days after the Lender gives the Borrower written notice
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thereof (or in the case of the agreements contained in Sections 6.13 and 6.15, immediately upon the occurrence of such failure, without notice or lapse of time), the Lender may, but need not, perform or observe such covenant on behalf and in the name, place and stead of the Borrower (or, at the Lender's option, in the Lender's name) and may, but need not, take any and all other actions which the Lender may reasonably deem necessary to cure or correct such failure (including the payment of taxes, the satisfaction of Liens, the performance of obligations owed to Account Debtors or other obligors, the procurement and maintenance of insurance, the execution of assignments, security agreements and financing statements, and the endorsement of instruments); and the Borrower shall thereupon pay to the Lender on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys' fees and legal expenses) incurred by the Lender in connection with or as a result of the performance or observance of such agreements or the taking of such action by the Lender, together with interest thereon from the date expended or incurred at the Default Rate. To facilitate the Lender's performance or observance of such covenants of the Borrower, the Borrower hereby irrevocably appoints the Lender, or the Lender's delegate, acting alone, as the Borrower's attorney in fact (which appointment is coupled with an interest) with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file in the name and on behalf of the Borrower any and all instruments, documents, assignments, security agreements, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by the Borrower under this Section 6.28.
ARTICLE VII
EVENTS OF DEFAULT, RIGHTS AND REMEDIES
        Section 7.1     Events of Default.     "Event of Default", wherever used herein, means any one of the following events:
        (a)   Default in the payment of any Obligations when they become due and payable;
        (b)   Default in the performance, or breach, of any covenant or agreement of either Borrower contained in this Agreement;
        (c)   A Change of Control shall occur;
        (d)   Any Financial Covenant shall become inapplicable due to the lapse of time and the failure to amend any such covenant to cover future periods;
        (e)   An Insolvency Proceeding is commenced by either Borrower or any Guarantor;
        (f)    An Insolvency Proceeding is commenced against either Borrower, or any Guarantor, and any of the following events occur: (a) such Borrower or such Guarantor consents to the institution of such Insolvency Proceeding against it, (b) the petition commencing the Insolvency Proceeding is not timely controverted, (c) the petition commencing the Insolvency Proceeding is not dismissed within 60 calendar days of the date of the filing thereof; provided, however, that, during the pendency of such period, the Lender shall be relieved of its obligations to extend credit hereunder, (d) an interim trustee is appointed to take possession of all or any substantial portion of the properties or assets of, or to operate all or any substantial portion of the business of, such Borrower or any such Guarantor, or (e) an order for relief shall have been entered therein;
        (g)   Any material portion of either Borrower's or any Guarantor's assets is attached, seized, subjected to a writ or distress warrant, levied upon, or comes into the possession of any third Person;
        (h)   Either Borrower or any Guarantor is enjoined, restrained, or in any way prevented by court order from continuing to conduct all or any material part of its business affairs;
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        (i)    A notice of Lien, levy, or assessment is filed of record with respect to any of Borrowers' or any Guarantor's assets by the United States, or any department, agency, or instrumentality thereof, or by any state, county, municipal, or governmental agency, or if any taxes or debts owing at any time hereafter to any one or more of such entities becomes a Lien, whether choate or otherwise, upon any of the Borrowers' or any Guarantor's assets and the same is not paid before such payment is delinquent;
        (j)    This Agreement or any other Loan Document that purports to create a Lien, shall, for any reason, fail or cease to create a valid and perfected and, except to the extent permitted by the terms hereof or thereof, first priority Lien on or security interest in the Collateral covered hereby or thereby;
        (k)   Any provision of any Loan Document shall at any time for any reason be declared to be null and void, or the validity or enforceability thereof shall be contested by either Borrower, or a proceeding shall be commenced by either Borrower, or by any Governmental Authority having jurisdiction over either Borrower, seeking to establish the invalidity or unenforceability thereof, or either Borrower shall deny that such Borrower has any liability or obligation purported to be created under any Loan Document.
        (l)    Any representation or warranty made by each Borrower in this Agreement, by any Guarantor in any guaranty delivered to the Lender, or by each Borrower (or any of its Officers) or any Guarantor in any agreement, certificate, instrument or financial statement or other statement contemplated by or made or delivered pursuant to or in connection with this Agreement or any such guaranty shall prove to have been incorrect in any material respect when deemed to be effective;
        (m)  The rendering against either Borrower of an arbitration award, final judgment, decree or order for the payment of money not covered by insurance, and the continuance of such arbitration award, judgment, decree or order unsatisfied and in effect for any period of 30 consecutive days without a stay of execution;
        (n)   A default under any bond, debenture, note or other evidence of material Indebtedness of either Borrower owed to any Person other than the Lender, or under any indenture or other instrument under which any such evidence of Indebtedness has been issued or by which it is governed, or under any material lease or other contract, and the expiration of the applicable period of grace, if any, specified in such evidence of Indebtedness, indenture, other instrument, lease or contract;
        (o)   Any Reportable Event, which the Lender determines in good faith might constitute grounds for the termination of any Pension Plan or for the appointment by the appropriate United States District Court of a trustee to administer any Pension Plan, shall have occurred and be continuing 30 days after written notice to such effect shall have been given to either Borrower by the Lender; or a trustee shall have been appointed by an appropriate United States District Court to administer any Pension Plan; or the Pension Benefit Guaranty Corporation shall have instituted proceedings to terminate any Pension Plan or to appoint a trustee to administer any Pension Plan; or either Borrower or any ERISA Affiliate shall have filed for a distress termination of any Pension Plan under Title IV of ERISA; or either Borrower or any ERISA Affiliate shall have failed to make any quarterly contribution required with respect to any Pension Plan under Section 412(m) of the IRC, which the Lender determines in good faith may by itself, or in combination with any such failures that the Lender may determine are likely to occur in the future, result in the imposition of a Lien on either Borrower's assets in favor of the Pension Plan; or any withdrawal, partial withdrawal, reorganization or other event occurs with respect to a Multiemployer Plan which results or could reasonably be expected to result in a material liability of either Borrower to the Multiemployer Plan under Title IV of ERISA.
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        (p)   An event of default shall occur under any Security Document;
        (q)   Either Borrower shall liquidate, dissolve, terminate or suspend its business operations or otherwise fail to operate its business in the ordinary course, or sell or attempt to sell all or substantially all of its assets;
        (r)   Default in the payment of any amount owed by the Borrowers to the Lender other than any Indebtedness arising hereunder;
        (s)   Any Guarantor or person signing a support agreement in favor of the Lender shall repudiate, purport to revoke or fail to perform his obligations under his guaranty or support agreement in favor of the Lender, any individual Guarantor shall die or any other Guarantor shall cease to exist;
        (t)    The Borrowers shall take or participate in any action which would be prohibited under the provisions of any Subordination Agreement or make any payment on the Subordinated Indebtedness that any Person was not entitled to receive under the provisions of the Subordination Agreements;
        (u)   Any event or circumstance with respect to either Borrower shall occur such that the Lender shall believe in good faith that the prospect of payment of all or any part of the Obligations or the performance by the Borrowers under the Loan Documents is impaired or any material adverse change in the business or financial condition of either Borrower shall occur;
        (v)   Any breach, default or event of default by or attributable to any Affiliate under any agreement between such Affiliate and the Lender shall occur; or
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        (w)  Any other Material Adverse Effect shall occur.
        Section 7.2     Rights and Remedies .    During any Default Period, the Lender may exercise any or all of the following rights and remedies, all of which each Borrower acknowledges and agrees are commercially reasonable:
        (a)   the Lender may, by notice to the Borrowers, declare the Commitment to be terminated, whereupon the same shall forthwith terminate;
        (b)   the Lender may, by notice to the Borrowers, declare the Obligations to be forthwith due and payable, whereupon all Obligations shall become and be forthwith due and payable, without presentment, notice of dishonor, protest or further notice of any kind, all of which each Borrower hereby expressly waives;
        (c)   the Lender may, without notice to the Borrowers and without further action, apply any and all money owing by the Lender to the Borrowers to the payment of the Obligations;
        (d)   the Lender may settle or adjust disputes and claims directly with Account Debtors for amounts and upon terms which the Lender considers advisable, and in such cases, the Lender will credit the Obligations with only the net amounts received by the Lender in payment of such disputed Accounts after deducting all expenses incurred or expended by the Lender in connection therewith;
        (e)   the Lender may cause the Borrowers to hold all returned Inventory in trust for the Lender, segregate all returned Inventory from all other assets of the Borrowers or in the Borrowers' possession and conspicuously label said returned Inventory as the property of the Lender;
        (f)    without notice to or demand upon the Borrowers or any Guarantor, the Lender may make such payments and do such acts as the Lender considers necessary or reasonable to protect its security interests in the Collateral. Each Borrower agrees to assemble the Collateral if the Lender so requires, and to make the Collateral available to the Lender at a place that the Lender may designate which is reasonably convenient to both parties. Each Borrower authorizes Lender to enter the premises where the Collateral is located, to take and maintain possession of the Collateral, or any part of it, and to pay, purchase, contest, or compromise any Lien that in the Lender's determination appears to conflict with the Lender's Liens and to pay all expenses incurred in connection therewith and to charge the Obligations therefor. With respect to any of either Borrower's owned or leased premises, such Borrower hereby grants the Lender a license to enter into possession of such premises and to occupy the same, without charge, in order to exercise any of the Lender's rights or remedies provided herein, at law, in equity, or otherwise;
        (g)   without notice to Borrowers (such notice being expressly waived), and without constituting a retention of any collateral in satisfaction of an obligation (within the meaning of the UCC), the Lender may set off and apply to the Obligations any and all (i) balances and deposits of the Borrowers held by the Lender (including any amounts received in the Lockbox), or (ii) Indebtedness at any time owing to or for the credit or the account of the Borrowers held by Lender;
        (h)   the Lender may hold, as cash collateral, any and all balances and deposits of the Borrowers held by the Lender, and any amounts received in the Lockbox, to secure the full and final repayment of all of the Obligations;
        (i)    the Lender may ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell (in the manner provided for herein) the Collateral;
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        (j)    the Lender may sell the Collateral at either a public or private sale, or both, by way of one or more contracts or transactions, for cash or on terms, in such manner and at such places (including each Borrower's premises) as the Lender determines is commercially reasonable. It is not necessary that the Collateral be present at any such sale;
        (k)   the Lender shall give notice of the disposition of the Collateral as follows:
        (l)    The Lender shall give the Borrowers a notice in writing of the time and place of public sale, or, if the sale is a private sale or some other disposition other than a public sale is to be made of the Collateral, the time on or after which the private sale or other disposition is to be made; and
          (i)  The notice shall be personally delivered or mailed, postage prepaid, to the Borrowers as provided in Section 8.3 , at least 10 days before the earliest time of disposition set forth in the notice; no notice needs to be given prior to the disposition of any portion of the Collateral that is perishable or threatens to decline speedily in value or that is of a type customarily sold on a recognized market;
         (ii)  the Lender may credit bid and purchase at any public sale;
        (m)  the Lender may seek the appointment of a receiver or keeper to take possession of all or any portion of the Collateral or to operate same and, to the maximum extent permitted by law, may seek the appointment of such a receiver without the requirement of prior notice or a hearing;
        (n)   If the Lender sells any of the Collateral on credit, the Obligations will be reduced only to the extent of payments actually received. If the purchaser fails to pay for the Collateral, the Lender may resell the Collateral and shall apply any proceeds actually received to the Obligations;
        (o)   the Lender shall have no obligation to attempt to satisfy the Obligations by collecting them from any third Person which may be liable for them or any portion thereof, and the Lender may release, modify or waive any collateral provided by any other Person as security for the Obligations or any portion thereof, all without affecting the Lender's rights against the Borrowers. Each Borrower waives any right it may have to require the Lender to pursue any third Person for any of the Obligations;
        (p)   the Lender may make demand upon the Borrowers and, forthwith upon such demand, the Borrowers will pay to the Lender in immediately available funds for deposit in the Special Account pursuant to Section 2.17 an amount equal to the aggregate maximum amount available to be drawn under all Letters of Credit then outstanding, assuming compliance with all conditions for drawing thereunder;
        (q)   the Lender may exercise and enforce its rights and remedies under the Loan Documents; and
        (r)   the Lender may exercise any other rights and remedies available to it by law or agreement.
Notwithstanding the foregoing, upon the occurrence of an Event of Default described in subsections (e) or (f) of Section 7.1, the Obligations shall be immediately due and payable automatically without presentment, demand, protest or notice of any kind.
        Section 7.3     Disclaimer of Warranties .    The Lender may sell the Collateral without giving any warranties as to the Collateral. The Lender may specifically disclaim any warranties of title or the like. This procedure will not be considered to adversely affect the commercial reasonableness of any sale of the Collateral.
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        Section 7.4     Compliance With Laws .    The Lender may comply with any applicable state or federal law requirements in connection with a disposition of the Collateral, and the Lender's compliance therewith will not be considered to adversely affect the commercial reasonableness of any sale of the Collateral.
        Section 7.5     No Marshalling .    The Lender shall be under no obligation to marshal any assets in favor of the Borrowers, or against or in payment of the Obligations or any other obligation owned to the Lender by the Borrowers or any other Person.
        Section 7.6     Borrowers to Cooperate .    Upon the exercise by the Lender of any power, right, privilege, or remedy pursuant to this Agreement which requires any consent, approval, registration, qualification, or authorization of any Governmental Authority, each Borrower agrees to execute and deliver, or will cause the execution and delivery of, all applications, certificates, instruments, assignments, and other documents and papers that the Lender or any purchaser of the Collateral may be required to obtain for such governmental consent, approval, registration, qualification, or authorization.
        Section 7.7     Application of Proceeds .    All proceeds realized as the result of any sale of the Collateral shall be applied by the Lender:
        FIRST to the costs, expenses, liabilities, obligations and attorneys' fees incurred by the Lender in the exercise of its rights under this Agreement;
        SECOND to the interest and fees due upon any of the Obligations; and
        THIRD to the principal of the Obligations, in such order as the Lender shall determine in its sole discretion. Any surplus shall be paid to the Borrowers or other Persons legally entitled thereto; the Borrowers shall remain liable to the Lender for any deficiency.
        Section 7.8     Remedies Cumulative .    The rights and remedies of the Lender under this Agreement, the other Loan Documents, and all other agreements contemplated hereby and thereby shall be cumulative. The Lender shall have all other rights and remedies not inconsistent herewith as provided under the UCC, by law, or in equity. No exercise by the Lender of any one right or remedy shall be deemed an election of remedies, and no waiver by the Lender of any default on the Borrowers' part shall be deemed a continuing waiver of any further defaults.
        Section 7.9     Lender Not Liable For The Collateral .    So long as the Lender complies with the obligations, if any, imposed by the UCC, the Lender shall not otherwise be liable or responsible in any way or manner for: (a) the safekeeping of the Collateral; (b) any loss or damage thereto occurring or arising in any manner or fashion or from any cause; (c) any diminution in the value thereof; or (d) any act or default of any carrier, warehouseman, bailee, forwarding agency, or other person whomsoever. The Borrowers bear the risk of loss or damage of the Collateral.
ARTICLE VIII
MISCELLANEOUS
        Section 8.1     No Waiver .    No failure or delay by the Lender in exercising any right, power or remedy under the Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any such right, power or remedy preclude any other or further exercise thereof or the exercise of any other right, power or remedy under the Loan Documents.
        Section 8.2     Amendments, Etc .    No amendment, modification, termination or waiver of any provision of any Loan Document or consent to any departure by the Borrowers therefrom or any release of a Security Interest shall be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the
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specific purpose for which given. No notice to or demand on the Borrowers in any case shall entitle the Borrowers to any other or further notice or demand in similar or other circumstances.
        Section 8.3     Addresses for Notices; Requests for Accounting .    Except as otherwise expressly provided herein, all notices, requests, demands and other communications provided for under the Loan Documents shall be in writing and shall be (a) personally delivered, (b) sent by first class United States mail, (c) sent by overnight courier of national reputation, or (d) transmitted by telecopy, in each case addressed or telecopied to the party to whom notice is being given at its address or telecopier number as set forth below next to its signature or, as to each party, at such other address or telecopier number as may hereafter be designated by such party in a written notice to the other party complying as to delivery with the terms of this Section. All such notices, requests, demands and other communications shall be deemed to have been given on (a) the date received if personally delivered, (b) when deposited in the mail if delivered by mail, (c) the date sent if sent by overnight courier, or (d) the date of transmission if delivered by telecopy, except that notices or requests to the Lender pursuant to any of the provisions of Article II shall not be effective until received by the Lender. All requests under Section 9210 of the UCC (i) shall be made in a writing signed by a person authorized under Section 2.2(b), (ii) shall be personally delivered, sent by registered or certified mail, return receipt requested, or by overnight courier of national reputation (iii) shall be deemed to be sent when received by the Lender and (iv) shall otherwise comply with the requirements of Section 9210. Each Borrower requests that the Lender respond to all such requests which on their face appear to come from an authorized individual and releases the Lender from any liability for so responding. The Borrowers shall pay Lender the maximum amount allowed by law for responding to such requests.
        Section 8.4     Intentionally Omitted .    
        Section 8.5     Further Documents .    The Borrowers will from time to time execute and deliver or endorse any and all instruments, documents, conveyances, assignments, security agreements, financing statements, control agreements and other agreements and writings that the Lender may reasonably request in order to secure, protect, perfect or enforce the Security Interest or the Lender's rights under the Loan Documents (but any failure to request or assure that the Borrowers execute, deliver or endorse any such item shall not affect or impair the validity, sufficiency or enforceability of the Loan Documents and the Security Interest, regardless of whether any such item was or was not executed, delivered or endorsed in a similar context or on a prior occasion).
        Section 8.6     Costs and Expenses .    The Borrowers shall pay on demand all costs and expenses, including reasonable attorneys' fees, incurred by the Lender in connection with the Obligations, this Agreement, the Loan Documents, any Letter of Credit and any other document or agreement related hereto or thereto, and the transactions contemplated hereby, including all such costs, expenses and fees incurred in connection with the negotiation, preparation, execution, amendment, administration, performance, collection and enforcement of the Obligations and all such documents and agreements and the creation, perfection, protection, satisfaction, foreclosure or enforcement of the Security Interest.
        Section 8.7     Indemnity .    In addition to the payment of expenses pursuant to Section 8.6, each Borrower shall indemnify, defend and hold harmless the Lender, and any of its participants, parent corporations, subsidiary corporations, affiliated corporations, successor corporations, and all present and future officers, directors, employees, attorneys and agents of the foregoing (the "Indemnitees") from and against any of the following (collectively, "Indemnified Liabilities"):
          (i)  any and all transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of the Loan Documents or the making of the Advances;
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         (ii)  any claims, loss or damage to which any Indemnitee may be subjected if any representation or warranty contained in Section 5.14 proves to be incorrect in any respect or as a result of any violation of the covenant contained in Section 6.12(b); and
        (iii)  any and all other liabilities, losses, damages, penalties, judgments, suits, claims, costs and expenses of any kind or nature whatsoever (including the reasonable fees and disbursements of counsel) in connection with the foregoing and any other investigative, administrative or judicial proceedings, whether or not such Indemnitee shall be designated a party thereto, which may be imposed on, incurred by or asserted against any such Indemnitee, in any manner related to or arising out of or in connection with the making of the Advances and the Loan Documents or the use or intended use of the proceeds of the Advances.
        If any investigative, judicial or administrative proceeding arising from any of the foregoing is brought against any Indemnitee, upon such Indemnitee's request, the Borrowers, or counsel designated by the Borrowers and satisfactory to the Indemnitee, will resist and defend such action, suit or proceeding to the extent and in the manner directed by the Indemnitee, at the Borrowers' sole costs and expense. Each Indemnitee will use its best efforts to cooperate in the defense of any such action, suit or proceeding. If the foregoing undertaking to indemnify, defend and hold harmless may be held to be unenforceable because it violates any law or public policy, the Borrowers shall nevertheless make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The Borrowers' obligation under this Section 8.7 shall survive the termination of this Agreement and the discharge of the Borrowers' other obligations hereunder.
        Section 8.8     Participants .    Each Borrower hereby authorizes the Lender to disclose to any assignee or any participant (either, a "Transferee") and any prospective Transferee any and all financial information in the Lender's possession concerning such Borrower which has been delivered to the Lender by the Borrower pursuant to this Agreement or which has been delivered to the Lender by the Borrower in connection with the Lender's credit evaluation prior to entering into this Agreement. The Lender and its participants, if any, are not partners or joint venturers, and the Lender shall not have any liability or responsibility for any obligation, act or omission of any of its participants. All rights and powers specifically conferred upon the Lender may be transferred or delegated to any of the Lender's participants, successors or assigns.
        Section 8.9     Advertising and Promotion .    Each Borrower agrees that the Lender may use such Borrower's name(s) in advertising and promotional materials, and in conjunction therewith, the Lender may disclose the amount of the Commitment and the purpose thereof.
        Section 8.10     Execution in Counterparts; Telefacsimile Execution .    This Agreement and other Loan Documents may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same instrument. Delivery of an executed counterpart of this Agreement by telefacsimile shall be equally as effective as delivery of an original executed counterpart of this Agreement. Any party delivering an executed counterpart of this Agreement by telefacsimile also shall deliver an original executed counterpart of this Agreement but the failure to deliver an original executed counterpart shall not affect the validity, enforceability, and binding effect of this Agreement.
        Section 8.11     Retention of Borrowers' Records .    The Lender shall have no obligation to maintain any electronic records or any documents, schedules, invoices, agings, or other papers delivered to the Lender by the Borrowers or in connection with the Loan Documents for more than four months after receipt by the Lender.
        Section 8.12     Binding Effect; Assignment; Complete Agreement; Exchanging Information .    The Loan Documents shall be binding upon and inure to the benefit of the Borrowers and the Lender and their respective successors and assigns, except that the Borrowers shall not have the right to assign their
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rights thereunder or any interest therein without the Lender's prior written consent. To the extent permitted by law, each Borrower waives and will not assert against any assignee any claims, defenses or set-offs which such Borrower could assert against the Lender. This Agreement shall also bind all Persons who become a party to this Agreement as a borrower. This Agreement, together with the Loan Documents, comprises the complete and integrated agreement of the parties on the subject matter hereof and supersedes all prior agreements, written or oral, on the subject matter hereof. Without limiting the Lender's right to share information regarding the Borrowers and their Affiliates with the Lender's participants, accountants, lawyers and other advisors, the Lender, Wells Fargo & Company, and all direct and indirect subsidiaries of Wells Fargo & Company, may exchange any and all information they may have in their possession regarding the Borrowers and their Affiliates, and each Borrower waives any right of confidentiality it may have with respect to such exchange of such information.
        Section 8.13     Severability of Provisions .    Any provision of this Agreement which is prohibited or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof.
        Section 8.14     Revival and Reinstatement of Obligations .    If the incurrence or payment of the Obligations by either Borrower or any Guarantor or the transfer to the Lender of any property should for any reason subsequently be declared to be void or voidable under any state or federal law relating to creditors' rights, including provisions of the Bankruptcy Code relating to fraudulent conveyances, preferences, or other voidable or recoverable payments of money or transfers of property (collectively, a "Voidable Transfer"), and if the Lender is required to repay or restore, in whole or in part, any such Voidable Transfer, or elects to do so upon the reasonable advice of its counsel, then, as to any such Voidable Transfer, or the amount thereof that the Lender is required or elects to repay or restore, and as to all reasonable costs, expenses, and attorneys fees of the Lender related thereto, the liability of such Borrower or any Guarantor automatically shall be revived, reinstated, and restored and shall exist as though such Voidable Transfer had never been made.
        Section 8.15     Headings .    Article, Section and subsection headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose.
        Section 8.16     Governing Law; Jurisdiction, Venue; Waiver of Jury Trial .    The Loan Documents shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of California. The parties hereto hereby (i) consent to the personal jurisdiction of the state and federal courts located in the State of California in connection with any controversy related to this Agreement; (ii) waive any argument that venue in any such forum is not convenient, (iii) agree that any litigation initiated by the Lender or the Borrowers in connection with this Agreement or the other Loan Documents may be venued in either the State or Federal courts located in Los Angeles County, State of California; and (iv) agree that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law.
THE PARTIES WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED ON OR PERTAINING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT.
ARTICLE IX
JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT
        Section 9.1     Joint and Several Liability .    Each Borrower agrees that it is jointly and severally, directly and primarily liable to Lender for payment, performance and satisfaction in full of the Obligations and that such liability is independent of the duties, obligations, and liabilities of the other
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Borrower. Lender may bring a separate action or actions on each, any, or all of the Obligations against any Borrower, whether action is brought against the other Borrower or whether the other Borrower is joined in such action. In the event that any Borrower fails to make any payment of any obligation on or before the due date thereof, the other Borrower immediately shall cause such payment to be made or each of such obligations to be made or each of such Obligations to be performed, kept, observed, or fulfilled.
        Section 9.2     Primary Obligation; Waiver of Marshalling .    This Agreement and the Loan Documents to which Borrowers are a party are a primary and original obligation of each Borrower, are not the creation of a surety relationship, and are an absolute, unconditional, and continuing promise of payment and performance which shall remain in full force and effect without respect to future changes in conditions, including any change of law or any invalidity or irregularity with respect to this Agreement or the Loan Documents to which Borrowers are a party. Each Borrower agrees that its liability under this Agreement and the Loan Documents which Borrowers are a party shall be immediate and shall not be contingent upon the exercise or enforcement by Lender of whatever remedies they may have against the other Borrower, or the enforcement of any lien or realization upon any security Lender may at any time possess. Each Borrower consents and agrees that Lender shall be under no obligation to marshal any assets of any Borrower against or in payment of any or all of the Obligations.
        Section 9.3     Financial Condition of Borrowers .    Each Borrower acknowledges that it is presently informed as to the financial condition of the other Borrower and of all other circumstances which a diligent inquiry would reveal and which bear upon the risk of nonpayment of the Obligations. Each Borrower hereby covenants that it will continue to keep informed as to the financial condition of the other Borrower, the status of the other Borrower and of all circumstances which bear upon the risk of nonpayment. Absent a written request from any Borrower to Lender for information, each Borrower hereby waives any and all rights it may have to require Lender to disclose to such Borrower any information which Lender may now or hereafter acquire concerning the condition or circumstances of the other Borrower.
        Section 9.4     Continuing Liability .    The liability of each Borrower under this Agreement and the Loan Documents to which Borrowers are a party includes Obligations arising under successive transactions continuing, compromising, extending, increasing, modifying, releasing, or renewing the Obligations, changing the interest rate, payment terms, or other terms and conditions thereof, or creating new or additional Obligations after prior Obligations have been satisfied in whole or in part. To the maximum extent permitted by law, each Borrower hereby waives any right to revoke its liability under this Agreement and Loan Documents as to future indebtedness, and in connection therewith, each Borrower hereby waives any rights it may have under Section 2815 of the California Civil Code.
        Section 9.5     Additional Waivers .    Each Borrower absolutely, unconditionally, knowingly, and expressly waives:
        (a)   (1) notice of acceptance hereof; (2) notice of any Advances or other financial accommodations made or extended under this Agreement and the Loan Documents to which Borrowers are a party or the creation or existence of any Obligations; (3) notice of the amount of the Obligations, subject, however, to each Borrower's right to make inquiry of Lender to ascertain the amount of the Obligations at any reasonable time; (4) notice of any adverse change in the financial condition of the other Borrower or of any other fact that might increase such Borrower's risk hereunder; (5) notice of presentment for payment, demand, protest, and notice thereof as to any instruments among the Loan Documents to which Borrowers are a party; (6) notice of any Default or Event of Default; and (7) all other notices (except if such notice is specifically required to be given to Borrowers hereunder or under the Loan Documents to which Borrowers are a party) and demands to which such Borrower might otherwise be entitled.
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        (b)   its right, under Sections 2845 or 2850 of the California Civil Code, or otherwise, to require Lender to institute suit against, or to exhaust any rights and remedies which Lender has or may have against, the other Borrower or any third party, or against any collateral for the Obligations provided by the other Borrower, or any third party. Each Borrower further waives any defense arising by reason of any disability or other defense (other than the defense that the Obligations shall have been fully and finally performed and indefeasibly paid) of the other Borrower or by reason of the cessation from any cause whatsoever of the liability of the other Borrower in respect thereof.
        (c)   (1) any rights to assert against Lender any defense (legal and equitable), set-off, counterclaim, or claim which such Borrower may now or at any time hereafter have against the other Borrower or any other party liable to Lender; (2) any defense, set-off, counterclaim, or claim, of any kind or nature, arising directly or indirectly from the present or future lack of perfection, sufficiency, validity, or enforceability of the Obligations or any security therefor; (3) any defense such Borrower has to performance hereunder, and any right such Borrower has to be exonerate, provided by Sections 2819, 2822, or 2825 of the California Civil Code, or otherwise, arising by reason of: the impairment or suspension of Lender's rights or remedies against the other Borrower; the alteration by Lender of the Obligations; any discharge of the other Borrower's obligations to Lender by operation of law as a result of Lender's intervention or omission; or the acceptance by Lender of anything in partial satisfaction of the Obligations; and (4) the benefit of any statute of limitations affecting such Borrower's liability hereunder or the enforcement thereof, and any act which shall defer or delay the operation of any statute of limitations applicable to the Obligations shall similarly operate to defer or delay the operation of such statute of limitations applicable to such Borrower's liability hereunder.
        (d)   Each Borrower absolutely, unconditionally, knowingly, and expressly waives any defense arising by reason of or deriving from (i) any claim or defense based upon an election of remedies by Lender including any defense based upon an election of remedies by Lender under the provisions of Sections 580a, 580b, 580d, and 726 of the California Code of Civil Procedure or any similar law of California or any other jurisdiction; or (ii) any election by Lender under Section 1111(b) of the Bankruptcy Code to limit the amount of, or any collateral securing, its claim against the Borrowers. Pursuant to California Civil Code Section 2856(b):
        Each Borrower waives all rights and defenses arising out of an election of remedies by the creditor, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed such Borrower's rights of subrogation and reimbursement against the other Borrower by the operation of Section 580(d) of the California Code of Civil Procedure or otherwise.
        Each Borrower waives all rights and defenses that such Borrower may have because the Obligations are secured by real property. This means, among other things: (1) Lender may collect from such Borrower without first foreclosing on any real or personal property collateral pledged by the other Borrower; and (2) if Lender forecloses on any real property collateral pledged by the other Borrower: (A) the amount of the Obligations may be reduced only by the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price; and (B) Lender may collect from such Borrower even if Lender, by foreclosing on the real property collateral, has destroyed any right such Borrower may have to collect from the other Borrower. This is an unconditional and irrevocable waiver of any rights and defenses each Borrower may have because the Obligations are secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580b, 580d, or 726 of the California Code of Civil Procedure.
46

        (e)   If any of the Obligations at any time are secured by a mortgage or deed of trust upon real property, Lender may elect, in its sole discretion, upon a default with respect to the Obligations, to foreclose such mortgage or deed of trust judicially or nonjudicially in any manner permitted by law, before or after enforcing this Agreement and the Loan Documents, without diminishing or affecting the liability of any Borrower hereunder except to the extent the Obligations are repaid with the proceeds of such foreclosure. Each Borrower understands that (a) by virtue of the operation of California's antideficiency law applicable to nonjudicial foreclosures, an election by Lender nonjudicially to foreclose such a mortgage or deed of trust probably would have the effect of impairing or destroying rights of subrogation, reimbursement, contribution, or indemnity of such Borrower against the other Borrower or other guarantors or sureties, and (b) absent the waiver given by such Borrower, such an election would prevent Lender from enforcing this Agreement and the Loan Documents to which Borrowers are a party against such Borrower. Understanding the foregoing, and understanding that such Borrower is hereby relinquishing a defense to the enforceability of this Agreement and the Loan Documents to which Borrowers are a party, such Borrower hereby waives any right to assert against Lender any defense to the enforcement of this Agreement and the Loan Documents to which Borrowers are a party, whether denominated "estoppel" or otherwise, based on or arising from an election by Lender nonjudicially to foreclose any such mortgage or deed of trust. Each Borrower understands that the effect of the foregoing waiver may be that each Borrower may have liability hereunder for amounts with respect to which such Borrower may be left without rights of subrogation, reimbursement, contribution, or indemnity against the other Borrower or other guarantors or sureties. Each Borrower also agrees that the "fair market value" provisions of Section 580a of the California Code of Civil Procedure shall have no applicability with respect to the determination of such Borrower's liability under this Agreement and the Loan Documents to which Borrowers are a party.
        (f)    Each Borrower hereby absolutely, unconditionally, knowingly, and expressly waives: (i) any right of subrogation such Borrower has or may have as against the other Borrower with respect to the Obligations; (ii) any right to proceed against the other Borrower or any other Person, now or hereafter, for contribution, indemnity, reimbursement, or any other suretyship rights and claims, whether direct or indirect, liquidated or contingent, whether arising under express or implied contract or by operation of law, which such Borrower may now have or hereafter have as against the other Borrower with respect to the Obligations; and (iii) any right to proceed or seek recourse against or with respect to any property or asset of the other Borrower.
        (g)   WITHOUT LIMITING THE GENERALITY OF ANY OTHER WAIVER OR OTHER PROVISION SET FORTH IN THIS AGREEMENT, EACH BORROWER HEREBY ABSOLUTELY, KNOWINGLY, UNCONDITIONALLY, AND EXPRESSLY WAIVES AND AGREES NOT TO ASSERT ANY AND ALL BENEFITS OR DEFENSES ARISING DIRECTLY OR INDIRECTLY UNDER ANY ONE OR MORE OF CALIFORNIA CIVIL CODE SECTIONS 2799, 2808, 2809, 2810, 2815, 2819, 2820, 2821, 2822, 2825, 2839, 2845, 2848, 2849, AND 2850, CALIFORNIA CODE OF CIVIL PROCEDURE SECTIONS 580a, 580b, 580c, 580d, AND 726, CALIFORNIA UNIFORM COMMERCIAL CODE SECTIONS 3116, 3118, 3119, 3419, AND 3605, AND CHAPTER 2 OF TITLE 14 OF PART 4 OF DIVISION 3 OF THE CALIFORNIA CIVIL CODE.
        Section 9.6     Settlement or Releases .    Each Borrower consents and agrees that without notice to or by such Borrower, and without affecting or impairing the liability of such Borrower hereunder, Lender may, by action or inaction:
        (a)   compromise, settle, extend the duration or the time for the payment of, or discharge the performance of, or may refuse to or otherwise not enforce this Agreement and the Loan Documents, or any part thereof, with respect to the other Borrower or any Guarantor;
47

        (b)   release the other Borrower or any Guarantor or grant other indulgences to the other Borrower or any Guarantor in respect thereof;
        (c)   amend or modify in any manner and at any time (or from time to time) this Agreement or any of the Loan Documents; or
        (d)   release or substitute any Guarantor, if any, of the Obligations, or enforce, exchange, release, or waive any security for the Obligations or any other guaranty of the Obligations, or any portion thereof.
        Section 9.7     No Election .    Lender shall have the right to seek recourse against each Borrower to the fullest extent provided for herein, and no election by Lender to proceed in one form of action or proceeding, or against any party, or on any obligation, shall constitute a waiver of Lender's right to proceed in any other form of action or proceeding or against other parties unless Lender has expressly waived such right in writing. Specifically, but without limiting the generality of the foregoing, no action or proceeding by Lender under this Agreement and the Loan Documents shall serve to diminish the liability of any Borrower under this Agreement and the Loan Documents to which Borrowers are a party except to the extent that Lender finally and unconditionally shall have realized indefeasible payment by such action or proceeding.
        Section 9.8     Indefeasible Payment .    The Obligations shall not be considered indefeasibly paid unless and until all payments to Lender are no longer subject to any right on the part of any Person, including any Borrower, any Borrower as a debtor in possession, or any trustee (whether appointed pursuant to the Bankruptcy Code, or otherwise) of any of Borrower's assets to invalidate or set aside such payments or to seek to recoup the amount of such payments or any portion thereof, or to declare same to be fraudulent or preferential. Upon such full and final performance and indefeasible payment of the Obligations, Lender shall have no obligation whatsoever to transfer or assign its interest in this Agreement and the Loan Documents to any Borrower. In the event that, for any reason, any portion of such payments to Lender is set aside or restored, whether voluntarily or involuntarily, after the making thereof, then the obligation intended to be satisfied thereby shall be revived and continued in full force and effect as if said payment or payments had not been made, and any Borrower shall be liable for the full amount Lender is required to repay plus any and all costs and expenses (including attorneys' fees and attorneys' fees incurred in proceedings brought under the Bankruptcy Code) paid by Lender in connection therewith.
        Section 9.9     Single Loan Account .    At the request of Borrowers to facilitate and expedite the administration and accounting processes and procedures of the Credit Facility, Lender has agreed, in lieu of maintaining separate loan accounts on Lender's books in the name of each of the Borrowers, that Lender may maintain a single loan account under the name of both Borrowers (the "Loan Account"). All Advances or any other borrowings under the Credit Facility shall be made jointly and severally to Borrowers and shall be charged to the Loan Account, together with all interest and other charges as permitted under and pursuant to this Agreement. The Loan Account shall be credited with all repayments of Obligations received by Lender, on behalf of Borrowers, from either Borrower pursuant to the terms of this Agreement.
        Section 9.10     Apportionment of Proceeds of Advances .    Each Borrower expressly agrees and acknowledges that Lender shall have no responsibility to inquire into the correctness of the apportionment or allocation of or any disposition by any of Borrowers of (a) the Advances or any borrowings under the Credit Facility, or (b) any of the expenses and other items charged to the Loan Account pursuant to this Agreement. The Advances and all such borrowings and such expenses and other item shall be made for the collective, joint, and several account of Borrowers and shall be charged to the Loan Account.
48

        Section 9.11     Lender Held Harmless .    Each Borrower agrees and acknowledges that the administration of this Agreement on a combined basis, as set forth herein, is being done as an accommodation to Borrowers and at their request, and that Lender shall incur no liability to Borrowers as a result thereof. To induce Lender to do so, and in consideration thereof, each Borrower hereby agrees to indemnify and hold Lender harmless from and against any and all liability, expense, loss, damage, claim of damage, or injury, made against Lender by Borrowers or by any other person or entity, arising from or incurred by reason of such administration of the Agreement.
        Section 9.12     Borrowers' Integrated Operations .    Each Borrower represents and warrants to Lender that the collective administration of the Credit Facility is being undertaken by Lender pursuant to this Agreement because Borrowers are integrated in their operation and administration and require financing on a basis permitting the availability of credit from time to time to Borrowers. Each Borrower will derive benefit, directly and indirectly, from such collective administration and credit availability because the successful operation of each Borrower is enhanced by the continued successful performance of the integrated group.
* * *
[remainder of this page intentionally left blank]
* * *
49

         IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized as of the date first above written.

Netlist, Inc.	 	NETLIST, INC.	

3 Goddard	

 	
Irvine, California 92618	 	By:	 	
Telecopier: (949) 435-0031	 	 		
Attention: Dan Skaggs
e-mail: dskaggs@netlistinc.com	 	 	Name: Chun K. Hong
Its: President	

Netlist Technology Texas, L.P.
9430 Research Blvd. Echelon IV, Suite 400	
 	
NETLIST TECHNOLOGY TEXAS L.P.
By: Netlist Holdings GP, Inc., its general partner	
Austin, Texas 78759
Attention: Dan Skaggs	 	 	 	
e-mail: dskaggs@netlistinc.com	 	By:	 	
 	 	 	
Name: Chun K. Hong
Its: President	

Wells Fargo Business Credit, Inc.	
 	
WELLS FARGO BUSINESS CREDIT, INC.	
245 S. Los Robles Avenue, Suite 700
Pasadena, California 91101	 	 	 	
Telecopier: (626) 844-9063	 	By:	 	
Attention: Hank Kaminski	 	 		
e-mail: kaminhm@wellsfargo.com	 	 	Name: Hank Kaminski
Its: Vice President	
S-1

 
 Table of Exhibits and Schedules

Exhibit A	 	Form of Replacement Revolving Note	

Exhibit C	
 	
Compliance Certificate	

Exhibit D	
 	
Premises	

Schedule 1	
 	
Unacceptable Countries	

Schedule 5.1	
 	
Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral	

Schedule 5.2	
 	
Capitalization and Organizational Chart	

Schedule 5.5	
 	
Subsidiaries	

Schedule 5.11	
 	
Intellectual Property Disclosures	

Schedule 6.3	
 	
Permitted Liens	

Schedule 6.4	
 	
Permitted Indebtedness and Guaranties	

Schedule E	
 	
Eligible Equipment	

 
 Exhibit A to Credit and Security Agreement

SECOND REPLACEMENT REVOLVING NOTE

$15,000,000	 	Irvine, California	

December 27, 2003	

        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promises to pay on the Termination Date under the Credit Agreement (defined below), to the order of WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), at its main office in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Fifteen Million Dollars ($15,000,000) or, if less, the aggregate unpaid principal amount of all Revolving Advances made by the Lender to the Borrowers under the Credit Agreement (defined below) together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Note is fully paid at the rate from time to time in effect under the Amended and Restated Credit and Security Agreement of even date herewith (the "Credit Agreement") by and between the Lender and the Borrowers. The principal hereof and interest accruing thereon shall be due and payable as provided in the Credit Agreement. This Note may be prepaid only in accordance with the Credit Agreement.
        This Note is issued pursuant, and is subject, to the Credit Agreement, which provides, among other things, for acceleration hereof. This Note is the Revolving Note referred to in the Credit Agreement. This Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.
        The Borrowers shall pay all costs of collection, including reasonable attorneys' fees and legal expenses if this Note is not paid when due, whether or not legal proceedings are commenced.
        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

 	 	NETLIST, INC.	

 	
By	

Its President	

 	
NETLIST TECHNOLOGY TEXAS L.P.	

 	
By:	
Netlist Holdings GP, Inc., its general partner	

 	
By	

Its President	

 
 Exhibit C to Credit and Security Agreement

Compliance Certificate
To:
Hank Kaminski
Wells Fargo Business Credit, Inc.
Date:                        , 200    
Subject:    Netlist, Inc. and Netlist Technology Texas LP
Financial Statements
        In accordance with our Amended and Restated Credit and Security Agreement dated as of December 27, 2003 ("Credit Agreement"), attached are the consolidated financial statements of Netlist, Inc. ("Netlist") and Netlist Technology Texas LP (collectively with Netlist, the "Borrowers" and, individually, the "Borrower") as of and for                        , 20    (the "Reporting Date") and the year-to-date period then ended (the "Current Financials"). All terms used in this certificate have the meanings given in the Credit Agreement.
        The undersigned certifies that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present Netlist's financial condition as of the date thereof.
Events of Default.     (Check one):
The undersigned does not have knowledge of the occurrence of a Default or Event of Default under the Credit Agreement except as previously reported in writing to the Lender.
The undersigned has knowledge of the occurrence of a Default or Event of Default under the Credit Agreement not previously reported in writing to the Lender and attached hereto is a statement of the facts with respect to thereto. Each of the Borrowers acknowledges that pursuant to Section 2.12(d) of the Credit Agreement, the Lender may impose the Default Rate at any time during the resulting Default Period.
Financial Covenants.     Each of the undersigned further hereby certify as follows:
        1.     Minimum Book Net Worth Plus Subordinated Indebtedness.     Pursuant to Section 6.2(a) of the Credit Agreement , as of the Reporting Date, the sum of the Book Net Worth plus Subordinated Indebtedness was $                        which o satisfies o does not satisfy the requirement that such amount be not less than $                        on the Reporting Date as set forth in table below:

Test Date
	 	Minimum Book Net Worth Plus Subordinated Indebtedness
	
12/27/03 and each month end thereafter	 	$	5,583,000	
        2.     Minimum Net Income.     Pursuant to Section 6.2(b) of the Credit Agreement, Netlist's year to date minimum Net Income for the            period ending on the Reporting Date, was $                        , which o satisfies o does not satisfy the requirement that such amount be not less than $                        during such period as set forth in table below:

Year to Date Period Ending
	 	Minimum Year to Date Net Income
	
12/27/03	 	$	3,833,000	
Exhibit C
1

        3.     Capital Expenditures.     Pursuant to Section 6.2(c) of the Credit Agreement, for the year-to-date period ending on the Reporting Date, the Borrowers have expended or contracted to expend during the                        year ended                        , 200    , for Capital Expenditures, $                        in the aggregate, which o satisfies o does not satisfy the requirement that such expenditures not exceed $1,300,000.
        4.     Minimum Monthly Net Income.     Pursuant to Section 6.2(d) of the Credit Agreement, for the monthly period ending on the Reporting Date, the Netlist's Net Income is $                        , which o satisfies o does not satisfy the requirement that Netlist will achieve minimum Net Income of not less than zero ($0) as at the end of each month.
        5.     Salaries.     As of the Reporting Date, salaries for all Directors, Officers, consultants, and any member of their families, is set forth on Schedule 1 attached hereto.
        Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

 	 	NETLIST, INC.	

 	
By	

Its Chief Financial Officer	

 	
NETLIST TECHNOLOGY TEXAS LP	

 	
By:	
Netlist Holdings GP, Inc.,
its general partner	

 	
By	

Its Chief Financial Officer	
Exhibit C
2

 
 Exhibit D to Credit and Security Agreement

Premises
        The Premises referred to in the Credit and Security Agreement are legally described as follows:
Irvine, CA Location
PARCEL 7 OF PARCEL MAP NO 99-125, IN THE CITY OF IRVINE, COUNTY OF ORANGE, STATE OF CALIFORNIA, AS PER MAP FILED IN BOOK 312, PAGES 33 THROUGH 37 OF PARCEL MAPS, IN THE OFFICE OF THE COUNTY RECORDER OF SAID COUNTY.
PROPERTY ADDRESS Known as: 3 Goddard, Building 7, Irvine, CA
And,
PM 302-38, PAR 6 AND IRVINE SU/B BLK 171 LOT 311 POR OF LOT AND BLK 171 POR OF B, IN THE CITY OF IRVINE, COUNTY OF ORANGE, STATE OF CALIFORNIA
PROPERTY ADDRESS Known as: 475 Goddard, Suite 100, Irvine, CA
Texas Location
9430 Research Boulevard Echelon IV
Suite 400
Austin, Texas 78759
Exhibit D
1

 
 Schedule 1 to Credit and Security Agreement
Unacceptable Countries

Afghanistan	 	Haiti	 	Romania	
Albania	 	Iran	 	Russia	
Algeria	 	Iraq	 	Serbia	
Argentina	 	Kampuchea	 	 	
Armenia	 	Kazakhstan	 	Slovenia	
Azerbaijan	 	Kyrgystan	 	Sudan	
Belarus	 	Laos	 	Syria	
Bosnia-Herzeqovina	 	Latvia	 	Turkmenistan	
Bulgaria	 	Lebanon	 	Tadjikistan	
Chad	 	Liberia	 	Ukraine	
Croatia	 	Libya	 	United States	
Cuba	 	Lithuania	 	Uzbekistan	
Estonia	 	Myanma	 	Venezuela	
Georgia	 	North Korea	 	 	
Schedule 1

 
 Schedule E to Credit and Security Agreement
Eligible Equipment
None
Schedule E

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 TABLE OF CONTENTS
 AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
ARTICLE I DEFINITIONS
 Table of Exhibits and Schedules
Exhibit A to Credit and Security Agreement SECOND REPLACEMENT REVOLVING NOTE
 Exhibit C to Credit and Security Agreement Compliance Certificate
 Exhibit D to Credit and Security Agreement Premises
 Schedule 1 to Credit and Security Agreement Unacceptable Countries
 Schedule E to Credit and Security Agreement Eligible Equipment
 
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EXHIBIT 10.2
 
 FIRST AMENDMENT TO AMENDED AND RESTATED
CREDIT AND SECURITY AGREEMENT
        This First Amendment to Amended and Restated Credit Agreement (this "Amendment"), dated as of June    , 2004, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), on the other hand.
Recitals
        The Borrowers and the Lender are parties to that certain Amended and Restated Credit and Security Agreement dated as of December 27, 2003 (as amended from time to time, the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.
        The Borrowers have requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.
        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:
        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.
        2.     Amendment.     Subsection (x) of the definition of Eligible Accounts set forth in Section 1.1 of the Credit Agreement is amended in its entirety to read as follows:
        "(x) Accounts owed by an Account Debtor (or an affiliate of such Account Debtor), regardless of whether otherwise eligible, to the extent that the balance of such Accounts exceeds 15% of the aggregate amount of all Accounts (except in the case of Dell Computer Corporation (excluding Dell Computer-Ireland), in which case such percentage shall be 65% through June 30, 2004, with such percentage thereafter reducing by 2.5% each month commencing July 1, 2004 and continuing on the first day of each month thereafter until such percentage is reduced to 50%);"
        3.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.
        4.     Conditions Precedent.     This Amendment shall be effective when the Lender shall have received: (a) an executed original hereof, together with the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor, each in substance and form acceptable to the Lender in its sole discretion; and (b) an accommodation fee of $2,500.
        5.     Representations and Warranties.     The Borrowers hereby represent and warrant to the Lender as follows:
        (a)   The Borrowers have all requisite power and authority to execute this Amendment and to perform all of their obligations hereunder, and this Amendment has been duly executed and delivered by the Borrowers and constitutes the legal, valid and binding obligation of the Borrowers, enforceable in accordance with its terms.
1

        (b)   The execution, delivery and performance by the Borrowers of this Amendment has been duly authorized by all necessary corporate action and does not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to the Borrowers, or the articles of incorporation or by-laws of the Borrowers, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrowers are a party or by which their properties may be bound or affected.
        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.
        6.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.
        7.     Costs and Expenses.     The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses.
        8.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.
2

        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

 	 	WELLS FARGO BUSINESS CREDIT, INC.	

 	
By:	

 	 	 	 	
Name: Hank Kaminski
Its: Vice President	

 	
NETLIST, INC.	

 	
By:	

 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its: President	

 	
NETLIST TECHNOLOGY TEXAS, L.P.	

 	
By:	

 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its: President	
3

 
 ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

CHUN K. HONG, an individual	

 	

CHRISTOPHER LOPES, an individual	

 	

JAYESH BHAKTA, an individual	

 	
NETLIST HOLDINGS GP, INC.	

 	
By:	

 	
 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its:	 	

 	
 	
NETLIST HOLDINGS LP, INC.	

 	
By:	

 	
 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its:	 	
 	 	 	 	 		
4

 
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	 	HEUNGHWA INDUSTRY CO., LTD	

 	
By:	

 	
 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its:	 	

 	
 	
SERIM PAPER MANUFACTURING CO., LTD	

 	
By:	

 	
 	 	 	 		
 	 	 	 	Name:	 	
 	 	 	 	 		
 	 	 	 	Its:	 	
 	 	 	 	 		
5

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 FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
 
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EXHIBIT 10.3
 
 SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT
AND WAIVER OF DEFAULTS
        THIS AMENDMENT, dated as of December    , 2005, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.
RECITALS
        The Borrower and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to a Credit and Security Agreement dated as of December 23, 2003 as amended by a First Amendment to Credit and Security Agreement dated as of June 30, 2004 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.
        WFBCI has merged with and into Lender and Lender is the surviving corporation.
        The Borrower has requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.
        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:
        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein. In addition, Section 1.1 of the Credit Agreement is amended by adding or amending, as the case may be, the following definitions:
        "Accounts Advance Rate" means up to eighty-five percent (85%), or such lesser rate as the Lender in its sole discretion may deem appropriate from time to time ; provided that, as of any date of determination, the Accounts Advance Rate shall be reduced by one (1) percentage point for each percentage by which Dilution is in excess of 5%.
        "Applicable Margin" means, in the case of Advances against Eligible Foreign Accounts, 4.75 percentage points (475 basis points), and in the case of all other Advances, 3.50 percentage points (350 basis points).
        "Bridge Loan" means certain Subordinated Indebtedness to be obtained by the Borrowers in the amount of $1,000,000 in or about December, 2005, upon terms and conditions satisfactory to the Lender.
        "Borrowing Base" means at any time the lesser of:
        (a)   The Maximum Line Amount; or
        (b)   Subject to change from time to time in the Lender's sole discretion, the sum of:
          (i)  The product of the Accounts Advance Rate times the Eligible Accounts; plus
         (ii)  During the Foreign Accounts Eligibility Period , the lesser of (A) the product of the Accounts Advance Rate times the Eligible Foreign Accounts, or (B) $1,800,000; plus
        (iii)  the lowest of (A) the product of the Inventory Advance Rate times the Eligible Inventory, or (B) eighty percent (80%) of the Net Orderly Liquidation Value of the Eligible Inventory, or (C) $2,500,000, or (D) 50% of Eligible Accounts; less
        (iv)  The Borrowing Base Reserve, less

         (v)  Obligations that the Borrower owes to the Lender that have not yet been advanced on the Revolving Note, and the dollar amount that the Lender in its reasonable discretion then determines to be a reasonable determination of the Borrower's credit exposure with respect to Wells Fargo Affiliate Obligations.
        "Borrowing Base Reserve" means, as of any date of determination, such amounts (expressed as either a specified amount or as a percentage of a specified category or item) as the Lender may from time to time establish and adjust in reducing Availability (a) to reflect events, conditions, contingencies or risks which, as determined by the Lender, do or may affect (i) the Collateral or its value, (ii) the assets, business or prospects of the Borrower, or (iii) the security interests and other rights of the Lender in the Collateral (including the enforceability, perfection and priority thereof), or (b) to reflect the Lender's judgment that any collateral report or financial information furnished by or on behalf of the Borrower to the Lender is or may have been incomplete, inaccurate or misleading in any material respect, or (c) in respect of any state of facts that the Lender determines constitutes a Default or an Event of Default.
        "Business Day" means a day on which the Federal Reserve Bank of New York is open for business.
        "Commercial Letter of Credit Agreement" means an agreement governing the issuance of documentary letters of credit by the Lender, entered into between the Borrower as applicant and the Lender as issuer.
        "Dilution" means, as of any date of determination, a percentage, based upon the experience of the trailing six (6) month period ending on the date of determination, which is the result of dividing (a) actual bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts as determined by Lender in its sole discretion during such period, by (b) Borrower's net sales during such period (excluding extraordinary items) plus the amount of clause (a).
        "Foreign Accounts Eligibility Period" means from date of the Lender's receipt of the FREP Activation Notice until November 30, 2006.
        "Inventory Advance Rate" means thirty-four percent (34%), or such other rate as the Lender in its sole discretion may deem appropriate from time to time.
        "L/C Application" means an application for the issuance of standby or documentary letters of credit pursuant to the terms of a Standby Letter of Credit Agreement or a Commercial Letter of Credit Agreement, in form acceptable to the Lender.
        "Loan Documents" means this Agreement, the Note, the Guaranties, the Subordination Agreements, any L/C Applications and the Security Documents, together with every other agreement, note, document, contract or instrument to which the Borrower now or in the future may be a party and which is required by the Lender.
        "Maturity Date" means July 31, 2007.
        "Net Cash Proceeds" means in connection with any asset sale, the cash proceeds (including any cash payments received by way of deferred payment whether pursuant to a note, installment receivable or otherwise, but only as and when actually received) from such asset sale, net of (i) attorneys' fees, accountants' fees, investment banking fees, brokerage commissions and amounts required to be applied to the repayment of any portion of the Debt secured by a Lien not prohibited hereunder on the asset which is the subject of such sale, and (ii) taxes paid or reasonably estimated to be payable as a result of such asset sale.
        "Net Orderly Liquidation Value" means a professional opinion of the estimated most probable Net Cash Proceeds which could typically be realized at a properly advertised and professionally managed liquidation sale, conducted under orderly sale conditions for an extended period of time (usually six to nine months), under the economic trends existing at the time of the appraisal.

        "Obligation of Reimbursement" means the obligation of the Borrower to reimburse the Lender pursuant to the terms of the Standby Letter of Credit Agreement or the Commercial Letter of Credit Agreement and any applicable L/C Application.
        "Obligations" means each Note, the Obligation of Reimbursement and each and every other debt, liability and obligation of every type and description which the Borrower may now or at any time hereafter owe to the Lender, whether such debt, liability or obligation now exists or is hereafter created or incurred, whether it arises in a transaction involving the Lender alone or in a transaction involving other creditors of the Borrower, and whether it is direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or sole, joint, several or joint and several, and including all indebtedness of the Borrower arising under any Loan Document or guaranty between the Borrower and the Lender, whether now in effect or subsequently entered into, and all Wells Fargo Affiliate Obligations.
        "Prime Rate" means at any time the rate of interest most recently announced by the Lender at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of the Lender's base rates, and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof in such internal publication or publications as the Lender may designate. Each change in the rate of interest shall become effective on the date each Prime Rate change is announced by the Lender.
        "Standby Letter of Credit Agreement" means an agreement governing the issuance of standby letters of credit by Lender entered into between the Borrower as applicant and Lender as issuer.
        "Subordinated Indebtedness" has the meaning given to such term in each Subordination Agreement.
        "Subordination Agreements" means (i) the Subordination Agreement, dated as of July 2, 2003, executed by Serim Paper Manufacturing Co., Ltd. in the Lender's favor and acknowledged by Netlist, (ii) the Subordination Agreement, dated as of July 2, 2003, executed by HeungHwa Industry Co. Ltd. in the Lender's favor and acknowledged by Netlist, (iii) the Subordination Agreement(s) in the Lender's favor executed by the lenders of the Bridge Loan in connection therewith and acknowledged by Netlist, and (iv) any other subordination agreement accepted by the Lender from time to time.
        "Wells Fargo Affiliate Obligations" means all obligations, liabilities, contingent reimbursement obligations, fees, and expenses owing by the Borrower or its Subsidiaries to any Person that is owned in material part by the Lender, and that relates to any service or facility extended to the Borrower or its Subsidiaries, including: (a) credit cards, (b) credit card processing services, (c) debit cards, and (d) purchase cards, as well as any other services or facilities from time to time specified by the Lender, whether direct or indirect, absolute or contingent, due or to become due, and whether existing now or in the future.
        2.     Rules of Interpretation.     Section 1.2 of the Credit Agreement is amended to read as follows:
        "Section 1.2     Other Definitional Terms; Rules of Interpretation .    The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. All accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. All terms defined in the UCC and not otherwise defined herein have the meanings assigned to them in the UCC. References to Articles, Sections, subsections, Exhibits, Schedules and the like, are to Articles, Sections and subsections of, or Exhibits or Schedules attached to, this Agreement unless otherwise expressly provided. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". Unless the context in which used herein otherwise clearly requires, "or" has the inclusive meaning represented by the phrase "and/or". Defined terms include in the singular number the plural and in the plural number the singular. Reference to any agreement (including the Loan Documents), document or instrument means such agreement, document or instrument as amended or modified and in effect from time to time in accordance with the terms thereof (and, if applicable, in accordance with the terms hereof and the other Loan

Documents), except where otherwise explicitly provided, and reference to any promissory note includes any promissory note which is an extension or renewal thereof or a substitute or replacement therefor. Reference to any law, rule, regulation, order, decree, requirement, policy, guideline, directive or interpretation means as amended, modified, codified, replaced or reenacted, in whole or in part, and in effect on the determination date, including rules and regulations promulgated thereunder."
        3.     Termination Fee.     Section 2.13(e) of the Credit Agreement is amended in its entirety as follows:
        (e)     Termination Fees.     If the Credit Facility is terminated (i) by the Lender during a Default Period that begins before a Maturity Date, or (ii) by the Borrowers (A) as of a date other than a Maturity Date or (B) as of a Maturity Date but without the Lender having received written notice of such termination at least 90 days before such Maturity Date, the Borrowers shall pay to the Lender a fee in an amount equal to a percentage of the Maximum Line (or the reduction of the Maximum Line, as the case may be) as follows: (A) two percent (2.0%) if the termination or reduction occurs on or before July 31, 2006; and (C) one percent (1.0%) if the termination or reduction occurs thereafter.
        4.     FREP Fee.     Section 2.13(j) of the Credit Agreement is amended in its entirety as follows:
        (j)     Foreign Receivable Subline Fee.     The Borrowers will pay a monthly fee, in advance, in the amount of $1,500, which monthly fee shall be due on the first day of each month, commencing on the first such day following receipt by the Lender of the FREP Activation Notice and continuing on the first day of each succeeding month for so long as the Lender is obligated to make Advances against Eligible Foreign Accounts hereunder. The Foreign Receivable Subline Fee shall be fully earned when paid and non-refundable.
        5.     Financing Statements.     Section 3.6 of the Credit Agreement is amended by adding the following new sentence before the first sentence of that Section:
        "The Borrower authorizes the Lender to file from time to time where permitted by law, such financing statements against collateral described as "all personal property" as the Lender deems necessary or useful to perfect the Security Interest."
        6.     Projections.     Section 6.1(d) of the Credit Agreement is amended in its entirety as follows:
        (d)     Projections.     At least 30 days before the beginning of each fiscal year of the Borrowers (except with respect to Borrower's fiscal year 2006, in which case by December 31, 2005), the Borrower will deliver to the Lender the projected consolidated balance sheets and income statements for each month of such year, each in reasonable detail, representing Netlist's good faith projections and certified by Netlist's chief financial Officer as being the most accurate projections available and identical to the projections used by the Borrowers for internal planning purposes, together with a statement of underlying assumptions and such supporting schedules and information as the Lender may in its discretion require.
        7.     Financial Covenants.     Section 6.2 of the Credit Agreement is amended in its entirety as follows:
        Section 6.2     Financial Covenants.     
        (a)    Minimum Book Net Worth.     Borrowers will maintain at all times the sum of Netlist's Book Net Worth plus Subordinated Indebtedness, determined as at the end of each month, at

an amount not less than the amount set forth in the table below opposite the applicable test date:

Test Date
	 	Minimum Book Net Worth Plus Subordinated Indebtedness(1)
	
10/31/05	 	$	5,300,000	
11/30/05	 	$	5,250,000	
12/31/05	 	$	5,150,000	
1/31/06	 	$	5,100,000	
2/28/06 and each month end thereafter	 	$	5,100,000	

(1)
The covenant levels set forth in this table shall be increased as follows:
        1)    On the funding of the Bridge Loan, Dollar for Dollar by the amount of the Bridge Loan;
        2)    Upon the sale of the Premises located at 3 Goddard, Irvine, CA 92618, Dollar for Dollar to the nearest $10,000,000 of the gain on such sale, calculated in accordance with GAAP; and
        3)    Upon the closing of any equity or debt offering of the Borrowers, an amount equal to 75% of the total capital raised in the month of closing.
        (b)    Minimum Net Income (Maximum Net Loss).     Netlist will achieve during each period described below minimum year to date Net Income (or Maximum Net Loss) of not less than (or more than, as applicable) the amount set forth opposite in the table below opposite such period:

Year to Date Period Ending
	 	Minimum Year to Date
Consolidated Net Income
(Maximum Net Loss)
	
12/31/05	 	<$450,000>	
        (c)    Capital Expenditures.     The Borrower will not incur or contract to incur Capital Expenditures of more than $1,500,000 in the aggregate during the fiscal year ending December 31, 2005.
        (d)    Stop Loss.     The Borrower will not suffer a Net Loss in excess of $200,000 during any of the months of October, November or December, 2005, or in excess of $150,000 during any month thereafter.
        8.     Permitted Indebtedness.     Section 6.4 of the Credit Agreement is amended in its entirety as follows:
        Section 6.4     Indebtedness.     The Borrower will not incur, create, assume or permit to exist any Indebtedness or liability on account of deposits or advances or any Indebtedness for borrowed money or letters of credit issued on the Borrower's behalf, or any other Indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:
        (a)   Indebtedness arising hereunder;
        (b)   Indebtedness of the Borrower in existence on the date hereof and listed in Schedule 6.4 hereto;
        (c)   Indebtedness relating to Permitted Liens;
        (e)   Indebtedness consisting of intercompany transactions in the ordinary course of business between the Borrowers;
        (f)    the Bridge Loan, provided that such loan is on terms and conditions (including subordination terms and conditions) satisfactory to the Lender in its sole and absolute discretion; and
        (g)   all other Subordinated Indebtedness.

        9.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.
        10.     Waiver of Defaults.     The Borrower is in default of the following provisions of the Credit Agreement (collectively, the "Existing Defaults"):

Section/Covenant
	 	Required Performance
	
7.2(a)—Minimum Book Net Worth Plus Subordinated Indebtedness	 	$5,583,000 from March 31, 2005 through September 30, 2005	

7.2(b)—Minimum Year to Date Consolidated Net Income	
 	
$3,833,000 from November 30, 2004 through September 30, 2005	

6.1(a)—Annual Financial Statements	
 	
Annual Financial Statements for fiscal year 2004 due 12/31/05	
        Upon the terms and subject to the conditions set forth in this Amendment, the Lender hereby waives the Existing Defaults. This waiver shall be effective only in this specific instance and for the specific purpose for which it is given, and this waiver shall not entitle the Borrower to any other or further waiver in any similar or other circumstances.
        11.     Amendment Fee.     The Borrower shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $25,000 in consideration of the Lender's execution and delivery of this Amendment.
        12.     Conditions Precedent.     This Amendment , and the waiver set forth in Paragraph 10 hereof, shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:
        (a)   A Standby Letter of Credit Agreement and a Commercial Letter of Credit Agreement, and L/C Application for each Letter of Credit that the Borrowers wish to have issued thereunder.
        (b)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.
        (c)   Payment of the fee described in Paragraph 11.
        (d)   Such other matters as the Lender may require.
        13.     Representations and Warranties.     The Borrower hereby represents and warrants to the Lender as follows:
        (a)   The Borrower has all requisite power and authority to execute this Amendment to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by the Borrower and constitutes the legal, valid and binding obligation of the Borrower, enforceable in accordance with its terms.
        (b)   The execution, delivery and performance by the Borrower of this Amendment have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to the Borrower, or the articles of incorporation or by-laws of the Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected.
        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.

        14.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.
        15.     Prime Rate.     Each reference in the Credit Agreement to "Base Rate" will be deleted and replaced with the newly defined term "Prime Rate" set forth in Paragraph 2 of this Amendment. Each reference in the Credit Agreement to "Banking Day" will be deleted and replaced with the newly defined term "Business Day" set forth in Paragraph 2 of this Amendment
        16.     No Other Waiver.     Except as set forth in Paragraph 10 hereof, the execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.
        17.     Release.     
        (a)   The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which the Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:
A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.
        (b)   The Borrower, and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, the Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause
        18.     Costs and Expenses.     The Borrower hereby reaffirms its agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrower specifically agrees to pay all fees and disbursements of counsel to the Lender for the services

performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrower hereby agrees that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrower, make a loan to the Borrower under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses and the fee required under paragraph 11 of this Amendment.
        19.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.
[remainder of this page intentionally left blank]

        IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

 	

 	

 	

WELLS FARGO BANK, NATIONAL ASSOCIATION	 	NETLIST, INC.	
Through its Wells Fargo Business Credit operating division	 	 	 	 	 	 	
 	 	 	 	By:	 	    
	
 	 	 	 	Name: Chun K. Hong
Its: President	

By	

 	

 	

Name: Jeffrey Cristol
Its Vice President	 	 	 	 	 	 	

 	

NETLIST TECHNOLOGY TEXAS L.P.	
 	 	 	 	By:	 	Netlist Holdings GP, Inc., its general partner	

 	

 	
 	
By:	

 	 	 	 	 	 	Name: Chun K. Hong
Its: President	
9

 
 ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

 	

CHUN K. HONG, an individual	

 	

CHRISTOPHER LOPES, an individual	

 	

JAYESH BHAKTA, an individual	

 	
NETLIST HOLDINGS GP, INC.	

 	
By:	

	
 	 	Name:
Its:	
10

ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	
 	
HEUNGHWA INDUSTRY CO., LTD	

 	
By:	

	
 	 	Name:
Its:	

 	
SERIM PAPER MANUFACTURING CO., LTD	

 	
By:	

	
 	 	Name:
Its:	
11

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 SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT AND WAIVER OF DEFAULTS
 ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
 
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Exhibit 10.4
 
 THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT
        THIS AMENDMENT, dated as of February 14, 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.
 
 RECITALS
        The Borrower and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to a Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Credit and Security Agreement, dated as of June 30, 2004 and a Second Amendment to Credit and Security Agreement, dated as of December 20, 2005 (as so amended, the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.
        WFBCI has merged with and into Lender and Lender is the surviving corporation.
        The Borrower has requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.
        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:
        1.     Defined Terms.     Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.
        2.     Amendment to Eligible Accounts.     Clause (x) of the definition of "Eligible Accounts" set forth in Section 1.1 of the Credit Agreement is amended in its entirety as follows:
        (x)    Accounts owed by an Account Debtor (or an Affiliate of such Account Debtor), regardless of whether otherwise eligible, to the extent that the balance of such Accounts exceeds 15% of the aggregate amount of all Accounts (except in the case of Dell Computer Corporation (excluding Dell Computer-Ireland), in which case such percentage shall be 50%, and Kingston Technology, in which case such percentage shall be 25%);
        3.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.
        4.     Conditions Precedent.     This amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:
        (a)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.
        (b)   Such other matters as the Lender may require.
1

        5.     Representations and Warranties.     The Borrower hereby represents and warrants to the Lender as follows:
        (a)   The Borrower has all requisite power and authority to execute this Amendment to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by the Borrower and constitutes the legal, valid and binding obligation of the Borrower, enforceable in accordance with its terms.
        (b)   The execution, delivery and performance by the Borrower of this Amendment have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to the Borrower, or the articles of incorporation or by-laws of the Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected.
        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.
        6.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.
        7.     No Waiver.     The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.
        8.     Costs and Expenses.     The Borrower hereby reaffirms its agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limited the generality of the foregoing, the Borrowers specifically agrees to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrower hereby agrees that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrower, make a loan to the Borrower under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses.
        12.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.
[remainder of this page is intentionally left blank]
2

         IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

 	 	WELLS FARGO BUSINESS CREDIT, INC.	

 	
By:	

Name:
Its:	

 	
NETLIST, INC.	

 	
By:	

Name:
Its:	

 	
NETLIST TECHNOLOGY TEXAS, L.P.	

 	
By:	

Name:
Its:	
Third Amendment to Amended and Restated
Credit and Security Agreement
S-1

ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

 	

CHUN K. HONG, an individual	

 	

CHRISTOPHER LOPES, an individual	

 	

JAYESH BHAKTA, an individual	

 	
NETLIST HOLDINGS GP, INC.	

 	
By:	

Name:
Its:	

 	
NETLIST HOLDINGS LP, INC.	

 	
By:	

Name:
Its:	
2

 
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	 	HEUNGHWA INDUSTRY CO., LTD	

 	
By:	

Name:
Its:	
3

 
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	 	SERIM PAPER MANUFACTURING CO., LTD	

 	
By:	

Name:
Its:	
4

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 THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT
RECITALS
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
 
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Exhibit 10.5
 
 FOURTH AMENDMENT TO
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
AND WAIVER OF DEFAULTS
        THIS AMENDMENT, dated as of April    , 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division.
RECITALS
        The Borrowers and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to an Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Credit and Security Agreement, dated as of June 30, 2004, a Second Amendment to Credit and Security Agreement, dated as of December 20, 2005, and a Third Amendment to Credit and Security Agreement, dated as of February 14, 2006 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.
        WFBCI has merged with and into Lender and Lender is the surviving corporation.
        The Borrowers are in default of the following provisions of the Credit Agreement for the dates indicated (collectively, the "Existing Defaults"):

Section/Covenant
	 	Required Performance
	
6.2(a)—Minimum Book Net Worth Plus Subordinated Indebtedness	 	$5,150,000 at 12/31/05
$5,100,00 at 1/31/06
$5,100,000 at 2/28/06	

6.2(b)—Maximum Year to Date Consolidated Net Loss	
 	
<$450,000> at 12/31/05	

6.2(d)—Stop Loss	
 	
The Borrowers will not suffer a Net Loss in excess of $200,000 during any of the months of October, November or December, 2005, or in excess of $150,000 during the months of January and February 2006	

6.1(a)—Reporting Requirements	
 	
The Borrowers shall deliver their audited Financial Statements within 90 days after the end of the fiscal years ended 12/31/04 and 12/31/05	
        The Borrowers have requested that the Lender waive the Existing Defaults and make certain amendments to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.
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        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:
        1.     Defined Terms .    
        (a)   Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.
        (b)   The following definitions set forth in Section 1.1 of the Credit Agreement are hereby amended in their entirety as follows:
        "Inventory Advance Rate" means thirty-one percent (31%), or such other rate as the Lender in its sole discretion may deem appropriate from time to time.
        "Net Income" and "Net Loss" mean fiscal year-to-date before-tax net income, or loss, as applicable, prepared on a consolidating and consolidated basis to include any Subsidiaries, from continuing operations as determined in accordance with GAAP
        (c)   The following new definitions are hereby added to Section 1.1 of the Credit Agreement in appropriate alphabetical order:
        "Acquiror" has the meaning given to such term in the Agreement of Merger.
        "Agreement of Merger" means that certain Agreement and Plan of Merger, dated on or about May, 2006, to be entered into among Netlist, its shareholders, and a to be determined public company and its wholly-owned subsidiary.
        "Merger" has the meaning given to such term in the Agreement of Merger.
        "Minimum Net Proceeds" means $4,000,000 in cash proceeds received from the Private Offering, net of (i) attorneys' fees, accountants' fees, investment banking fees, brokerage commissions and amounts required to be applied to the repayment of any portion of any Indebtedness, (ii) other customary fees, expenses and commissions, and (iii) taxes paid or reasonably estimated to be payable as a result of the Private Offering.
        "Private Offering" means a private offering of securities of Acquiror following the Merger.
        (d)   Clause (b)(iii) of the definition of "Borrowing Base" set forth in Section 1.1 of the Credit Agreement is hereby amended in its entirety as follows:
        (iii)  the lowest of (A) the product of the Inventory Advance Rate times the Eligible Inventory, or (B) eighty percent (80%) of the Net Orderly Liquidation Value of the Eligible Inventory, or (C) $2,500,000, or (D) 50% of Eligible Accounts; less
        (e)   Upon consummation of the Private Offering and the Lender's verification of Borrowers' receipt of the Minimum Net Proceeds, the definitions of "Applicable Margin" and "Inventory Advance Rate" set forth in Section 1.1 of the Credit Agreement shall be automatically amended in their entirety as follows without further action required:
        "Applicable Margin" means, in the case of Advances against Eligible Foreign Accounts, 1.50 percentage points (150 basis points), and in the case of all other Advances, 0.50 percentage points (50 basis points).
        "Inventory Advance Rate" means forty percent (40%), or such other rate as the Lender in its sole discretion may deem appropriate from time to time.
        (f)    Upon consummation of the Private Offering and the Lender's verification of Borrowers' receipt of the Minimum Net Proceeds, clause (b)(iii) of the definition of "Borrowing Base" set forth in
2

Section 1.1 of the Credit Agreement shall be automatically amended in its entirety as follows without further action required:
        (iii)  the lowest of (A) the product of the Inventory Advance Rate times the Eligible Inventory, or (B) eighty percent (80%) of the Net Orderly Liquidation Value of the Eligible Inventory, or (C) $5,000,000, or (D) 50% of Eligible Accounts; less
        (g)   Clause (x) of the definition of "Eligible Accounts" set forth in Section 1.1 of the Credit Agreement is hereby amended in its entirety as follows:
         (x)  Accounts owed by an Account Debtor (or an Affiliate of such Account Debtor), regardless of whether otherwise eligible, to the extent that the balance of such Accounts exceeds 15% of the aggregate amount of all Accounts (except Dell Computer Corporation (excluding Dell Computer-Ireland) and Kingston Technology for which in case such percentage shall be 40%),
        2.     Financial Covenants .    Section 6.2 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.2     Financial Covenants .    
        (a)      Minimum Book Net Worth .    Borrowers will maintain at all times the sum of Netlist's Book Net Worth plus Subordinated Indebtedness, determined as at the end of each month, at an amount not less than the amount set forth in the table below opposite the applicable test date:

Test Date
	 	Minimum Book Net Worth Plus
Subordinated Indebtedness(1)
	
3/31/06	 	$5,350,000	
4/30/06	 	$5,200,000	
5/31/06	 	$5,050,000	
6/30/06	 	$5,100,000	
7/31/06	 	$4,900,000	
8/31/06	 	$4,925,000	
9/30/06	 	$5,300,000	
10/31/06	 	$5,450,000	
11/30/06	 	$5,750,000	
12/31/06 and thereafter	 	$6,250,000	

(1)
The covenant levels set forth in this table shall be increased (1) upon the closing of the Private Offering or any other equity or debt offering of the Borrowers or Acquiror, by an amount equal to 100% of the total capital raised in the month of closing, and (2) by the amount of any positive adjustments to the Book Net Worth set forth in the Borrowers' consolidated financial statements for the fiscal years ended 12/31/04 and 12/31/05 as a result of the finalization of the CPA audits of those financial statements.
        (b)      Minimum Net Income (Maximum Net Loss).     Netlist will achieve during each month or fiscal quarter, as applicable, described below minimum Net Income (or Maximum Net
3

Loss) of not less than (or more than, as applicable) the amount set forth opposite in the table below opposite such period:

Month Ending
	 	Minimum Consolidated
Net Income (Maximum
Net Loss) if Private
Offering has not been
consummated prior to
such measurement period
	 	Minimum Consolidated
Net Income (Maximum
Net Loss) if Private
Offering has been
consummated prior to
such measurement period
	
3/31/06	 	$150,000	 	<$275,000>	
4/30/06	 	<$350,000>	 	<$325,000>	
5/31/06	 	<$300,000>	 	<$300,000>	
6/30/06	 	<$50,000>	 	<$100,000>	

 	

 	
Fiscal Quarter Ending
	 	 	 	 	
9/30/06	 	$550,000	 	$300,000	
12/31/06	 	$900,000	 	$700,000	
        (c)      Capital Expenditures .    The Borrowers will not incur or contract to incur Capital Expenditures of more than $1,500,000 in the aggregate during the fiscal year ending December 31, 2006.
        (d)      Stop Loss .    The Borrowers will not suffer a Net Loss in excess of $150,000 during any month, commencing with the month ending July 31, 2006.
        3.     Permitted Liens .    Section 6.3(a) of the Credit Agreement is hereby amended in its entirety as follows:
        (a)   The Borrowers will not create, incur or suffer to exist any Lien upon or of any of its assets, now owned or hereafter acquired, to secure any indebtedness; excluding, however, from the operation of the foregoing, the following (collectively, "Permitted Liens"):
          (i)  in the case of any of the Borrowers' property which is not Collateral, covenants, restrictions, rights, easements and minor irregularities in title which do not materially interfere with the Borrowers' business or operations as presently conducted;
         (ii)  Liens in existence on the date hereof and listed in Schedule 6.3 hereto, securing indebtedness for borrowed money permitted under Section 6.4;
        (iii)  the Security Interest and Liens created by the Security Documents;
        (iv)  purchase money Liens relating to the acquisition of machinery and equipment of the Borrowers not exceeding the lesser of cost or fair market value thereof, not exceeding $150,000 for any one purchase or $1,300,000 in the aggregate during any fiscal year, and so long as no Default Period is then in existence and none would exist immediately after such acquisition; and
         (v)  Liens securing the Bridge Loan that are permitted under the Subordination Agreement(s) in the Lender's favor executed by the lenders of the Bridge Loan.
        4.      Merger.    Section 6.19 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.19     Consolidation and Merger; Asset Acquisitions .    The Borrowers will not consolidate with or merge into any Person, or permit any other Person to merge into it (other than the Merger), or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person.
4

        5.     Private Offering .    The following new Section 6.29 is hereby added to the Credit Agreement immediately following Section 6.28 thereof as follows:
        Section 6.29     Private Offering .    The Private Offering shall be consummated on terms and conditions satisfactory to the Lender not later than March 31, 2007, and Borrowers' shall receive the proceeds of the Private Offering which proceeds shall be in an amount not less than the Minimum Net Proceeds.
        6.     Change of Control .    Section 7.1(c) of the Credit Agreement is hereby amended in its entirety as follows:
        (c)   A Change of Control (other than as a result of the Merger) shall occur;
        7.     Waiver of Existing Defaults .    Upon the terms and subject to the conditions set forth in this Amendment, the Lender hereby waives the Existing Defaults; provided that the Borrowers shall deliver their audited Financial Statements for their fiscal year ended December 31, 2005 on or before May 1, 2006 and otherwise in compliance with Section 6.1(a) of the Credit Agreement. Failure by the Borrowers to comply with the proviso at the end of the prior sentence shall constitute a new and separate Event of Default. The waiver set forth in the first sentence of this Paragraph 7 shall be effective only in this specific instance and for the specific purpose for which it is given, and this waiver shall not entitle the Borrowers to any other or further waiver in any similar or other circumstances.
        8.     Amendment Fee .    The Borrowers shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $15,000 in consideration of the Lender's execution and delivery of this Amendment.
        9.     No Other Changes .    Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.
        10.     Conditions Precedent .    This Amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:
        (a)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.
        (b)   Payment of the Amendment Fee described in Paragraph 8 above.
        (c)   Such other matters as the Lender may require.
        11.     Representations and Warranties .    Each Borrower hereby represents and warrants to the Lender as follows:
        (a)   Such Borrower has all requisite power and authority to execute this Amendment to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by such Borrower and constitutes the legal, valid and binding obligation of such Borrower, enforceable in accordance with its terms.
        (b)   The execution, delivery and performance by each Borrower of this Amendment have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to such Borrower, or the articles of incorporation or by-laws of such Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or
5

instrument to which such Borrower is a party or by which it or its properties may be bound or affected.
        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.
        12.     References .    All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby.
        13.     No Waiver .    The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement (except for the Existing Defaults) or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.
        14.     Release .    
        (a)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which such Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:
A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.
        (b)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, each Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause.
6

        15.     Costs and Expenses .    The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses, and the Amendment Fee described in Paragraph 8 above.
        16.     Miscellaneous .    This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.
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7

         IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

WELLS FARGO BANK, NATIONAL ASSOCIATION 
Through its Wells Fargo Business Credit operating division	 	NETLIST, INC.	

By:	

	
 	
By:	

	
Name:	 	Jeffrey Cristol	 	Name:	 	Chun K. Hong	
Its	 	Vice President	 	Its:	 	President	

 	

NETLIST TECHNOLOGY TEXAS L.P.	
 	 	 	 	By:	 	Netlist Holdings GP, Inc., its general partner	

 	

By:	

	
 	 	 	 	Name:	 	Chun K. Hong	
 	 	 	 	Its:	 	President	
8

ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 14 thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.

 	

CHUN K. HONG , an individual	

 	

CHRISTOPHER LOPES , an individual	

 	

JAYESH BHAKTA , an individual	

 	
NETLIST HOLDINGS GP, INC.	

 	
By:	

 	 	Name:
Its:	 	
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ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Business Credit, Inc. (the "Lender") pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 14 thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	 	HEUNGHWA INDUSTRY CO., LTD	

 	
By:	

 	 	Name:
Its:	 	

 	
SERIM PAPER MANUFACTURING CO., LTD	

 	
By:	

 	 	Name:
Its:	 	
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 FOURTH AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT AND WAIVER OF DEFAULTS
 
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Exhibit 10.6
 
 FIFTH AMENDMENT TO
AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
        This Amendment, dated as of July 28, 2006, is made by and between NETLIST, INC., a Delaware corporation, and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership (each a "Borrower" and collectively, the "Borrowers"), on the one hand, and WELLS FARGO BANK, NATIONAL ASSOCIATION (as more fully defined in Paragraph 1 of this Amendment, the "Lender"), acting through its WELLS FARGO BUSINESS CREDIT operating division, on the other hand.
RECITALS
        The Borrowers and Wells Fargo Business Credit, Inc., a Minnesota corporation ("WFBCI"), are parties to an Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, as amended by a First Amendment to Amended and Restated Credit and Security Agreement, dated as of June 30, 2004, a Second Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of December 20, 2005, a Third Amendment to Credit and Security Agreement, dated as of February 14, 2006, and a Fourth Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of April 18, 2006 (as so amended , the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified.
        WFBCI has merged with and into Lender and Lender is the surviving corporation.
        The Borrowers have requested that the Lender make certain amendments to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein.
        NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows:
        1.     Defined Terms .    
        (a)   Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein.
        (b)   The following definitions set forth in Section 1.1 of the Credit Agreement are hereby amended in their entirety as follows:
        "Advance" means a Revolving Advance, the Term Advance, and an Equipment Advance.
        "Book Net Worth" means the aggregate of the common and preferred stockholders' equity in the Borrowers, prepared on a consolidating and consolidated basis, including any domestic Subsidiaries but excluding all foreign Subsidiaries, determined in accordance with GAAP.
        "Borrowing Base" means at any time the lesser of:
        (a)   The Maximum Line then in effect; or
        (b)   Subject to change from time to time in the Lender's sole discretion, the sum of:
          (i)  The product of the Accounts Advance Rate times Eligible Accounts ( provided that Advances against Accounts described in clause (xiv) of the definition of Eligible Accounts set forth in Section 1.1 shall not exceed 75% of the Maximum Line then in effect), plus
         (ii)  During the Foreign Accounts Eligibility Period, the lesser of (A) the product of the Accounts Advance Rate times Eligible Foreign Accounts or (B) $1,800,000, plus
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        (iii)  The lowest of (A) the product of the Inventory Advance Rate times Eligible Inventory or (B) eighty percent (80%) of the Net Orderly Liquidation Value of Eligible Inventory, or (C) $7,000,000, less
        (iv)  The Borrowing Base Reserve, less
         (v)  Indebtedness that the Borrowers owe to the Lender that has not yet been advanced on the Revolving Note, and the dollar amount that the Lender in its reasonable discretion then determines to be a reasonable determination of the Borrowers' credit exposure with respect to any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement offered to Borrowers by Lender that is not described in Article II of this Agreement and any indebtedness owed by Borrowers to Wells Fargo Merchant Services, LLC.
        "Bridge Loan" means that certain Subordinated Indebtedness owing to ARC by the Borrowers in the amount of $1,000,000.
        "Business Day" means a day on which the Federal Reserve Bank of New York is open for business and, if such day relates to a LIBOR Advance, a day on which dealings are carried on in the London interbank eurodollar market.
        "Floating Rate" means (i) with respect to Revolving Advances evidenced by the Revolving Note, an annual interest rate equal to the sum of the Prime Rate plus the applicable Margin, and (ii) with respect to the Term Advance evidenced by the Term Note, an annual interest rate equal to the sum of the Prime Rate plus the applicable Margin, which interest rate shall, in each case, change when and as the Prime Rate changes, and (iii) with respect to Equipment Advances evidenced by the Equipment Note, an annual interest rate equal to the sum of the Prime Rate plus the applicable Margin, which interest rate shall, in each case, change when and as the Prime Rate changes.
        "Foreign Accounts Eligibility Period" means until July 31, 2007.
        "Lender" means Wells Fargo Bank, National Association in its broadest and most comprehensive sense as a legal entity, and is not limited in its meaning to Lender's Wells Fargo Business Credit operating division, or to any other operating division of Lender.
        "Loan Documents" means this Agreement, the Revolving Note, the Term Note, the Equipment Note, each Guaranty, each Subordination Agreement, each L/C Application and the Security Documents, together with every other agreement, note, document, contract or instrument to which either Borrower now or in the future may be a party and which is required by the Lender.
        "Maturity Date" means July 31, 2008.
        "Maximum Line" means $25,000,000.
        "Minimum Interest Charge" means $37,500; provided that (i) upon the Lender's receipt of satisfactory evidence that the Borrowers have received not less than $15,000,000 Net Cash Proceeds from an IPO on terms and conditions satisfactory to the Lender, in its sole discretion, and (ii) no Default Period then exists, Minimum Interest Charge shall mean $25,000 effective from and after the date of any reduction in the Margin pursuant to Section 2.12(b).
        "Net Cash Proceeds" means (1) in connection with any asset sale, the cash proceeds (including any cash payments received by way of deferred payment whether pursuant to a note, installment receivable or otherwise, but only as and when actually received) from such asset sale, net of (i) attorneys' fees, accountants' fees, investment banking fees, brokerage commissions and amounts required to be applied to the repayment of any portion of the Debt secured by a Lien not
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prohibited hereunder on the asset which is the subject of such sale, and (ii) taxes paid or reasonably estimated to be payable as a result of such asset sale, and (2) in connection with any IPO, the cash proceeds from such IPO, net of (i) attorneys' fees, accountants' fees, investment banking fees, underwriters' fees, and other transaction fees and expenses, and (ii) taxes paid or reasonably estimated to be payable as a result of such IPO.
        "Net Income" and "Net Loss" mean fiscal year-to-date before-tax net income, or loss, as applicable, prepared on a consolidating and consolidated basis to include any domestic Subsidiaries (but to exclude all foreign Subsidiaries), from continuing operations as determined in accordance with GAAP.
        "Subordination Agreements" means (i) the Subordination Agreement, dated as of July 2, 2003, executed by Serim Paper Manufacturing Co., Ltd. in the Lender's favor and acknowledged by Netlist, (ii) the Subordination Agreement, dated as of July 2, 2003, executed by HeungHwa Industry Co. Ltd. in the Lender's favor and acknowledged by Netlist, and (iii) any other subordination agreement accepted by the Lender from time to time.
        (c)   The following new definitions are hereby added to Section 1.1 of the Credit Agreement in appropriate alphabetical order:
        "After Tax Net Income" means, for any period of determination, Borrowers' consolidated after-tax net income (including any domestic Subsidiaries (but excluding all foreign Subsidiaries), from continuing operations as determined in accordance with GAAP.
        "Applicable Period" means, for purposes of the Debt Service Coverage Ratio, the period indicated in the table below opposite the applicable test date:

Test Date
	 	Applicable Period
	
9/30/06	 	Three months ending on the test date	
12/31/06	 	Six months ending on the test date	
3/31/07	 	Nine months ending on the test date	
6/30/07 and each fiscal quarter end thereafter	 	Twelve months ending on the test date	
        "ARC" means ARC Investment Partners.
        "Current Maturities of Long Term Debt" means, for the Applicable Period, the amount of the Borrowers' long-term debt and capitalized leases which become due during that period.
        "Cut-off Time" means 10:30 a.m. Pasadena, California time.
        "Debt Service Coverage Ratio" means, for the Applicable Period, (i) the sum of (A) Funds from Operations and (B) Interest Expense minus (C) unfinanced Capital Expenditures divided by (ii) the sum of (A) Current Maturities of Long Term Debt and (B) Interest Expense.
        "Fifth Amendment" means that certain Fifth Amendment to Amended and Restated Credit and Security Agreement, dated as of July 28, 2006, among the Borrowers and the Lender.
        "Funds from Operations" means, for the Applicable Period, the sum of (i) Net Income, (ii) depreciation and amortization, (iii) any increase (or decrease) in deferred income taxes, (iv) any increase (or decrease) in lifo reserves, and (v) other non-cash items, each as determined for such period in accordance with GAAP.
        "Equipment Advance" is defined in Section 2.10(a).
        "Equipment Advance Commitment" means $2,000,000.
        "Equipment Advance Conversion Date" means January 31, 2007.
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        "Equipment Note" means the Borrowers' promissory note, payable to the order of the Lender in substantially the form of Exhibit B attached to the Fifth Amendment, as same may be renewed and amended from time to time, and all replacements thereto.
        "Excess Cash Flow" means, for any fiscal year, after-tax net income from continuing operations, including extraordinary losses but excluding extraordinary gains, depreciation and amortization, all as determined in accordance with GAAP.
        "Floating Rate Advance" means an Advance bearing interest at the Floating Rate.
        "Indebtedness" is used herein in its most comprehensive sense and means any and all advances, debts, obligations and liabilities of the Borrowers to the Lender, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, including under any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement at any time entered into by the Borrowers with the Lender or with Wells Fargo Merchant Services, L.L.C., and whether the Borrowers may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable.
        "Interest Expense" means, for the Applicable Period, the Borrowers' total gross interest expense during such period (excluding interest income), and shall in any event include (i) interest expensed (whether or not paid) on all Debt, (ii) the amortization of debt discounts, (iii) the amortization of all fees payable in connection with the incurrence of Debt to the extent included in interest expense, and (iv) the portion of any capitalized lease obligation allocable to interest expense.
        "Interest Period" means the period that commences on (and includes) the Business Day on which either a LIBOR Advance is made or continued, or on which a Floating Rate Advance is converted to a LIBOR Advance, and ending on (but excluding) the Business Day numerically corresponding to such date that is three, six, or twelve months thereafter as designated by the Borrowers, during which period the outstanding principal balance of the LIBOR Advance shall bear interest at the LIBOR Advance Rate; provided , however , that:
        (a)   No Interest Period may be selected for an Advance for a principal amount less than One Million Dollars ($1,000,000), and no more than four (4) different Interest Periods may be outstanding at any one time;
        (b)   If an Interest Period would otherwise end on a day which is not a Business Day, then the Interest Period shall end on the next Business Day thereafter, unless that Business Day is the first Business Day of a month, in which case the Interest Period shall end on the last Business Day of the preceding month);
        (c)   No Interest Period applicable to a Revolving Advance may end later than the Maturity Date; and
        (d)   In no event shall the Borrowers select Interest Periods with respect to Advances which, in the aggregate, would require payment of a contracted funds breakage fee under this Agreement in order to make required principal payments.
        "IPO" means an initial public offering of the Borrowers.
        "Letter of Credit Sublimit" means $3,000,000.
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        "LIBOR" means the rate per annum (rounded upward, if necessary, to the nearest whole 1 / 8 th of one (1%)) determined pursuant to the following formula:

LIBOR
	 	Base LIBOR
	
 	 	100%—LIBOR Reserve Percentage	
          (i)  "Base LIBOR" means the rate per annum for United States dollar deposits quoted by the Lender as the Inter-Bank Market Offered Rate, with the understanding that such rate is quoted by the Lender for the purpose of calculating effective rates of interest for loans making reference thereto, on the first day of a Interest Period for delivery of funds on said date for a period of time approximately equal to the number of days in such Interest Period and in an amount approximately equal to the principal amount to which such Interest Period applies. The Borrowers understand and agree that the Lender may base its quotation of the Inter-Bank Market Offered Rate upon such offers or other market indicators of the Inter-Bank Market as the Lender in its discretion deems appropriate including the rate offered for U.S. dollar deposits on the London Inter-Bank Market.
         (ii)  "LIBOR Reserve Percentage" means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for "Eurocurrency Liabilities" (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by the Lender for expected changes in such reserve percentage during the applicable Interest Period.
        "LIBOR Advance" means an Advance bearing interest at the LIBOR Advance Rate.
        "LIBOR Advance Rate" means (i) with respect to Revolving Advances evidenced by the Revolving Note, an annual interest rate equal to the sum of LIBOR plus the applicable Margin, and (ii) with respect to the Term Advance evidenced by the Term Note, an annual interest rate equal to the sum of LIBOR plus the applicable Margin, and (iii) with respect to all Equipment Advances evidenced by the Equipment Note, an annual interest rate equal to the sum of LIBOR plus the applicable Margin.
        "Overadvance" means the amount, if any, by which the outstanding principal balance of the Revolving Note, plus the L/C Amount, is in excess of the then-existing Borrowing Base.
        "Revolving Note" means the Borrowers' revolving promissory note, payable to the order of the Lender in substantially the form of Exhibit A attached to the Credit Agreement, as same may be renewed and amended from time to time, and all replacements thereto.
        "Term Advance" is defined in Section 2.9(a).
        "Term Note" means the Borrowers' promissory note, payable to the order of the Lender in substantially the form of Exhibit A attached to the Fifth Amendment, as same may be renewed and amended from time to time, and all replacements thereto.
        (d)   Clause (x) of the definition of "Eligible Accounts" set forth in Section 1.1 of the Credit Agreement is hereby amended in its entirety as follows:
         (x)  Accounts owed by an Account Debtor (or an Affiliate of such Account Debtor), regardless of whether otherwise eligible, to the extent that the balance of such Accounts exceeds 15% of the aggregate amount of all Accounts; provided that such concentration limit shall be 40% in the case of each of Dell Computer Corporation (excluding Dell Computer-Ireland), IBM, and Kingston Technology;
        (e)   The following definitions are hereby deleted in their entirety from Section 1.1 of the Credit Agreement: Applicable Margin, Banking Day, Base Rate, Issuer, Minimum Net Proceeds, Note, Obligations, Private Offering, and Wells Fargo Affiliate Obligations.
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        2.     Amendments to Sections 2.2 and 2.3 .    Sections 2.2 and 2.3 of the Credit Agreement are hereby amended in their entirety as follows:
        Section 2.2     Procedures for Requesting Advances .    The Borrowers shall comply with the following procedures in requesting Revolving Advances:
        (a)    Type of Advances.     Each Advance shall be funded as either a Floating Rate Advance or a LIBOR Advance, as the Borrowers shall specify in a request delivered to the Lender conforming to the requirements of Section 2.2(b); Floating Rate Advances and LIBOR Advances may be outstanding at the same time. Each request for a LIBOR Advance shall be in multiples of $1,000,000, with a minimum request of at least $1,000,000. LIBOR Advances shall not be available during Default Periods. The aggregate outstanding LIBOR Advances shall not exceed at any time 90% of the Maximum Line then in effect.
        (b)    Time for Requests.     The Borrowers shall request each Advance not later than the Cut-off Time on the Business Day immediately preceding the Business Day on which the Advance is to be made in the case of a Floating Rate Advance, and not later than the Cut-off Time on the third Business Day immediately preceding the Business Day on which the Advance is to be made in the case of a LIBOR Advance . Each request that conforms to the terms of this Agreement shall be effective upon receipt by the Lender, shall be in writing or by telephone or telecopy transmission, and shall be confirmed in writing by the Borrowers if so requested by the Lender , by (i) an Officer of the Borrowers; or (ii) a Person designated as the Borrowers' agent by an Officer of each Borrower in a writing delivered to the Lender; or (iii) a Person whom the Lender reasonably believes to be an Officer of each Borrower or such a designated agent, which confirmation shall specify whether the Advance shall be a Floating Rate Advance or a LIBOR Advance and, with respect to any LIBOR Advance, shall specify the principal amount of the LIBOR Advance and the Interest Period applicable thereto. The Borrowers shall repay all Advances even if the Lender does not receive such confirmation and even if the Person requesting an Advance was not in fact authorized to do so. Any request for an Advance, whether written or telephonic, shall be deemed to be a representation by the Borrowers that the conditions set forth in Section 4.2 have been satisfied as of the time of the request.
        (c)    Disbursement.     Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall disburse the proceeds of the requested Advance by crediting the same to the Borrowers' demand deposit account maintained with the Lender unless the Lender and the Borrowers shall agree in writing to another manner of disbursement.
        Section 2.3     LIBOR Advances .    
        (a)    Converting Floating Rate Advances to LIBOR Advances; Procedures.     So long as no Default Period is in effect, the Borrowers may convert all or any part of the principal amount of any outstanding Floating Rate Advance into a LIBOR Advance by requesting that the Lender convert same no later than the Cut-off Time on the third Business Day immediately preceding the Business Day on which the Borrowers wish the conversion to become effective. Each request that conforms to the terms of this Agreement shall be effective upon receipt by the Lender and shall be confirmed in writing by the Borrowers if the Lender so requests by any Officer or designated agent identified in Section 2.2(b) or Person reasonably believed by the Lender to be such an Officer or designated agent, which request shall specify the Business Day on which the conversion is to occur, the total amount of the Floating Rate Advance to be converted, and the applicable Interest Period. Each such conversion shall occur on a Business Day, and the aggregate amount of Floating Rate Advances converted to LIBOR Advances shall be in multiples of $1,000,000, with a minimum conversion amount of at least $1,000,000,
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provided that the aggregate outstanding LIBOR Advances shall not exceed at any time 90% of the Maximum Line then in effect.
        (b)    Procedures at End of an Interest Period.     Unless the Borrowers request a new LIBOR Advance in accordance with the procedures set forth below, or prepays the principal of an outstanding LIBOR Advance at the expiration of an Interest Period, the Lender shall automatically and without request of the Borrowers convert each LIBOR Advance to a Floating Rate Advance on the last day of the relevant Interest Period. So long as no Default exists, the Borrowers may cause all or any part of any maturing LIBOR Advance to be renewed as a new LIBOR Advance by requesting that the Lender continue the maturing Advance as a LIBOR Advance no later than the Cut-off Time on the third Business Day immediately preceding the Business Day constituting the first day of the new Interest Period. Each such request shall be confirmed in writing by the Borrowers upon the Lender's request by any Officer or designated agent identified in Section 2.2(b), which confirmation shall be effective upon receipt by the Lender, and which shall specify the amount of the expiring LIBOR Advance to be continued and the applicable Interest Period. Each new Interest Period shall begin on a Business Day and the amount of each LIBOR Advance shall be in multiples of $1,000,000, with a minimum Advance of at least $1,000,000, provided that the aggregate outstanding LIBOR Advances shall not exceed at any time 90% of the Maximum Line then in effect.
        (c)    Setting and Notice of Rates.     The Lender shall, with respect to any request for a LIBOR Advance under Section 2.2 or a conversion or renewal of a LIBOR Advance under this Section 2.3, provide the Borrowers with a LIBOR quote for each Interest Period identified by the Borrowers on the Business Day on which the request was made, if the request is received by the Lender prior to the Cut-off Time, or for requests received by the Lender after the Cut-off Time, on the next Business Day or on the Business Day on which the Borrowers have requested that the LIBOR Advance be made effective. If the Borrowers do not immediately accept a LIBOR quote, the quoted rate shall expire and any subsequent request from the Borrowers for a LIBOR quote shall be subject to redetermination by the Lender of the applicable LIBOR for the LIBOR Advance.
        (d)    Taxes and Regulatory Costs.     The Borrowers shall pay the Lender with respect to any Advance, upon demand and in addition to any other amounts due or to become due hereunder, any and all (i) withholdings, interest equalization taxes, stamp taxes or other taxes (except income and franchise taxes) imposed by any domestic or foreign governmental authority and related in any manner to LIBOR, and (ii) future, supplemental, emergency or other changes in the LIBOR Reserve Percentage, assessment rates imposed by the Federal Deposit Insurance Corporation, or similar requirements or costs imposed by any domestic or foreign governmental authority or resulting from compliance by the Lender with any request or directive (whether or not having the force of law) from any central bank or other governmental authority and related in any manner to LIBOR to the extent they are not included in the calculation of LIBOR. In determining which of the foregoing are attributable to any LIBOR option available to the Borrowers hereunder, any reasonable allocation made by the Lender among its operations shall be conclusive and binding upon the Borrowers.
        3.     Amendment to Sections 2.5, 2.6, 2.7 and 2.8 .    Sections 2.5, 2.6, 2.7 and 2.8 of the Credit Agreement are hereby amended in their entirety as follows:
        Section 2.5     Letters of Credit .    
        (a)   The Lender agrees, subject to the terms and conditions of this Agreement, to issue, at any time after the Funding Date and prior to the Termination Date, one or more irrevocable standby or documentary letters of credit (each, a "Letter of Credit") for the
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Borrowers' account. The Lender will not issue any Letter of Credit if the face amount of the Letter of Credit to be issued would exceed the lesser of:
          (i)  The Letter of Credit Sublimit less the L/C Amount, or
         (ii)  Availability.
Each Letter of Credit, if any, shall be issued pursuant to a separate L/C Application made by the Borrowers to the Lender, which must be completed in a manner satisfactory to the Lender. The terms and conditions set forth in each such L/C Application shall supplement the terms and conditions of the Standby Letter of Credit Agreement or the Commercial Letter of Credit Agreement, as applicable.
        (b)   No Letter of Credit shall be issued with an expiry date later than one (1) year from the date of issuance or the Maturity Date in effect as of the date of issuance, whichever is earlier.
        (c)   Any request for issuance of a Letter of Credit shall be deemed to be a representation by the Borrowers that the conditions set forth in Section 4.2 have been satisfied as of the date of the request.
        (d)   If a draft is submitted under a Letter of Credit when the Borrowers are unable, because a Default Period exists or for any other reason, to obtain a Revolving Advance to pay the Obligation of Reimbursement, the Borrowers shall pay to the Lender on demand and in immediately available funds, the amount of the Obligation of Reimbursement together with interest, accrued from the date of the draft until payment in full at the Default Rate. Notwithstanding the Borrowers' inability to obtain a Revolving Advance for any reason, the Lender is irrevocably authorized, in its sole discretion, to make a Revolving Advance in an amount sufficient to discharge the Obligation of Reimbursement and all accrued but unpaid interest thereon.
        Section 2.6     Special Account .    If the Credit Facility is terminated for any reason while any Letter of Credit is outstanding, the Borrowers shall thereupon pay the Lender in immediately available funds for deposit in the Special Account an amount equal to the L/C Amount plus any anticipated fees and costs. If the Borrowers fail to promptly make any such payment in the amount required hereunder, then the Lender may make a Revolving Advance against the Credit Facility in an amount sufficient to fulfill this obligation and deposit the proceeds to the Special Account. The Special Account shall be an interest bearing account either maintained with the Lender or with a financial institution acceptable to the Lender. Any interest earned on amounts deposited in the Special Account shall be credited to the Special Account. The Lender may apply amounts on deposit in the Special Account at any time or from time to time to the Indebtedness in the Lender's sole discretion. The Borrowers may not withdraw any amounts on deposit in the Special Account as long as the Lender maintains a security interest therein. The Lender agrees to transfer any balance in the Special Account to the Borrowers when the Lender is required to release its security interest in the Special Account under applicable law.
        Section 2.7     Intentionally Deleted .    
        Section 2.8     Intentionally Deleted .    
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         4.     Amendments to Section 2.9, 2.10 and 2.11.     Sections 2.9, 2.10 and 2.11 of the Credit Agreement are hereby amended in their entirety as follows:
        Section 2.9     Term Advance .    
        (a)   The Lender agrees, subject to the terms and conditions of this Agreement, to make one or two advances to the Borrowers up to the aggregate amount of $2,000,000 (collectively the "Term Advance") which shall be advanced as follows: (i) $1,000,000 on the first Business Day following the effective date of the Fifth Amendment; and (ii) $1,000,000 if and only if the Borrowers' year to date After Tax Net Income as at August 31, 2006 equals or exceeds $1,208,000 as verified by the Borrowers' monthly financial statements delivered pursuant to Section 6.1(b), which, if such condition is met, shall be advanced on the Business Day following such verification. The Borrowers' obligation to pay the Term Advance shall be evidenced by the Term Note and shall be secured by the Collateral as provided in Article III.
        (b)   On the dates specified above, the Lender shall deposit the proceeds of the Term Advance by crediting the same to the Borrowers' demand deposit account specified in Section 2.2(c) unless the Lender and the Borrowers shall agree in writing to another manner of disbursement.
        Section 2.10     Payment of Term Note .    
        (a)   The outstanding principal balance of the Term Note shall be due and payable as follows:
          (i)  In equal monthly installments of $83,350, beginning on September 1, 2006, and on the first day of each month thereafter; and
         (ii)  The Borrowers shall make a principal reduction payment on the Term Note in an amount equal to the lesser of (1) 10% of the Borrowers' Excess Cash Flow for its fiscal year ending December 31, 2006, or (2) $500,000, in either case together with any prepayment fee owed pursuant to Section 2.13(h). Such principal reduction payment shall be due concurrent with the Borrowers' delivery of its annual audited financial statements for such fiscal year delivered pursuant to Section 6.1(a) indicating the amount of such Excess Cash Flow.
        (b)   All prepayments of principal with respect to the Term Note shall be applied to the most remote principal installment or installments then unpaid.
        (c)   On the earlier of (i) the closing of an IPO, or (ii) the Termination Date of the Credit Facility, the entire unpaid principal balance of the Term Note and all unpaid interest accrued thereon shall also be fully due and payable.
        Section 2.11     Equipment Advances.     
        (a)   Subject to the terms and conditions hereof, from the first Business Day following the effective date of the Fifth Amendment up to but not including the Equipment Advance Conversion Date, the Lender agrees to make one or more advances (each, an "Equipment Advance" and collectively the "Equipment Advances") to or for the benefit of the Borrowers, in minimum amounts of $100,000 up to an aggregate amount not to exceed the Equipment Advance Commitment. The Borrowers' obligation to pay the Equipment Advances shall be evidenced by the Equipment Note and shall be secured by the Collateral as provided in Article III. Equipment Advances may not be re-borrowed after repayment is made by the Borrowers. Each Equipment Advance shall be advanced directly to the applicable vendor or the Borrowers, as the Borrowers may request. The foregoing to the contrary notwithstanding, (i) each Equipment Advance shall be in an amount, as determined by the Lender, not to
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exceed 80% of the Borrowers' invoice cost (net of shipping, taxes, freight, installation, and other so-called "soft costs") of new or used Equipment that is to be purchased by the Borrowers with the proceeds of such Advance, or new or used Equipment that has been purchased by the Borrowers within 30 days prior to the date of such Advance, (ii) the Equipment that is to be acquired or that has been purchased by the Borrowers must be acceptable to the Lender in all respects, not be a fixture, and not be intended to be affixed to real property or to become installed in or affixed to other goods, and must be located at one of the Borrowers' facilities located in the United States, (iii) the Lender shall have no obligation to make any Equipment Advance hereunder to the extent that the making thereof would cause the then outstanding amount of all Equipment Advances to exceed the Equipment Advance Commitment, (iv) prior to each such Equipment Advance, the Lender shall have received an invoice for the Equipment to be purchased in form and substance satisfactory to the Lender, together with evidence satisfactory to the Lender that the delivery of such Equipment has been made and unconditionally accepted by the Borrowers, (v) the Lender may review the value of any Equipment purchased with any Equipment Advance, with the results of such review to be satisfactory to the Lender in its sole discretion, (vi) the aggregate amount of all Equipment Advances outstanding at any time (including giving effect to any requested Equipment Advance) shall not exceed the lesser of cost or fair market value, of all of the Equipment acquired or financed with the proceeds of such Equipment Advances, and (vii) on the Equipment Advance Conversion Date the Equipment Advance Commitment and the Lender's obligation to make Equipment Advances shall terminate.
        (b)   Until the Equipment Advance Conversion Date, no principal payments shall be due on the outstanding Equipment Advances; provided that the Borrowers shall make interest payments thereon during such period in accordance with Section 2.12. The Borrowers shall repay the Equipment Advances in equal monthly installments of principal, each in the amount equal to 1 / 42 of the aggregate amount of all Equipment Advances outstanding on the Equipment Advance Conversion Date and such installments to be due and payable on the first day of each month commencing February 1, 2007 and continuing on the first day of each succeeding month.
        (c)   If the Lender at any time obtains an appraisal of the Equipment as permitted under Section 6.10(e) herein, and the appraisal shows the aggregate outstanding principal balance of the Equipment Note to exceed eighty percent (80%) of the Net Orderly Liquidation Value of the Equipment financed with the Equipment Advances, then the Borrowers, upon demand by the Lender, shall immediately prepay the Equipment Note in the amount of such excess, together with any prepayment fee owed pursuant to Section 2.13(k). All prepayments of principal with respect to the Equipment Note shall be applied to the most remote principal installment or installments then unpaid.
        (d)   Notwithstanding the foregoing, on the Termination Date, the entire unpaid principal balance of the Equipment Note, and all unpaid interest accrued thereon, shall in any event be due and payable.
        5.     Amendment to Sections 2.12(a), (b) and (c).     Sections 2.12(a), (b) and (c) of the Credit Agreement are hereby amended in their entirety as follows:
        (a)    Interest.     Except as provided in Section 2.3, Section 2.12(d) and Section 2.12(g), the principal amount of each Advance shall bear interest as a Floating Rate Advance.
        (b)    Margins.     The Margins through and including the first adjustment occurring as specified below shall be one half of one percent (0.5%) for all portions of the Term Advance that are Floating Rate Advances, one half of one percent (0.5%) for Revolving Advances that are Floating Rate Advances, one half of one percent (0.5%) for Equipment Advances that are
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Floating Rate Advances, three percent (3.0%) for all portions of the Term Advance that are LIBOR Advances, three percent (3.0%) for Revolving Advances that are LIBOR Advances, and three percent (3.0%) for Equipment Advances that are LIBOR Advances. The Margins shall be reduced in accordance with the table below provided that the Borrowers meet either one of the two conditions set forth in the following table:

 	 	Margins
	 	
 	 	Floating Rate Advances
	 	LIBOR Advances
	 	
Condition
	 	Revolving
Advances
	 	Term
Advance
and
Equipment
Advances
	 	Revolving
Advances
	 	Term
Advance
and
Equipment
Advances

(i) Upon the Lender's receipt of satisfactory evidence that the Borrowers have received not less than $15,000,000 Net Cash Proceeds from an IPO on terms and conditions satisfactory to the Lender, in its sole discretion; or	
 	
0.0	
%	
0.0	
%	
2.5	
%	
2.5	
%	

(ii) Annual Net Income is determined by the Lender to be greater than $2,500,000	

 	

 	

 	
        Any reductions in the Margins will be made upon the Lender's verification that the Borrowers have met either of the conditions set forth above, effective the first day of the month following such verification. Notwithstanding the foregoing, no reduction in any Margin will be made if a Default Period exists at the time that such reduction would otherwise be made.
        If the Margins are reduced as a result of the Borrower's achieving annual Net Income greater than $2,500,000 and if amended or restated financial statements disclose annual Net Income less than that amount, the Lender may increase the Margins to their prior level from the date of receipt of such amended or restated financial statements, to the beginning of the appropriate month to which the restated statements relate or to the beginning of the month in which any Event of Default has occurred, as the Lender in its sole discretion deems appropriate.
        (c)    Minimum Interest Charge.     Notwithstanding any other terms of this Agreement to the contrary, the Borrowers shall pay to the Lender interest of not less than the Minimum Interest Charge per calendar quarter during the term of this Agreement, and the Borrowers shall pay any deficiency between the Minimum Interest Charge and the amount of interest otherwise calculated under Subsection (a) on the first day of each month and on the Termination Date.
        6.     Amendment to Section 2.13(e).     Section 2.13(e) of the Credit Agreement is hereby amended in its entirety as follows:
        (e)    Termination Fees.     If the Credit Facility is terminated (i) by the Lender during a Default Period that begins before the Maturity Date, or (ii) by the Borrowers as of a date other than the Maturity Date, the Borrowers shall pay to the Lender a fee in the amount of $350,000.
        7.     Contracted Funds Breakage Fees; Overadvance Fees.     New Sections 2.13(k) and (l) are hereby added to the Credit Agreement immediately following Section 2.13(j) thereof as follows:
        (k)    Contracted Funds Breakage Fees.     The Borrowers may prepay the principal amount of the Revolving Note, the Term Note and/or the Equipment Note at any time in any amount, whether voluntarily or by acceleration, subject to the payment of fees as follows: If the
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principal amount of any Revolving Note, Term Note or Equipment Note LIBOR Advance is prepaid, the Borrowers shall pay to the Lender immediately upon demand a contracted funds breakage fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which such Interest Period matures, calculated as follows for each such month:
        (A)   Determine the amount of interest which would have accrued each month on the amount prepaid at the interest rate applicable to such amount had it remained outstanding until the last day of the applicable Interest Period.
        (B)   Subtract from the amount determined in (A) above the amount of interest which would have accrued for the same month on the amount prepaid for the remaining term of such Interest Period at LIBOR in effect on the date of prepayment for new loans made for such term and in a principal amount equal to the amount prepaid.
        (C)  If the result obtained in (B) for any month is greater than zero, discount that difference by LIBOR used in (B) above.
The Borrowers acknowledge that prepayment of the Revolving Note, the Term Note and/or the Equipment Note may result in the Lender incurring additional costs, expenses or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses or liabilities. The Borrowers therefore agree to pay the above-described prepayment fee and contracted funds breakage fee and agrees that said amounts represent a reasonable estimate of the prepayment costs, contracted funds breakage costs, expenses and/or liabilities of the Lender.
        (l)     Overadvance Fees.     The Borrowers shall pay an Overadvance fee in an amount equal to the greater of 0.1% of the amount of the Overadvance or $500.00, at the Lender's discretion, for each day or portion thereof during which an Overadvance exists, regardless of how the Overadvance arises or whether or not the Overadvance has been agreed to in advance by the Lender. The acceptance of payment of an Overadvance fee by the Lender shall not be deemed to constitute either consent to the Overadvance or a waiver of the resulting Event of Default, unless the Lender specifically consents to the Overadvance in writing and waives the Event of Default on whatever conditions the Lender deems appropriate.
        8.     Repayment of Bridge Loan.     Section 2.19 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 2.19     Use of Proceeds.     The Borrowers shall use the proceeds of Advances and each Letter of Credit for ordinary working capital purposes, and to repay in full the Bridge Loan.
        9.     Amendment to Section 3.1.     Section 3.1 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 3.1     Grant of Security Interest.     Each Borrower hereby pledges, assigns and grants to the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a lien and security interest (collectively referred to as the "Security Interest") in the Collateral, as security for the payment and performance of: (a) all present and future Indebtedness of the Borrowers to the Lender; (b) all obligations of the Borrowers and rights of the Lender under this Agreement; and (c) all present and future obligations of the Borrowers to the Lender of other kinds. Upon request by the Lender, each Borrower will grant the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a security interest in all commercial tort claims that such Borrower may have against any Person.
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        10.     Amendment to Section 6.1(b).     Section 6.1(b) of the Credit Agreement is amended in its entirety as follows:
        (b)    Monthly and Quarterly Financial Statements.
        (1)   As soon as available and in any event within 20 days after the end of each month, the Borrowers will deliver to the Lender an unaudited/internal balance sheet and statements of income and retained earnings of the Borrowers as at the end of and for such month and for the year to date period then ended, prepared, on a consolidated basis, in reasonable detail and stating in comparative form the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments and absence of footnotes, and which fairly represent the Borrowers' financial position and the results of its operations; and accompanied by a certificate of each Borrower's chief financial Officer, substantially in the form of Exhibit C to the Fifth Amendment stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end audit adjustments and absence of footnotes, (ii) whether or not such officer has knowledge of the occurrence of any Default or Event of Default not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrowers are in compliance with the Financial Covenants.
        (2)   As soon as available and in any event within 20 days after the end of each fiscal quarter, the Borrowers will deliver to the Lender an unaudited/internal balance sheet and statements of income and retained earnings of the Borrowers as at the end of and for such quarter and for the year to date period then ended, prepared, on a consolidating and consolidated basis to include all domestic and foreign Subsidiaries, in reasonable detail and stating in comparative form the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments and absence of footnotes, and which fairly represent the Borrowers' financial position and the results of its operations; and accompanied by a certificate of each Borrower's chief financial Officer, substantially in the form of Exhibit C to the Fifth Amendment stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end audit adjustments and absence of footnotes, (ii) whether or not such officer has knowledge of the occurrence of any Default or Event of Default not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrowers are in compliance with the Financial Covenants.
        11.     Projections.     Section 6.1(d) of the Credit Agreement is amended in its entirety as follows:
        (d)    Projections .    At least 30 days before the beginning of each fiscal year of the Borrowers (except with respect to the Borrowers' fiscal year 2007, in which case by December 31, 2006), the Borrowers will deliver to the Lender the projected consolidated balance sheets and income statements for each month of such year, each in reasonable detail, representing the Borrowers' good faith projections and certified by each Borrower's chief financial Officer as being the most accurate projections available and identical to the projections used by the Borrowers for internal planning purposes, together with a statement of underlying assumptions and such supporting schedules and information as the Lender may in its discretion require.
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        12.     Financial Covenants.     Section 6.2 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.2     Financial Covenants.     
        (a)    Minimum Book Net Worth Plus Subordinated Indebtedness.     The Borrowers will maintain at all times the sum of Netlist's Book Net Worth plus Subordinated Indebtedness, determined as at the end of each month, at an amount not less than the amount set forth in the table below opposite the applicable test date:

Test Date
	 	Minimum Book Net Worth Plus
Subordinated Indebtedness(1)
	
7/31/06	 	$	5,550,000	
8/31/06	 	$	5,550,000	
9/30/06	 	$	5,850,000	
10/31/06	 	$	6,000,000	
11/30/06	 	$	6,250,000	
12/31/06 and each month end thereafter	 	$	6,700,000	

(1)
The covenant levels set forth in this table shall be increased upon the closing of the Private Offering or any IPO or debt offering of the Borrowers or Acquiror, by an amount equal to 100% of the total capital raised in the month of closing.
        (b)    Minimum Net Income. Netlist will achieve during each fiscal quarter described below minimum Net Income of not less than the amount set forth in the table below opposite such period:

Fiscal Quarter Ending
	 	Minimum Net Income
	
9/30/06	 	$	300,000	
12/31/06	 	$	700,000	
3/31/07	 	$	300,000	
        (c)    Capital Expenditures .    The Borrowers will not incur or contract to incur Capital Expenditures of more than $2,000,000 in the aggregate during the period from July 1, 2006 through December 31, 2006.
        (d)    Stop Loss.     The Borrowers will not suffer a Net Loss in excess of $150,000 during any month, commencing with the month ending July 31, 2006.
        (e)    Minimum Debt Service Coverage Ratio.     The Borrowers will maintain , as of each fiscal quarter end commending with the fiscal quarter ending September 30, 2006, a Debt Service Coverage Ratio of not less than 1.10 to 1.0.
        13.     Amendment to Section 6.4.     Section 6.4 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.4     Indebtedness.     The Borrowers will not incur, create, assume or permit to exist any indebtedness or liability on account of deposits or advances or any indebtedness for borrowed money or letters of credit issued on the Borrowers' behalf, or any other indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:
        (a)   Any existing or future Indebtedness or any other obligations of the Borrowers to the Lender;
        (b)   Any indebtedness of the Borrowers in existence on the date hereof and listed in Schedule 6.4 hereto;
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        (c)   Any indebtedness relating to Permitted Liens;
        (d)   Indebtedness consisting of intercompany transactions in the ordinary course of business between the Borrowers;
        (e)   the Bridge Loan; provided that such loan is repaid in full with the proceeds of the first installment of the Term Advance; and
        (f)    Subordinated Indebtedness.
        14.     Amendments to Section 6.6.     
        (a)   Section 6.6(e) of the Credit Agreement is hereby amended in its entirety as follows:
        (e)   Debt consisting of intercompany transactions in the ordinary course of business between the Borrowers; provided that the aggregate Debt due from any Chinese Subsidiary formed by Borrowers together with any equity investment made in such Chinese Subsidiary pursuant to Section 6.6(f) shall not exceed at any time the aggregate amount $5,000,000.
        (b)   A new clause (f) is hereby added to Section 6.6 of the Credit Agreement immediately following clause (e) thereof as follows:
        (f)    The Borrowers shall be permitted to form and own a wholly-owned Subsidiary under the laws of the People's Republic of China or any province thereof; provided that (i) on or within thirty (30) days following the issuance of stock of such Subsidiary to the Borrowers, the Borrowers shall pledge to the Lender 65% of such stock to secure the Obligations pursuant to a stock pledge agreement and such other documentation as the Lender shall reasonably require in connection therewith, all in form and substance satisfactory to the Lender in its sole discretion, and (ii) the aggregate Debt due from any Chinese Subsidiary formed by Borrowers together with any equity investment made in such Chinese Subsidiary pursuant to this Section 6.6(f) shall not exceed at any time the aggregate amount $5,000,000.
        15.     Amendment to Section 6.10.     Section 6.10 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.10     Books and Records; Collateral Examination, Inspection and Appraisals.     
        (a)   The Borrowers will keep accurate books of record and account for themselves pertaining to the Collateral and pertaining to each Borrower's business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender's request, will permit any officer, employee, attorney, accountant or other agent of the Lender to audit, review, make extracts from or copy any and all company and financial books and records of the Borrowers at all times during ordinary business hours, to send and discuss with account debtors and other obligors requests for verification of amounts owed to either Borrower, and to discuss each Borrower's affairs with any of its Directors, Officers, employees or agents.
        (b)   Each Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to the Lender or its designated agent, at the Borrowers' expense, all financial information, books and records, work papers, management reports and other information in their possession regarding the Borrowers ("Borrower Information"). Lender agrees that it shall only request the Borrower Information from such accountants and third parties following the occurrence and during the continuance of an Event of Default.
        (c)   The Borrowers will permit the Lender or its employees, accountants, attorneys or agents, to examine and inspect any Collateral or any other property of either Borrower at any time during ordinary business hours.
15

        (d)   The Lender may also, from time to time (but no more frequently than quarterly unless an Event of Default has occurred and is continuing), obtain at the Borrowers' expense an appraisal of the Inventory by an appraiser acceptable to the Lender in its sole discretion.
        (e)   The Lender may also, from time to time (and will no less than once per year), obtain at the Borrowers' expense an appraisal of the Equipment by an appraiser acceptable to the Lender in its sole discretion.
        16.     Amendment to Section 6.29.     Section 6.29 of the Credit Agreement is hereby amended in its entirety as follows:
        Section 6.29     Intentionally Deleted.     
        17.     Amendment to Section 7.1.     Section 7.1 of the Credit Agreement is hereby amended by adding a new clause (x) immediately following clause (w) thereof as follows:
        (x)   An Overadvance arises as the result of any reduction in the Borrowing Base, or arises in any manner on terms not otherwise approved of in advance by the Lender in writing.
        18.     Amendment Fee.     The Borrowers shall pay the Lender as of the date hereof a fully earned, non-refundable fee in the amount of $30,000 in consideration of the Lender's execution and delivery of this Amendment.
        19.     No Other Changes.     Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder.
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         20.     Conditions Precedent.     This Amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion:
        (a)   The Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors set forth at the end of this Amendment, duly executed by each Guarantor and Subordinated Creditor.
        (b)   The Term Note and the Equipment Note, each duly executed by the Borrowers.
        (c)   A Payoff Letter from ARC indicating the amount required to repay the Bridge Loan in full and obtain a termination or release of all of the Liens existing in favor of ARC in and to the assets of Borrowers, and otherwise in form and substance satisfactory to the Lender.
        (d)   An Authority to Pay Letter on the Lender's standard form duly executed by the Borrowers authorizing and directing the Lender to pay ARC the amounts demanded in the Payoff Letter described in clause (c) above.
        (e)   Payment of the Amendment Fee described in Paragraph 18 above.
        (f)    Such other matters as the Lender may require.
        21.     Conditions Subsequent.     The effectiveness of this Amendment is further subject to and contingent upon the receipt by the Lender, on or before 5:00 p.m., August 28, 2006, of a Certificate of the Secretary of each Borrower, in form and substance satisfactory to the Lender in its sole discretion, certifying as to (i) the resolutions of the board of directors of such Borrower ratifying and approving the execution and delivery of this Amendment, the Term Note and the Equipment Note, (ii) true, correct and complete copies of such Borrower's Constituent Documents, and (iii) that the officers and agents of such Borrower who have been certified to the Lender pursuant to a Certificate of Authority of such Borrower's secretary or assistant secretary, as being authorized to sign and to act on behalf of such Borrower continue to be so authorized or setting forth the sample signatures of each of the officers and agents of such Borrower authorized to execute and deliver this Amendment, the Term Note and the Equipment Note, and all other documents, agreements and certificates on behalf of such Borrower. In the event that the Borrowers shall fail to fulfill the condition subsequent set forth in this Paragraph 21 to the satisfaction of the Lender, in its sole discretion, on or before the date indicated, such failure shall constitute an Event of Default.
        22.     Representations and Warranties.     Each Borrower hereby represents and warrants to the Lender as follows:
        (a)   Such Borrower has all requisite power and authority to execute this Amendment, the Term Note and the Equipment Note, to perform all of its obligations hereunder and thereunder, and this Amendment, the Term Note and the Equipment Note have been duly executed and delivered by such Borrower and constitute the legal, valid and binding obligation of such Borrower, enforceable in accordance with their terms.
        (b)   The execution, delivery and performance by each Borrower of this Amendment, the Term Note and the Equipment Note have been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to such Borrower, or the articles of incorporation or by-laws of such Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which such Borrower is a party or by which it or its properties may be bound or affected.
17

        (c)   All of the representations and warranties contained in Article V of the Credit Agreement are correct on and as of the date hereof as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date.
        23.     References.     All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby. All references in the Credit Agreement to "Obligations" (prior to giving effect to this Amendment) shall be deemed to be a reference to the new term "Indebtedness" set forth in Paragraph 1 above.
        24.     No Waiver.     The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement (except for the Existing Defaults) or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment.
        25.     Release.     
        (a)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which such Borrower or such Guarantor or such Subordinated Creditor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each certifies that it has read the following provisions of California Civil Code Section 1542:
A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.
        (b)   Each Borrower , and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, each understands and acknowledges that the significance and consequence of this waiver of California Civil Code Section 1542 is that even if it should eventually suffer additional damages arising out of the facts referred to above, they will not be able to make any claim for those damages. Furthermore, each Borrower and each Guarantor by signing the Acknowledgment and Agreement of Guarantors set forth below, and each Subordinated Creditor by signing the Acknowledgment and Agreement of Subordinated Creditors set forth below, acknowledges that it intends these consequences even as to claims for damages that may exist as of the date of this release but which it does not know exist, and which, if known, would materially affect its decision to execute this Agreement, regardless of whether its lack of knowledge is the result of ignorance, oversight, error, negligence, or any other cause.
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        26.     Costs and Expenses.     The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Loan Documents, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to the Borrowers under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses, and the Amendment Fee described in Paragraph 18 above.
        27.     Miscellaneous.     This Amendment and the Acknowledgment and Agreement of Guarantors and the Acknowledgment and Agreement of Subordinated Creditors may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument.
[remainder of this page intentionally left blank]
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         IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first written above.

WELLS FARGO BANK, NATIONAL ASSOCIATION 
Through its Wells Fargo Business Credit operating division	 	NETLIST, INC.	

By	

	
 	
By:	

	
Name:	 	Jeffrey Cristol	 	Name:	 	Chun K. Hong	
Its	 	Vice President	 	Its:	 	President	

 	

NETLIST TECHNOLOGY TEXAS L.P.	
 	 	 	 	By:	 	Netlist Holdings GP, Inc., its general partner	

 	

 	
 	
By:	

	
 	 	 	 	 	 	Name:	 	Chun K. Hong	
 	 	 	 	 	 	Its:	 	President	
Signature page to
Fifth Amendment To
Amended And Restated Credit And Security Agreement
S-1

 
 ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS
AND AMENDMENT TO GUARANTY
        The undersigned, each a guarantor of the indebtedness of Netlist, Inc. and Netlist Technology Texas L.P. (collectively, the "Borrowers") to Wells Fargo Bank, National Association (the "Lender"), acting through its Wells Fargo Business Credit operating division, successor-by-merger to Wells Fargo Business Credit, Inc., pursuant to a separate guaranty (each, a "Guaranty"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 25 thereof; (iii) reaffirms his obligations to the Lender pursuant to the terms of his/its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under his/its Guaranty for all of the Borrowers' present and future indebtedness to the Lender.
        Section 4 of each Guaranty is hereby amended in its entirety as follows:
         4.     Performance Under This Guaranty.     In the event that Borrowers fail to make any payment of any Guaranteed Obligations on or before the due date thereof, or if Borrowers shall fail to perform, keep, observe, or fulfill any other obligation referred to in clause (b) of Section 2 hereof in the manner provided in the Loan Agreement or the other Loan Documents, as applicable, Guarantor immediately shall cause such payment to be made or each of such obligations to be performed, kept, observed, or fulfilled; provided , however , that the liability of Guarantor hereunder shall not exceed (i) the principal amount of One Million Dollars ($1,000,000), (ii) interest on such principal amount calculated pursuant to the terms of the Loan Agreement; plus (iii) the amounts owing under Section 13 hereof, if any.
        A new Section 25 is hereby added to each Guaranty immediately following Section 24 thereof as follows:
         25.     Termination and Release of Guaranty.     The Lender agrees to terminate and release this Guaranty promptly upon the Lender's receipt of satisfactory evidence that Borrowers have received not less than $15,000,000 Net Cash Proceeds from an IPO on terms and conditions satisfactory to the Lender, in its sole discretion; provided that no Default Period then exists.
[remainder of this page intentionally left blank]

 	 	
CHUN K. HONG, an individual	

 	

CHRISTOPHER LOPES, an individual	

 	

JAYESH BHAKTA, an individual	

 	
NETLIST HOLDINGS GP, INC.	

 	
By:	

 	 	Name:
Its:	
Agreed:	 	 	

WELLS FARGO BANK, NATIONAL ASSOCIATION 
Through its Wells Fargo Business Credit operating division	

By	

 	
 		 	 	
Name: Jeffrey Cristol
Its Vice President	 	 	
Signature page to
Acknowledgment And Agreement Of Guarantors
And Amendment To Guaranty
S-1

 
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
        The undersigned, each a subordinated creditor of Netlist, Inc. and Netlist Technology Texas L.P. (collectively the "Borrowers") to Wells Fargo Bank, National Association (the "Lender"), acting through its Wells Fargo Business Credit operating division, successor-by-merger to Wells Fargo Business Credit, Inc., pursuant to a separate Subordination Agreement each dated as of July 2, 2003 (each, a "Subordination Agreement"), hereby (i) acknowledges receipt of the foregoing Amendment; (ii) consents to the terms and execution thereof, including the Release set forth in Paragraph 25 thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Subordination Agreement; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Loan Documents and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the obligations of the undersigned under its Subordination Agreement.

 	 	HEUNGHWA INDUSTRY CO., LTD	

 	
By:	

 	 	Name:
Its:	

 	
SERIM PAPER MANUFACTURING CO., LTD	

 	
By:	

 	 	Name:
Its:	
Signature page to
Acknowledgment And Agreement Of Guarantors
And Amendment To Guaranty
S-1

Exhibit A
to
Fifth Amendment to Amended and Restated Credit and Security Agreement
 
 TERM NOTE

 	$2,000,000	 	July 28, 2006	
        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promise to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Lender"), acting through its Wells Fargo Business Credit operating division, on the Termination Date set forth in the Amended and Restated Credit and Security Agreement dated as of December 27, 2003 that was entered into by the Lender and the Borrowers (as amended to date and as may be further amended from time to time, the "Credit Agreement"), at Lender's main office located at in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Two Million Dollars ($2,000,000) or the aggregate unpaid principal amount of the Term Advance made by the Lender to the Borrowers under the Credit Agreement together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Term Note is fully paid at the rate from time to time in effect under the Credit Agreement.
        This Term Note is the Term Note referred to in the Credit Agreement, and is subject to the terms of, the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Term Note may be prepaid only in accordance with the terms of the Credit Agreement. This Term Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.
        The Borrowers hereby agree to pay all costs of collection, including attorneys' fees and legal expenses in the event this Term Note is not paid when due, whether or not legal proceedings are commenced.
        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

 	 	NETLIST, INC.	

 	
By:	

 	

 	 	 	 	Name: Chun K. Hong	
 	 	 	 	Its: President	

 	
NETLIST TECHNOLOGY TEXAS L.P. 
By: Netlist Holdings GP, Inc., its general partner	

 	

By:	

 	 	 	 	 	 		
 	 	 	 	Name: Chun K. Hong	
 	 	 	 	Its: President	
Exhibit A

 
 Exhibit B
to
Fifth Amendment to Amended and Restated Credit and Security Agreement
  EQUIPMENT NOTE

$2,000,000	 	July 28, 2006	
        For value received, the undersigned, NETLIST, INC., a Delaware corporation ("Netlist") and NETLIST TECHNOLOGY TEXAS, L.P., a Texas limited partnership ("NTTLP" and Netlist referred to herein collectively as the "Borrowers" and individually as the "Borrower"), hereby jointly and severally promise to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Lender"), acting through its Wells Fargo Business Credit operating division, on the Termination Date set forth in the Amended and Restated Credit and Security Agreement dated as of December 27, 2003 that was entered into by the Lender and the Borrowers (as amended to date and as may be further amended from time to time, the "Credit Agreement"), at Lender's main office located at in Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Two Million Dollars ($2,000,000) or the aggregate unpaid principal amount of all Equipment Advances made by the Lender to the Borrowers under the Credit Agreement together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Term Note is fully paid at the rate from time to time in effect under the Credit Agreement.
        This Equipment Note is the Equipment Note referred to in the Credit Agreement, and is subject to the terms of, the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Term Note may be prepaid only in accordance with the terms of the Credit Agreement. This Term Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.
        The Borrowers hereby agree to pay all costs of collection, including attorneys' fees and legal expenses in the event this Term Note is not paid when due, whether or not legal proceedings are commenced.
        Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

 	 	NETLIST, INC	

 	
By:	

	
 	 	Name:	 	Chun K. Hong	
 	 	Its:	 	President	

 	
NETLIST TECHNOLOGY TEXAS L.P. 
By: Netlist Holdings GP, Inc., its general partner	

 	

By:	

	
 	 	 	 	Name:	 	Chun K. Hong	
 	 	 	 	Its:	 	President	
1

 
 Exhibit C
to
Fifth Amendment to Amended and Restated Credit and Security Agreement

Compliance Certificate

To:	 	Jeffrey Cristol
Wells Fargo Business Credit	

Date:	
 	
                        , 200    	

Subject:	
 	
Netlist, Inc. and Netlist Technology Texas LP	
Financial Statements
        In accordance with our Amended and Restated Credit and Security Agreement dated as of December 27, 2003 (as amended to date, the "Credit Agreement"), attached are the consolidated financial statements of Netlist, Inc. ("Netlist") and Netlist Technology Texas LP (collectively with Netlist, the "Borrowers" and, individually, the "Borrower") as of and for                        , 20    (the "Reporting Date") and the year-to-date period then ended (the "Current Financials"). All terms used in this certificate have the meanings given in the Credit Agreement.
        The undersigned certifies that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present Netlist's financial condition as of the date thereof.
Events of Default.     (Check one):
o
The undersigned does not have knowledge of the occurrence of a Default or Event of Default under the Credit Agreement except as previously reported in writing to the Lender.

o
The undersigned has knowledge of the occurrence of a Default or Event of Default under the Credit Agreement not previously reported in writing to the Lender and attached hereto is a statement of the facts with respect to thereto. Each of the Borrowers acknowledges that pursuant to Section 2.12(d) of the Credit Agreement, the Lender may impose the Default Rate at any time during the resulting Default Period.
Financial Covenants.    Each of the undersigned further hereby certify as follows:
        1.     Minimum Book Net Worth Plus Subordinated Indebtedness.     Pursuant to Section 6.2(a) of the Credit Agreement, as of the Reporting Date, the sum of the Book Net Worth plus Subordinated Indebtedness was $                        which o  satisfies o  does not satisfy the requirement that such amount be not less than $                        on the Reporting Date as set forth in Section 6.2(a).
        2.     Minimum Net Income.     Pursuant to Section 6.2(b) of the Credit Agreement, Netlist's year to date minimum Net Income for the             period ending on the Reporting Date, was $                        , which o  satisfies o  does not satisfy the requirement that such amount be not less than $                        during such period as set forth in Section 6.2(b).
        3.     Capital Expenditures.     Pursuant to Section 6.2(c) of the Credit Agreement, for the period from                        and ending on the Reporting Date, the Borrowers have expended or contracted to expend for Capital Expenditures, $                        in the aggregate, which o  satisfies o  does not satisfy the requirement that such expenditures not exceed $                        , as set forth in Section 6.2(c).

        4.     Maximum Net Loss.     Pursuant to Section 6.2(d) of the Credit Agreement, for the month ending on the Reporting Date, the Borrowers' Net Income (Net Loss) is $                        , which o  satisfies o  does not satisfy the requirement that the Borrowers will not suffer a Net Loss in excess of $150,000 during any month.
        5.     Minimum Debt Service Coverage Ratio.     Pursuant to Section 6.2(e) of the Credit Agreement, as of the Reporting Date, the Borrowers' Debt Service Coverage Ratio was [            ] to 1.00, which o  satisfies o  does not satisfy the requirement that such ratio be no less than 1.10 to 1.00 on the Reporting Date.
        6.     Salaries.     As of the Reporting Date, salaries for all Directors, Officers, consultants, and any member of their families, is set forth on Schedule 1 attached hereto.
        Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

 	 	NETLIST, INC.	

 	
By	

 	 	 	 	
Its Chief Financial Officer	

 	
NETLIST TECHNOLOGY TEXAS LP	

 	
By:	
 	
Netlist Holdings GP, Inc.,
its general partner	
 	 	 	 	By	 	
 	 	 	 	 	
Its Chief Financial Officer	

QuickLinks
 FIFTH AMENDMENT TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT
 ACKNOWLEDGMENT AND AGREEMENT OF GUARANTORS AND AMENDMENT TO GUARANTY
 ACKNOWLEDGMENT AND AGREEMENT OF SUBORDINATED CREDITORS
 TERM NOTE
 Exhibit B to Fifth Amendment to Amended and Restated Credit and Security Agreement
EQUIPMENT NOTE
 Exhibit C to Fifth Amendment to Amended and Restated Credit and Security Agreement Compliance Certificate
 
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Exhibit 10.8
         
January 11, 2006
Mr. Lee Kim
19172 Red Bluff Drive
Trabuco Canyon, CA 92679
Dear Lee:
        This letter will serve as the entire agreement between Netlist, Inc. (the "Company") and you, Lee Kim (the "Employee"), with respect to your employment with the Company.
        1.     Term     
        The Employee will work full-time for the Company, beginning on January 14, 2006 (the "Beginning Date"). As an employee of the Company, the Employee will serve as its Chief Financial Officer and perform such services as are customary for an individual having such title and holding such position. The Employee agrees to comply with the Company's rules, regulations and practices adopted from time to time, so long as they are uniformly applied to all employees of the Company. The Employee further agrees that during his employment with the Company he shall not, directly or indirectly, engage or participate in any activities which are in conflict with the best interests of the Company.
        2.     Salary     
        Initially, the Employee will be paid an annual salary (the "Salary") of $200,000. Salary for any portion of a month will be prorated based upon the number of normal workdays remaining in the month. The salary will be subject to increase by the Company from time to time. The salary will be processed through payroll and paid at the same time as other executive employees.
        3.     Incentive Bonus and Equity Participation     
        The Employee will be entitled to receive incentive cash bonuses and/or warrants or options for the purchase of the Company's stock as specified on the attached Schedule A . During the course of the Employee's engagement hereunder, the Employee will remain a partner of Tatum CFO Partners, LLP ("Tatum") or its successor organization. As a partner of Tatum, the Employee will share with Tatum a portion of his economic interest in any stock options or equity bonus that the Company may grant the Employee and may also share with Tatum (to the extent specified in the Resources Agreement referenced below) a portion of any cash bonus and severance paid to the Employee by the Company. The Company acknowledges and consents to such arrangement.
        4.     Tatum Resources     
        The Company acknowledges and agrees that the Employee is and will remain a partner of, and has and will retain an interest in, Tatum, which will benefit the Company in that the Employee will have access to certain Tatum resources pursuant to a certain Full-Time Permanent Engagement Resources Agreement between the Company and Tatum (the "Resources Agreement").
1

        5.     Employee Benefits     
        The Employee will be eligible for vacation and holidays consistent with the Company's policy as it applies to executive management and no waiting period will apply.
        The Company will reimburse the Employee for all out-of-pocket business expenses promptly after they are incurred.
        The Company will reimburse the Employee for the cost of continuing professional education consistent with the currently effective continuing education requirements of the American Institute of Certified Public Accountants.
        The Employee may elect to participate in the Company's employee retirement plan and/or 401(k) plan, and the Employee will be exempt from any delay periods required for eligibility.
        In lieu of the Employee participating in the Company-sponsored employee medical, dental and vision insurance benefit, the Employee will remain on his or her current Tatum medical plan. The Company will reimburse the Employee for amounts paid by the Employee for such medical insurance for himself and his family of up to $750.00 per month. In accordance with the U.S. federal tax law, such amount will not be considered reportable W-2 income, but instead non-taxable benefits expense.
        If the Company has directors' and officers' liability insurance in effect, the Company will provide such insurance coverage for the Employee, along with written evidence to the Employee that the Employee is covered by such insurance.
        Furthermore, the Company will maintain such insurance coverage, if any, with respect to occurrences arising during the term of this agreement for at least three years following the termination or expiration of this agreement or will purchase a directors' and officers' extended reporting period, or "tail," policy to cover the Tatum Partner.
        The Company agrees to indemnify the Employee to the full extent permitted by law for any losses, costs, damages, and expenses, including reasonable attorneys' fees, as they are incurred, in connection with any cause of action, suit, or other proceeding arising in connection with Employee's employment with the Company. This indemnity will not apply to Employee's gross negligence or willful misconduct or to actions taken by the Employee in bad faith.
        6.     Non-competition, Non-recruitment and Non-solicitation by Employee.     
        The Employee agrees that, during his employment with the Company, the Employee will not engage in any activity competitive with or adverse to the Company's business or welfare, whether alone, as a partner, or as an officer, director, employee or shareholder, of any other corporation or business entity and shall not otherwise undertake planning for or the organization of any business activity competitive with the Company's business or combine or conspire with other employees or representatives of the Company for the purpose of organizing any such competitive business activity. This prohibition shall not include ownership of less than five percent (5%) of the outstanding stock by the Employee in a publicly traded corporation.
        During his employment with the Company and for a period of two (2) years following the termination of the Employment, the Employee shall not, directly or indirectly, induce, solicit or influence or attempt to induce, solicit or influence any person who is engaged or employed by the Company (whether part-time or full-time and whether as an officer, employee, consultant, agent or advisor), to terminate his or her employment or other engagement with the Company. The Employee further agrees that, during his employment with the Company and for two (2) years after termination of such employment, the Employee will not in any manner seek to engage or employ any individual who is employed or engaged by the Company, as an officer, employee, consultant, agent or advisor for any person or entity other than the Company.
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        The Employee agrees that during his employment with the Company and for two (2) years after termination of such employment, the Employee shall not, directly or indirectly, personally, or on behalf of or in conjunction with any person or entity, divert or take away any client or customer of the Company.
        7.     Trade Secrets of the Company.     
        The Employee acknowledges and understands that during his employment with the Company, the Employee will have access to and will utilize and review information which constitutes valuable, important and confidential trade secrets, as that term is interpreted under the Uniform Trade Secrets Act (California Civil Code Section 3426 et seq.) and/or confidential and proprietary material and information of or relating to the business of the Company necessary for the successful conduct of the Company's business. This information includes, but is not limited to: (a) listings of and data regarding the clients (past and current) of the Company (collectively, the "Clients"); (b) information regarding potential customers and clients; (c) data relating to the identity of the Clients of the Company; (d) information regarding bidding, billing and pricing practices; (e) information regarding the nature and type of services rendered to the Clients; (f) other methodologies, computer programs, databases, processes, compilations of information, results of proposals, job notes, reports and records, and (g) information regarding the nature and type of software products sold to or under development with any Client (all of which information is sometimes referred to in this Agreement as the "Secrets"). The foregoing notwithstanding, the Secrets shall not include information or data which is (i) in the public domain, (ii) generally known in the information technology staffing services industry, (iii) already known to the Employee as of the date he began his employment with the Company, or (iv) rightfully disclosed to the Employee outside of the scope of his employment with the Company by a third party not under a duty of confidentiality to the Company. The Employee understands further that the Secrets have been and will be accumulated, by the Employee and other personnel at the Company at considerable expense to the Company (including but not limited to compensation paid to the Company personnel dealing with the Secrets and the Clients), and that the Company has and will continue to expend its resources in order to maintain actively and vigorously the confidentiality of the Secrets, as such information is extremely valuable to the Company, and well worth the expense of enforcement and preservation of such confidentiality. Accordingly, the Employee agrees as follows:
        (a)   All of the Secrets shall be safeguarded and treated as confidential by Employee.
        (b)   Any and all data, notes, letters, computer programs, email records, reports, telephone records and all other written documentation relating to the business of the Company (including but not limited to the Secrets) that may be collected, compiled, written, reviewed or conceived by the Employee, whether set forth in tangible media or intangible, from or by reason of services performed by the Employee for the Company shall become the sole and absolute property of the Company, and the Employee shall not assert or establish a claim for any statutory or common law right or any other possessory or proprietary right with respect to any of the above.
        (c)   The Employee shall hold the Secrets in strictest confidence and shall not (i) disclose any Secrets to any person, corporation, firm, or other entity, either during or after his employment with the Company, or (ii) use any Secrets in the Employee's subsequent business or employment, without the prior express written authorization of the Company; provided, however, that the Employee may disclose Secrets to the extent required to do so by a subpoena lawfully issued in a judicial proceeding or arbitration.
        (d)   The Employee shall not otherwise commit any act which shall compromise the confidentiality of any Secrets, including but not limited to making a copy of such property (whether electronic, paper or otherwise) without the prior express written authorization of the Company.
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        8.     Confidential Information of Clients.     
        All ideas, concepts, information and written material disclosed to the Employee by the Company, or acquired from any of the Clients, and all financial, accounting, statistical, personnel, and business data and plans of the Clients, are and shall remain the sole and exclusive property and proprietary information of the Company, or said Client, and are disclosed in confidence by the Company or permitted to be acquired from the Clients in reliance on the Employee's agreement to maintain them in confidence and not to use or disclose them to any other person except in furtherance of the Company's business.
        9.     Return of Information.     
        At the time of the termination of his employment with the Company, or upon request, the Employee agrees to deliver promptly to the Company all notes, books, electronic data (regardless of storage media), correspondence and other written or graphical records (including all copies thereof) in the Employee's possession or under the Employee's control relating to any business, work, the Clients or any other aspect of the Company, whether or not they contain any Secrets, including but not limited to each original and all copies of all or any part thereof.
        10.     Cooperation.     
        The Employee agrees to cooperate in good faith with the Company in connection with any defense, prosecution, or investigation by the Company regarding any actual or potential litigation, administrative proceeding, or other such procedures, in which the Company may be involved as a party or non-party from time to time.
        11.     Termination; Severance Payments     
        The Company and the Employee may terminate this Agreement at any time with 30 days written notice. In the event this Agreement is terminated other than by the Employee voluntarily or by the Company for Cause (as defined below), or by reason of the Employee's death or permanent disability, the Employee shall be entitled to the following: If the termination of this agreement is within one year of the Beginning Date, the Employee will be entitled to receive a severance payment ("Severance Payment") equal to one month's Salary. After one year of employment, the Employee will be entitled to receive a Severance Payment equal to four months' Salary. After two years of employment, the Employee will be entitled to receive a Severance Payment equal to six months' Salary. For each additional period of six (6) months' employment, the Employee will receive an additional one (1) month's Salary as a Severance Payment, provided that the total Severance Payment will be limited to a maximum of twelve (12) months' Salary. If this agreement is terminated by the Company without cause or the required notice, or by the Employee for cause, the Employee will be entitled to receive the Severance Payments noted in this paragraph, plus one additional month's compensation for early termination, and all cash bonuses, equity, and other compensation covered by this agreement will vest immediately and become payable at the date of termination.
        If the Employee is terminated without Cause as a result of, and within six (6) months of, a merger, sale or other change of control event of the Company, the Employee will be entitled to receive a Severance Payment equal to twelve (12) months' Salary, regardless of length of service. If immediately following a sale, merger or other change of control event the Employee's title is not Chief Financial Officer or the Employee's duties do not reflect those duties normally associated with the duties of a chief financial officer, the Employee can self-terminate after ninety (90) days following the change of control event and be entitled to receive a Severance Payment of twelve (12) months' Salary, regardless of length of service.
        For purposes of this Agreement, the term "Cause" means (1) the Employee's violation of this Agreement; (2) conviction of a felony, misappropriation of any material funds or property of the
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Company, commission of fraud or embezzlement with respect to the Company, or any act or acts of dishonesty relating to the Employee's employment by the Company resulting or intended to result in direct or indirect personal gain or enrichment at the expense of the Company; (3) failing to perform his obligations or carry out his duties to the Company competently due to use of alcohol or drugs that renders the Employee unable to perform the essential functions of his job; (4) committing any act or omission of a nature involving malfeasance or negligence in the performance of the Employee's duties to the Company that is likely to cause a material adverse effect on the business of the Company; or (5) materially deviating from the written policies or directives of the Company, as communicated by its Chief Executive Officer or Board of Directors, in such manner as would reasonably be expected to constitute grounds for termination of an employee in a position similar to the Employee; provided that, with respect to (4) or (5) above, the Company shall have first provided the Employee written notice stating with specificity the acts, duties or directives the Employee has failed to observe or perform, and the Employee shall not have, in the reasonable opinion of the Company, corrected the acts or omissions complained of within thirty (30) days following delivery of such notice.
        This agreement will terminate immediately upon the death or disability of the Employee. For purposes of this agreement, disability will be as defined by the applicable policy of disability insurance or, in the absence of such insurance, by the Company's Board of Directors acting in good faith.
        12.     Miscellaneous     
        This agreement contains the entire agreement between the parties, superseding any prior oral or written statements or agreements.
        Neither the Employee nor the Company will be deemed to have waived any rights or remedies accruing under this agreement unless such waiver is in writing and signed by the party electing to waive the right or remedy. This agreement binds and benefits the successors of the parties.
        The provisions of this agreement concerning the payment of salary and bonuses, directors' and officers' insurance and confidentiality will survive any termination or expiration of this agreement.
        The terms of this agreement are severable and may not be amended except in a writing signed by the parties. If any portion of this agreement is found to be unenforceable, the rest of this agreement will be enforceable except to the extent that the severed provision deprives either party of a substantial portion of its bargain.
        This agreement will be governed by and construed in all respects in accordance with the laws of the State of California, without giving effect to conflicts-of-laws principles.
        Each person signing below is authorized to sign on behalf of the party indicated, and in each case such signature is the only one necessary.
        Please sign below and return a signed copy of this letter to indicate your agreement with its terms and conditions.
Sincerely yours,
NETLIST, INC.
By:
/s/ Chun K. Hong
Signature
Name: Chun K. Hong
5

Title: President
Acknowledged and agreed by:

 	 	EMPLOYEE	

(Signature)	
 	 	 	 	 	
 	 	Lee Kim

(Print name)	
 	 	 	 	 	
 	 	Date:	 		
Netlist, Inc.
475 Goddard
Irvine, CA 92618
T. 949.435.0025
F. 949.435.0031
6

 
 SCHEDULE A 

Incentive Cash Bonus, Stock, or Warrants/Options
1.     Incentive Cash Bonus     
        The Employee shall be entitled to an annual performance based incentive cash bonus equal to 50% of Salary. Performance goals will be agreed upon with the Company's Chief Executive Officer no later than 45 days after the Beginning Date.
2.     Stock, Warrants, Stock Options or Other Equity-Based Incentive Compensation     
        The Employee shall be granted as of the Beginning Date options to purchase 150,000 shares of common stock of the Company. Such options will vest over a 4-year period as follows: a) 25% upon the one-year anniversary of Beginning Date; and b) monthly thereafter at the rate of 2.083% per month. All unvested shares shall immediately vest upon a change of control as defined by the Company's approved option plan.
7

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 SCHEDULE A Incentive Cash Bonus, Stock, or Warrants/Options
 
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EXHIBIT 10.9
 
 Tatum, LLC
Full-Time Permanent Engagement Resources Agreement
January 10, 2006
Mr. C. K. Hong
Chief Executive Officer
Netlist, Inc.
475 Goddard
Irvine, CA 92618
Dear Mr. Hong:
        Tatum, LLC ("Tatum") understands that Netlist, Inc. (the "Company") desires to hire Lee Kim, one of our partners, as an employee of the Company (the "Employee"). The Company acknowledges that the Employee is and will remain a partner in our firm so that he will have access to our firm's resources for use in his employment with the Company. This Full-Time Permanent Engagement Resources Agreement (the "Resources Agreement") sets forth the rights of the Company, through the Employee, to use such resources for the benefit of the Company and for the payment for such services.
        Since the Employee will be under the control and direct management of the Company, and not Tatum, Tatum's obligations to the Company are exclusively those set forth in this Resources Agreement. This document will serve as the entire agreement between the Company and Tatum.
Compensation
        The Company will pay directly to Tatum, as partial compensation for the resources provided, an amount equal to (i) 1.67% of monthly Salary of the Employee during the first and second 12 months of the term of the Resources Agreement, (ii) 1.00% of monthly Salary during the third 12 months, and (iii) $1,000 per month during the remainder of the term of this Resources Agreement.
        The Company will pay directly to Tatum a portion of any Severance Payments that the Company may make to Employee equal to the same percentage that applies above with respect to Salary, or $1,000 per month of Severance Payment after 36 months under this Resources Agreement.
        In addition, the Company will pay directly to Tatum 15% of any Cash Bonus otherwise payable to the Employee during the term of this Resources Agreement. With respect to 15% of any Equity Bonus otherwise to be granted to the Employee, after receiving appropriate representations from Tatum for securities law purposes, the Company agrees to issue such 15% portion directly to Tatum, in lieu of the Employee, in the form of one or more warrants containing terms and conditions substantially equivalent to those applicable to the portion of Equity Bonus retained by the Employee.
        For purposes hereof, (i) "Cash Bonus" means any contingent cash consideration (i.e., not yet realized in cash) that is paid, (ii) "Equity Bonus" means any stock, option, warrant, or similar right (i.e., not yet realized in cash) that is granted, in each case in connection with services rendered by the Employee, and (iii) "Salary" means all compensation, including severance, paid to Employee, except bonuses and benefits (including medical benefits subsidy paid to Employee). All compensation payable or deliverable to Tatum is referred to herein as the "Resource Fee."
        Payments to Tatum should be made by direct deposit through the Company's payroll system, or by an automated clearing house ("ACH") payment at the same time as payments are made to the Employee. If such payment method is not available and payments are made by check, Tatum will issue invoices to the Company, and the Company agrees to pay such invoices no later than ten (10) days after receipt of invoices.

Deposit
        Company agrees to pay Tatum and maintain a security deposit of $5,000 for the Company's future payment obligations to Tatum under this Resources Agreement (the "Deposit"). If the Company breaches this Resources Agreement and fails to cure such breach as provided herein, Tatum will be entitled to apply the Deposit to its damages resulting from such breach. Upon termination or expiration of this Resources Agreement, Tatum will return to the Company the balance of the Deposit remaining after application of any amounts to unfulfilled payment obligations of the Company to Tatum as provided for in this Resources Agreement.
Termination
        This Resources Agreement will terminate immediately upon the effective date of termination or expiration of the Employee's employment with the Company or upon the Employee ceasing to be a partner of Tatum.
        In the event that either party commits a breach of this Resources Agreement and fails to cure the same within seven (7) days following delivery by the non-breaching party of written notice specifying the nature of the breach, the non-breaching party will have the right to terminate this Resources Agreement immediately effective upon written notice of such termination.
Hiring Employee Outside of Resources Agreement
        The parties recognize and agree that Tatum is responsible for introducing the Employee to the Company. Therefore, if, at any time during the twelve (12)-month period following the termination or expiration of this Resources Agreement as a result of the termination of Employee's employment with the Company, the Company employs the Employee or engages the Employee as an independent contractor (other than in connection with another form of Tatum agreement) to render services of substantially the same nature as those for which Tatum is making the Employee available pursuant to this Resources Agreement, Tatum will be entitled to receive as a placement fee an amount equal to forty-five percent (45%) of the Employee's Annualized Compensation (as defined below). The amount will be due and payable to Tatum upon written demand to the Company. In addition, any equity previously granted to Tatum will continue to vest for as long as Employee or independent contractor, as the case may be, provides services for the Company. For this purpose, "Annualized Compensation" will mean the lesser of: a) the most recent annual Salary and the maximum amount of any bonus for which the Employee was eligible with respect to the then current bonus year; or b) if the Employee becomes an independent contractor, the amount of total fees paid or payable over the course of the 12 months following the first date that independent contractor provides services to the Company.
Insurance
        To the extent the Company has directors' and officers' liability insurance in effect, the Company will provide such insurance coverage for the Employee, along with written evidence to Tatum or the Employee that the Employee is covered by such insurance.
        Furthermore, the Company will maintain such insurance coverage, if any, with respect to occurrences arising during the term of this agreement for at least three years following the termination or expiration of this agreement or will purchase a directors' and officers' extended reporting period, or "tail," policy to cover the Employee.
Disclaimers, Limitations of Liability & Indemnity
        It is understood that Tatum does not have a contractual obligation to the Company other than to make its resources available to the Employee (by virtue of the Employee being a partner in Tatum) for the benefit of the Company under the terms and conditions of this Resources Agreement. The Resource Fee will be for the resources provided. Tatum assumes no responsibility or liability under this Resources Agreement other than to render the services called for hereunder and will not be

responsible for any action taken by the Company in following or declining to follow any of Tatum's advice or recommendations.
        Tatum represents to the Company that Tatum has conducted its standard screening and investigation procedures with respect to the Employee becoming a partner in Tatum, and the results of the same were satisfactory to Tatum. Tatum disclaims all other warranties, either express or implied. Without limiting the foregoing, Tatum makes no representation or warranty as to the accuracy or reliability of reports, projections, forecasts, or any other information derived from use of Tatum's resources, and Tatum will not be liable for any claims of reliance on such reports, projections, forecasts, or information. Tatum will not be liable for any non-compliance of reports, projections, forecasts, or information or services with federal, state, or local laws or regulations. Such reports, projections, forecasts, or information or services are for the sole benefit of the Company and not any unnamed third parties.
        In the event that any partner of Tatum (including without limitation the Employee to the extent not otherwise entitled in his or her capacity as an officer of the Company) is subpoenaed or otherwise required to appear as a witness or Tatum or such partner is required to provide evidence, in either case in connection with any action, suit, or other proceeding initiated by a third party or by the Company against a third party, then the Company shall reimburse Tatum for the costs and expenses (including reasonable attorneys' fees) actually incurred by Tatum or such partner and provide Tatum with compensation at Tatum's customary rate for the time incurred.
        The Company agrees that, with respect to any claims the Company may assert against Tatum in connection with this Resources Agreement or the relationship arising hereunder, Tatum's total liability will not exceed twelve (12) months of the then current monthly Resource Fee.
        As a condition for recovery of any liability, the Company must assert any claim against Tatum within three (3) months after discovery or ninety (90) days after the termination or expiration of this Resources Agreement, whichever is earlier.
        Tatum will not be liable in any event for incidental, consequential, punitive, or special damages, including without limitation, any interruption of business or loss of business, profit, or goodwill.
Arbitration
        If the parties are unable to resolve any dispute arising out of or in connection with this Resources Agreement, either party may refer the dispute to arbitration by a single arbitrator selected by the parties according to the rules of the American Arbitration Association ("AAA"), and the decision of the arbitrator will be final and binding on both parties. In the event that the parties fail to agree on the selection of the arbitrator within thirty (30) days after either party's request for arbitration under this paragraph, the arbitrator will be chosen by AAA. The arbitrator may in his discretion order documentary discovery but shall not allow depositions without a showing of compelling need. The arbitrator will render his decision within ninety (90) days after the call for arbitration. The arbitrator will have no authority to award punitive damages. Judgment on the award of the arbitrator may be entered in and enforced by any court of competent jurisdiction. The arbitrator will have no authority to award damages in excess or in contravention of this Resources Agreement and may not amend or disregard any provision herein. Notwithstanding the foregoing, no issue related to the ownership of intellectual property will be subject to arbitration but will instead be subject to determination by a court of competent jurisdiction, and either party may seek injunctive relief in any court of competent jurisdiction.
Miscellaneous
        Tatum will be entitled to receive all reasonable costs and expenses incidental to the collection of overdue amounts under this Resources Agreement, including but not limited to attorneys' fees actually incurred.

        Neither the Company nor Tatum will be deemed to have waived any rights or remedies accruing under this Resources Agreement unless such waiver is in writing and signed by the party electing to waive the right or remedy. This Resources Agreement binds and benefits the successors of Tatum and the Company.
        Neither party will be liable for any delay or failure to perform under this Resources Agreement (other than with respect to payment obligations) to the extent such delay or failure is a result of an act of God, war, earthquake, civil disobedience, court order, labor dispute, or other cause beyond such party's reasonable control.
        The terms of this Resources Agreement are severable and may not be amended except in a writing signed by Tatum and the Company. If any portion of this Resources Agreement is found to be unenforceable, the rest of the Resources Agreement will be enforceable except to the extent that the severed provision deprives either party of a substantial portion of its bargain.
        The provisions in this Resources Agreement concerning payment of compensation and reimbursement of costs and expenses, limitation of liability, directors' and officers' insurance, and arbitration will survive any termination or expiration of this Resources Agreement.
        This Resources Agreement will be governed by and construed in all respects in accordance with the laws of the State of Georgia, without giving effect to conflicts-of-laws principles.
        Nothing in this Resources Agreement shall confer any rights upon any person or entity other than the parties hereto and their respective successors and permitted assigns and the Employee.
        Each person signing below is authorized to sign on behalf of the party indicated, and in each case such signature is the only one necessary.
Bank Lockbox Mailing Address for Deposit and Resource Fee only:
Tatum, LLC
P.O. Box 403291
Atlanta, GA 30384-3291
Electronic Payment Instructions for Deposit and Resource Fee:

Bank Name:	 	Bank of America	
Branch:	 	Atlanta	
Routing Number:	 	For ACH Payments: 061 000 052
For Wires: 026 009 593	
Account Name:	 	Tatum, LLC	
Account Number:	 	003 279 247 763	
Please reference Netlist, Inc. in the body of the wire.	
        Please sign below and return a signed copy of this letter to indicate the Company's agreement with its terms and conditions.
We look forward to serving you.
Sincerely yours,
TATUM, LLC
/s/   KARL HARDESTY      
Signature
Karl Hardesty
Area Managing Partner

Acknowledged and agreed by:

 	 	NETLIST, INC.	

 	
By:	
/s/   CHUN K. HONG       

 	
 	
Title:	
President	

 	
Date:	
January 11, 2006	

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 Tatum, LLC Full-Time Permanent Engagement Resources Agreement
 
Exhibit 10.10
MASTER SALES AND SUPPLY AGREEMENT
BY AND BETWEEN
NETLIST, INC.
AND
NETLIST TECHNOLOGY TEXAS LP
EFFECTIVE AS OF January 1, 2004

SALES AND SUPPLY AGREEMENT ("AGREEMENT")
        This AGREEMENT is entered into as of January 1, 2004 (the "Effective Date"), by and between Netlist, Inc. (the "Supplier"), a Delaware corporation, and Netlist Technology Texas LP (the "Purchaser"), a Texas limited partnership.
RECITALS
        1.     Supplier is engaged in the development and manufacture of board level products for the high performance computing market;
        2.     The Purchaser desires to engage Supplier as its exclusive source for the type of consumer products produced by Supplier;
        3.     Supplier desires to sell its line of products to Purchaser and provide the services stated above.
        Therefore, in consideration of the mutual covenants and conditions contained herein, and for other good and valuable consideration, the parties hereby agree as follows:
ARTICLE I
DEFINITIONS
        Affiliate or Affiliates.     "Affiliate" or "Affiliates" shall mean a Texas LP, firm, partnership or other entity that directly or indirectly owns, is owned by, or is under common ownership with a party to this Agreement to the extent of at least fifty percent (50%) of the equity having the power to vote on or direct the affairs of the entity and any person, firm, partnership, corporation or other entity actually controlled by, controlling, or under common control with a party to this Agreement.
        Effective Date.     "Effective Date" is as defined immediately prior to the Recitals at the beginning of this Agreement.
        Product.     "Product" shall mean the board level products that are necessary to Purchaser's operations and that Purchaser purchases from Supplier.
        Purchase Price.     "Purchase Price" shall mean the amount computed per Section 2.2 of this Agreement, or another price agreed upon by Purchaser and Supplier.
        Purchaser Inventory.     "Purchaser Inventory" shall mean inventory owned by Purchaser and made available to Purchaser for sales to each company's respective customers.
        Term.     "Term" shall have the meaning set forth in Section 5.1 of this Agreement.
        Third Party or Third Parties.     "Third Party" or "Third Parties" shall mean any entity other than a party to this Agreement or an Affiliate.
        Year.     "Year" shall mean the twelve (12) month period ending on the 31 st of December.
ARTICLE II
TERMS OF SALES
         Section 2.1.    Orders.     Purchaser shall order Product as it shall desire from Supplier, and Supplier shall supply such Product as Purchaser desires, pursuant to such procedures as Supplier periodically shall specify.
         Section 2.2.    Pricing.     The Purchase Price of Product and Services ordered by Purchaser shall be calculated according to the formula described in Appendix A. Periodic pricing adjustments or credits
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may be made by Supplier to ensure that Purchaser maintains such Gross Profit Margin after taking into account an offset to Purchases reflecting inventory Supplier uses to fulfill its own customer orders.
         Section 2.3.    Supplier Advice.     Supplier shall advise Purchaser of all shipments of Products on a monthly basis.
         Section 2.4.    Payment Terms.     Payment generally should be paid within 30 day(s) of the end of each month. Any requests for credit or deduction by Purchaser (e.g., due to shortage in shipment quantity, quality defects, damage in transit, or related matters), shall be communicated promptly to Supplier.
        The above payments are to be made in currency of the United States during business hours, on the day due, either (1) by check or wire transfer, or (2) by an adjustment to the intercompany payable and receivable accounts between Supplier and Purchaser.
         Section 2.5.    Delivery, Title, and Risk of Loss.     The parties agree that delivery and transfer of title of Product to Purchaser will occur at Supplier's warehouse. Delivery and transfer of title to Product that is purchased by Supplier as a finished good will occur as inventory is shipped to Purchaser's warehouse. As such, Purchaser shall own all inventory located in the Netlist Technology Warehouse (NTW) (known as Purchaser Inventory). Periodically, Supplier will be allowed to fulfill orders for its customers from Purchaser Inventory. Purchaser shall lease or license from Supplier, warehouse and distribution areas within the Supplier's facilities to facilitate such title transfer and store Purchaser Inventory.
         Section 2.6.    Sales.     Supplier shall maintain complete and accurate records of all Product supplied to Purchaser. Purchaser shall have the right, at its expense and on a reasonable basis with reasonable prior written notice to Supplier, to examine such records during regular business hours during the term of this Agreement and for twelve months after termination of this Agreement.
         Section 2.7.    Intellectual Property.     With respect to all Product, Supplier grants Purchaser a non-exclusive, limited use, sublicensable, royalty-free license to use the logos, trademarks, patents, and other marks inherent in the Product. In addition, Supplier grants Purchaser a non-exclusive, limited use, sublicensable, royalty-free license to use its customer lists.
ARTICLE III
WARRANTIES AND REPRESENTATIONS
         Section 3.1.    Of Supplier.     Supplier warrants that:
a.
It has the right to transfer full unencumbered title to all Product sold to Purchaser under the terms of this Agreement;

b.
It will extend to Purchaser all standard Supplier warranties that apply to specific Product sold to Purchaser under the terms of this Agreement, upon written request by Purchaser; and

c.
It has the right and authority to enter into this Agreement.
         Section 3.2.    Of Purchaser.     Purchaser warrants that:
a.
It has the right and authority to enter into this Agreement; and

b.
Will advise Supplier of any claim for damages or breach of warranty with respect to Product asserted by it or a customer purchasing Product.
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ARTICLE IV
INDEMNIFICATION
        Supplier shall save, hold harmless, and defend Purchaser from and against any loss, cost, or expense, including reasonable attorneys' fees, damages, or penalties of any kind, on account of or resulting from any claim or action for infringement of any existing or future patent, copyright, or trademark, or misappropriation of any trade secret or other intellectual property right with respect to Product. Supplier shall defend any such claim or action at its expense provided that Purchaser promptly notifies Supplier on learning of any such claim or action and cooperates with Supplier in defending any such claim or action.
ARTICLE V
TERM AND TERMINATION
         Section 5.1.    Term.     This Agreement shall remain in effect for a period of one year from the Effective Date and shall automatically renew at the end of such year, and each succeeding year, for an additional one year.
         Section 5.2.    Termination.     Either party shall have the right to terminate this Agreement at any time by giving written notice to the other party on the occurrence of any of the following events:
a.
Desire to terminate for any reason, with 90 days prior written notice;

b.
Failure or neglect of a party to perform covenants or provisions of this Agreement if such default is not corrected within 45 days after receiving written notice from the other party with respect to such default;

c.
Any act, determination, filing , judgment, declaration, notice, appointment of receiver or trustee, failure to pay debts, or other events under any law applicable to a party indicating the insolvency or bankruptcy of such party;

d.
Any extraordinary government action, including, without limitation, seizure or nationalization of assets, stock or other property relating to a party; or

e.
Any other event that shall cause Supplier to have concern about the financial stability of Purchaser.
         Section 5.3.    Rights and Duties on Termination.     On termination of this Agreement:
a.
Purchaser shall have no further right to purchase Product or Services;

b.
Supplier shall have the right to retain any sums already paid by Purchaser under this Agreement, and Purchaser shall pay all sums accrued that are then due under this Agreement; and

c.
Purchaser shall have no further rights whatsoever under this Agreement.
ARTICLE VI
MISCELLANEOUS
         Section 6.1.    Notices.     Any and all notices, elections, offers, acceptances, and demands permitted or required to be made under this Agreement shall be in writing, signed by the person giving such notice, election, offer, acceptance, or demand and shall be delivered personally, or sent by registered or certified mail, to the party, at its address on file with the other party, or at such other address as may
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be supplied in writing. The date of personal delivery or the date of mailing, as the case may be, shall be the date of such notice, election, offer, acceptance, or demand.
         Section 6.2.    Force-Majeure.     If the performance of any part of this Agreement by either party, or of any obligation under this Agreement, is prevented, restricted, interfered with, or delayed by reason of any cause beyond the reasonable control of the party liable to perform, unless conclusive evidence to the contrary is provided, the party so affected shall, on giving written notice to the other party, be excused from such performance to the extent of such prevention, restrictions interference or delay, provided that the affected party shall use its reasonable best efforts to avoid or remove such causes of nonperformance and shall continue performance with the utmost dispatch whenever such causes are removed. When such circumstances arise, the parties shall discuss what, if any, modification of the terms of this Agreement may be required in order to arrive at an equitable solution.
         Section 6.3.    Successors and Assigns.     This Agreement shall be binding on and shall inure to the benefit of the parties, Affiliates, their respective successors, successors in title, and assigns, and each party agrees, on behalf of it, its Affiliates, successors, successors in title, and assigns, to execute any instruments that may be necessary or appropriate to carry out and execute the purpose and intentions of this Agreement and hereby authorizes and directs its Affiliates, successors, successors in title, and assigns to execute any and all such instruments. Each and every successor in interest to any party or Affiliate, whether such successor acquires such interest by way of gift, devise, assignment, purchase, conveyance, pledge, hypothecation, foreclosure, or by any other method, shall hold such interest subject to all of the terms and provisions of this Agreement. The rights of the parties, Affiliates, and their successors in interest, as among themselves and shall be governed by the terms of this Agreement, and the right of any party, affiliate or successor in interest to assign, sell, or otherwise transfer or deal with its interests under this Agreement shall be subject to the limitations and restrictions of this Agreement.
         Section 6.4.    Amendment.     No change, modification, or amendment of this Agreement shall be valid or binding on the parties unless such change or modification shall be in writing signed by the party or parties against whom the same is sought to be enforced.
         Section 6.5.    Remedies Cumulative.     The remedies of the parties under this Agreement are cumulative and shall not exclude any other remedies to which the party may be lawfully, entitled.
         Section 6.6.    Further Assurances.     Each party hereby covenants and agrees that it shall execute and deliver such deeds and other documents as may be required to implement any of the provisions of this Agreement.
         Section 6.7.    No Waiver.     The failure of any party to insist on strict performance of a covenant hereunder or of any obligation hereunder shall not be a waiver of such party's right to demand strict compliance therewith in the future, nor shall the same be construed as a novation of this Agreement.
         Section 6.8.    Integration.     This Agreement constitutes the full and complete agreement of the parties.
         Section 6.9.    Captions.     Titles or captions of articles and paragraphs contained in this Agreement are inserted only as a matter of convenience and for reference, and in no way define, limit, extend, or describe the scope of this Agreement or the intent of any provision hereof.
         Section 6.10.    Number and Gender.     Whenever required by the context, the singular number shall include the plural, the plural number shall include the singular, and the gender of any pronoun shall include all genders.
         Section 6.11.    Counterparts.     This Agreement may be executed in multiple copies, each of which shall for all purposes constitute an Agreement, binding on the parties, and each party hereby covenants and agrees to execute all duplicates or replacement counterparts of this Agreement as may be required.
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         Section 6.12.    Applicable Law.     This Agreement shall be governed by and construed in accordance with the laws of the State of California of the United States.
         Section 6.13.    Computation of Time.     Whenever the last day for the exercise of any privilege or the discharge of any duty hereunder shall fall on a Saturday, Sunday, or any public or legal holiday, whether local or national, the person having such privilege or duty shall have until 5:00 p.m. on the next succeeding business day to exercise such privilege, or to discharge such duty.
         Section 6.14.    Severability.     In the event any provision, clause, sentence, phrase, or word hereof, or the application thereof in any circumstances, is held to be invalid or unenforceable, such invalidity or unenforceability shall not affect the validity or enforceability of the remainder hereof, or of the application of any such provision, sentence, clause, phrase, or word in any other circumstances.
         Section 6.15.    Costs and Expenses.     Unless otherwise provided in this Agreement, each party shall bear all fees and expenses incurred in performing its obligations under this Agreement.
         Section 6.16.    Nature of Relationship.     The relationship established between Supplier and purchaser by this Agreement is that of supplier and buyer. Purchaser is an independent contractor. Nothing in this Agreement shall be deemed to establish or otherwise create a relationship of principal and agent, employer and employee, or otherwise between Supplier and Purchaser.
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         IN WITNESS WHEREOF , the parties have caused this Agreement to be executed on the date first written above by their authorized officers.

Netlist, Inc.. (Supplier)	 	 	

By:	

 	

Title:	 	 	 	 	

Netlist Technology Texas LP (Purchaser)	

By:	

 	

Title:	 	 	 	 	
 	 		 	 	
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APPENDIX A
 PRODUCT PURCHASE PRICE
        Supplier will charge Purchaser an appropriate Product Purchase Price so that Purchaser covers its expected operating expenses and earns an arm's length operating profit. The arm's length Operating Profit Margin of Purchaser has been determined to be approximately    %. Since "Operating Profit Margin" is defined as gross profits minus operating expenses divided by net sales and since Purchaser expected operating expenses will be    % of sales, the Purchaser and Supplier have agreed to establish a Product Purchase Price that equals to the price received by the Purchaser from its customers minus a            % discount. This discount will be reviewed periodically to see if it is adequate to insure that the Purchaser can earn a            % Operating Profit Margin.
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Exhibit 10.11
 
 MANAGEMENT FEE AGREEMENT BETWEEN
NETLIST, INC. AND NETLIST TECHNOLOGY TEXAS LP
        This Management Fee Agreement ("Agreement") made and entered into as of January 1, 2004, by and between Netlist, Inc. and Netlist Technology Texas LP has reference to the following facts and circumstances:
        (a)   Netlist, Inc. regularly provides the following services to its subsidiaries (collectively, the "Services"):
i.
Accounting Services

ii.
Financial Statement Preparation

iii.
Tax Return Preparation and Advice

iv.
Treasury Management

v.
Personnel and Payroll Administration

vi.
Insurance and Risk Management

vii.
Legal

viii.
General Executive Management and Oversight
        (b)   Texas LP desires to avail itself of the Services and Netlist, Inc. is amenable to providing such, in each case, on the terms and conditions hereinafter set forth.
        Now, therefore, in consideration of the foregoing and the mutual covenants herein contained, the parties agree as follows:
        (1)     PROVISION OF SERVICES .    By its execution of this Agreement. Netlist, Inc. agrees to provide Services to Netlist Technology Texas LP to the extent and at the times requested by Netlist Technology Texas LP. In consideration of services rendered and/or available to be rendered to Netlist Technology Texas LP, Netlist Technology Texas LP agrees to pay to Netlist, Inc. a fee calculated by allocating actual expenses incurred by the relative headcount by entity or square footage used by entity.
        (2)     TERM .    The term of this Agreement shall be for one year commencing as of January 1, 2004 and shall automatically, without notice, be renewed for the same term at the expiration of each preceding term; provided, however, that either party may terminate this Agreement by giving written notice of termination to the other at its principal place of business at any time not less than 3 months prior to the expiration date of the current term.
        (3)     LAW .    This Agreement shall be governed by and construed in accordance with the internal law of the State of California, notwithstanding any choice of law principles.

NETLIST, INC.	 	 	

By:	

	

Name:	 	    
	 	 	
Title:	 	    

NETLIST TECHNOLOGY TEXAS LP	

By:	

	

Name:	 	    
	 	 	
Title:	 	    

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 MANAGEMENT FEE AGREEMENT BETWEEN NETLIST, INC. AND NETLIST TECHNOLOGY TEXAS LP
 
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Exhibit 10.12
 
 FORM OF
INDEMNITY AGREEMENT
        THIS INDEMNITY AGREEMENT (this "Agreement"), dated as of                , 200  , is made by and between Netlist, Inc., a Delaware corporation (the "Company"), and                        (the "Indemnitee").
R E C I T A L S :
        A.    The Company recognizes that competent and experienced persons are increasingly reluctant to serve as directors and officers of corporations unless they are protected by comprehensive liability insurance or indemnification, or both, due to increased exposure to litigation costs and risks resulting from their service to such corporations, and due to the fact that the exposure frequently bears no reasonable relationship to the compensation of such directors and officers.
        B. The statutes and judicial decisions regarding the duties of directors and officers are often difficult to apply, ambiguous, or conflicting, and therefore fail to provide such directors with adequate, reliable knowledge of legal risks to which they are exposed or information regarding the proper course of action to take.
        C. The Company and the Indemnitee recognize that plaintiffs often seek damages in such large amounts, and the costs of litigation may be so substantial (whether or not the case is meritorious), that the defense and/or settlement of such litigation is often beyond the personal resources of directors and officers.
        D. The Company believes that it is unfair for its directors and officers to assume the risk of substantial judgments and other expenses which may occur in cases in which the director and/or officer, as the case may be, received no personal profit and in cases where such person acted in good faith.
        E. The Company is organized under the Delaware General Corporation Law (the "DGCL"), and Section 145 of the DGCL ("Section 145") empowers the Company to indemnify its directors and officers by agreement and to indemnify persons who serve, at the request of the Company, as the directors and officers of other corporations or enterprises, and expressly provides that the indemnification provided by Section 145 is not exclusive.
        F. The Board of Directors of the Company has determined that contractual indemnification as set forth herein is not only reasonable and prudent but necessary to promote the best interests of the Company and its stockholders.
        G. The Company desires and has requested the Indemnitee to serve or continue to serve as a director and/or officer of the Company.
        H. The Indemnitee only is willing to serve, or to continue to serve, as a director and/or officer of the Company if the Indemnitee is furnished the indemnity provided for herein by the Company.
A G R E E M E N T :
        NOW THEREFORE, in consideration of the mutual covenants and agreements set forth below, the parties hereto, intending to be legally bound, hereby agree as follows:
        1.     Definitions.     
        (a)     Agent.     For purposes of this Agreement, "agent" of the Company means any person who: (i) is or was a director and/or officer of the Company or a subsidiary of the Company; or (ii) is or was serving at the request of, for the convenience of, or to represent the interest of the
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Company or a subsidiary of the Company as a director and/or officer of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise.
        (b)     Change in Control.     For the purposes of this Agreement, "Change in Control" means, and shall be deemed to have occurred if, on or after the date of this Agreement, (i) any "person" (as such term is used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company acting in such capacity, becomes the "beneficial owner" (as defined in Rule 13d-3 under said act), directly or indirectly, of securities of the Company representing more than 50% of the total voting power represented by the Company's then outstanding voting securities, (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director whose election by the Board of Directors of the Company or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds ( 2 / 3 ) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof, (iii) a merger or consolidation of the Company is consummated with any other corporation other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 80% of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (iv) the Company consummates a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of related transactions) of all or substantially all of the Company's assets.
        (c)     Expenses.     For purposes of this Agreement, "expenses" includes all direct and indirect costs of any type or nature whatsoever (including, without limitation, all attorneys' fees and related disbursements, other out-of-pocket costs and reasonable compensation for time spent by the Indemnitee for which he is not otherwise compensated by the Company or any third party, provided that the rate of compensation and estimated time involved is approved in advance by the Board of Directors of the Company), actually and reasonably incurred by the Indemnitee in connection with either the investigation, defense or appeal of a proceeding or establishing or enforcing a right to indemnification under this Agreement, Section 145 or otherwise, and amounts paid in settlement by or on behalf of the Indemnitee, but shall not include any judgments, fines, ERISA excise taxes or penalties actually levied against the Indemnitee.
        (d)     Proceedings.     For the purposes of this Agreement, "proceeding" means any threatened, pending, or completed action, suit, arbitration, hearing or other proceeding, whether civil, criminal, administrative, investigative or any other type whatsoever.
        (e)     Reviewing Party.     For the purposes of this Agreement, "Reviewing Party" means, subject to the provisions of Section 7(c) below, any person or body appointed by the Board of Directors of the Company in accordance with applicable law to review the Company's obligations hereunder, under the Company's Certificate of Incorporation and Bylaws and under applicable law, which may include a member or members of the Company's Board of Directors, independent legal counsel or any other person or body not a party to the particular claim for which the Indemnitee is seeking indemnification.
        (f)     Subsidiary.     For purposes of this Agreement, "subsidiary" means any corporation of which more than 50% of the outstanding voting securities are owned, directly or indirectly, by the Company.
        2.     Agreement to Serve.     The Indemnitee agrees to serve and/or continue to serve as an agent of the Company, at the will of such corporation (or under separate agreement, if such agreement exists),
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in the capacity the Indemnitee currently serves as an agent of such corporation, so long as the Indemnitee is duly appointed or elected and qualified in accordance with the applicable provisions of the Bylaws of such corporation or of any subsidiary thereof, or until such time as the Indemnitee tenders his resignation in writing; provided, however, that nothing contained in this Agreement is intended to create any right to continued employment of the Indemnitee in any capacity.
        3.     Indemnification.     
        (a)     Indemnification in Third Party Proceedings.     Subject to Section 10 below, the Company shall indemnify the Indemnitee if the Indemnitee is a party to or threatened to be made a party to or otherwise involved in any proceeding (other than a proceeding by or in the name of the Company to procure a judgment in its favor) by reason of the fact that the Indemnitee is or was an agent of the Company, or by reason of any act or inaction by him in any such capacity (including, but not limited to, any written statement of the Indemnitee that (i) is required to be, and is, filed with the Securities and Exchange Commission (the "SEC") regarding the adequacy of the Company's internal controls or the accuracy of reports or statements filed by the Company with the SEC pursuant to federal laws and/or administrative regulations (each, a "Required Statement") or (ii) is made to another officer or employee of the Company to support a Required Statement), against any and all expenses and liabilities of any type whatsoever (including, but not limited to, judgments, fines and penalties), actually and reasonably incurred by him in connection with the investigation, defense, settlement or appeal of such proceeding, but only if the Indemnitee acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe Indemnitee's conduct was unlawful. The termination of any proceeding by judgment, order of court, settlement, conviction or on plea of nolo contendere, or its equivalent, shall not, of itself, create a presumption that the Indemnitee did not act in good faith in a manner which he reasonably believed to be in, or not opposed to, the best interests of the Company, and with respect to any criminal proceedings, that such person had reasonable cause to believe that his conduct was unlawful.
        (b)     Indemnification in Derivative Actions.     Subject to Section 10 below, the Company shall indemnify the Indemnitee if the Indemnitee is a party to or threatened to be made a party to or otherwise involved in any proceeding by or in the name of the Company to procure a judgment in its favor by reason of the fact that the Indemnitee is or was an agent of the Company, or by reason of any act or inaction by him in any such capacity (including, but not limited to, any written statement of the Indemnitee that (i) is a Required Statement or (ii) is made to another officer or employee of the Company to support a Required Statement), against all expenses actually and reasonably incurred by the Indemnitee in connection with the investigation, defense, settlement, or appeal of such proceedings, but only if the Indemnitee acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the Company; provided, however, that no indemnification under this subsection (b) shall be made in respect of any claim, issue or matter as to which the Indemnitee shall have been finally adjudged to be liable to the Company by a court of competent jurisdiction, unless and only to the extent that any court in which such proceeding was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses as such court shall deem proper.
        4.     Indemnification of Expenses of Successful Party.     Notwithstanding any other provisions of this Agreement, to the extent that the Indemnitee has been successful on the merits or otherwise in defense of any proceeding or in defense of any claim, issue or matter therein, including the dismissal of any action without prejudice, the Company shall indemnify the Indemnitee against all expenses actually and reasonably incurred in connection with the investigation, defense or appeal of such proceeding.
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        5.     Partial Indemnification.     If the Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of any expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes or penalties) actually and reasonably incurred by him in the investigation, defense, settlement or appeal of a proceeding but is not entitled, however, to indemnification for the total amount thereof, the Company shall nevertheless indemnify the Indemnitee for the portion thereof to which the Indemnitee is entitled.
        6.     Advancement of Expenses.     Subject to Section 10(b) below, the Company shall advance all expenses incurred by the Indemnitee in connection with the investigation, defense, settlement or appeal of any proceeding to which the Indemnitee is a party or is threatened to be made a party by reason of the fact that the Indemnitee is or was an agent of the Company. The Indemnitee's obligation, if any, to reimburse the Company shall be unsecured and no interest shall be charged thereon. The Indemnitee hereby undertakes to repay such amounts advanced only if, and to the extent that, it shall ultimately be determined that the Indemnitee is not entitled to be indemnified by the Company as authorized by this Agreement. The advances to be made hereunder shall be paid by the Company to or on behalf of the Indemnitee within 30 days following delivery of a written request therefor by the Indemnitee to the Company. In the event that the Company fails to pay expenses as incurred by the Indemnitee as required by this paragraph, the Indemnitee may seek mandatory injunctive relief from any court having jurisdiction to require the Company to pay expenses as set forth in this paragraph. If the Indemnitee seeks mandatory injunctive relief pursuant to this paragraph, it shall not be a defense to enforcement of the Company's obligations set forth in this paragraph that the Indemnitee has an adequate remedy at law for damages.
        7.     Notice and Other Indemnification Procedures.     
        (a)     Notification of Proceeding.     Promptly after receipt by the Indemnitee of notice of the commencement of or the threat of commencement of any proceeding, the Indemnitee shall, if the Indemnitee believes that indemnification with respect thereto may be sought from the Company under this Agreement, notify the Company of the commencement or threat of commencement thereof, provided, however, that the failure to give such notice shall not limit the Indemnitee's rights to indemnification hereunder, except to the extent that the Company is materially prejudiced by such failure to give notice or delay in giving notice.
        (b)     Notification of Insurance Company.     If, at the time of the receipt of a notice of the commencement of a proceeding pursuant to Section 7(a) hereof, the Company has directors' and officers' liability insurance ("D&O Insurance") in effect, the Company shall give prompt notice of the commencement of such proceeding to the insurers in accordance with the procedures set forth in the respective policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts as a result of such proceeding in accordance with the terms of such policies.
        (c)     Selection of Reviewing Party.     If the Indemnitee shall make a claim for indemnification, advancement of expenses or other benefits hereunder, a majority of the disinterested members of the Board of Directors of the Company shall appoint a Reviewing Party to determine the rights of Indemnitee and obligations of the Company hereunder, under the Company's Certificate of Incorporation and Bylaws, any other applicable agreements and applicable law; provided, however, that if there has been a Change in Control or if there are no disinterested members of the Board of Directors of the Company, the Reviewing Party shall be independent legal counsel selected by the disinterested members of the Board of Directors of the Company (or if there shall be no disinterested directors, by the General Counsel of the Company, if there is a disinterested General Counsel, and if not, then by the most senior disinterested officer of the Company) and approved by the Indemnitee if the Indemnitee shall so request. Such counsel, among other things, shall
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render its written opinion to the Company and the Indemnitee as to whether and to what extent the Indemnitee would be entitled to be indemnified hereunder under applicable law and the Company shall abide by such opinion. The Company shall pay the reasonable fees of the independent legal counsel referred to above and to indemnify fully such counsel against any and all expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement or its engagement pursuant hereto.
        (d)     Timing of Payments.     All payments on account of the Company's indemnification obligations under this Agreement, other than expense advances made pursuant to Section 6 above, shall be made within thirty (30) days of the Indemnitee's request therefor.
        (e)     Application for Enforcement.     Notwithstanding a determination under Section 7(c) above that the Indemnitee is not entitled to indemnification with respect to any specific proceeding, the Indemnitee shall have the right to apply to any court of competent jurisdiction for the purpose of enforcing the Indemnitee's right to indemnification pursuant to this Agreement. In such an enforcement hearing or proceeding, the burden of proving by clear and convincing evidence that indemnification or advances are not appropriate shall be on the Company. Neither the failure of the Company (including its Board of Directors, stockholders, independent legal counsel or the panel of arbitrators) to have made a determination prior to the commencement of such action that the Indemnitee is entitled to indemnification hereunder, nor an actual determination by the Company (including its Board of Directors or independent legal counsel or the panel of arbitrators) that the Indemnitee is not entitled to indemnification hereunder, shall be a defense to the action or create any presumption that the Indemnitee is not entitled to indemnification hereunder.
        (f)     Indemnification of Certain Expenses.     The Company shall indemnify the Indemnitee against all expenses incurred in connection with any hearing or proceeding under this Section 7 unless the Company prevails by clear and convincing evidence in such hearing or proceeding.
        8.     Assumption of Defense.     In the event the Company shall be obligated to pay the expenses of any proceeding against the Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such proceeding, with counsel reasonably acceptable to the Indemnitee, upon the delivery to the Indemnitee of written notice of its election to do so. After delivery of such notice, approval of such counsel by the Indemnitee and the retention of such counsel by the Company, the Company shall not be liable to the Indemnitee under this Agreement for any fees of counsel subsequently incurred by the Indemnitee with respect to the same proceeding, provided that (a) the Indemnitee shall have the right to employ his counsel in such proceeding at the Indemnitee's expense; and (b) if (i) the employment of counsel by the Indemnitee has been previously authorized in writing by the Company, (ii) the Indemnitee's counsel delivers a written notice to the Company stating that such counsel has reasonably concluded that there may be a conflict of interest between the Company and the Indemnitee in the conduct of any such defense or (iii) the Company shall not, in fact, have employed counsel to assume the defense of such proceeding within a reasonable time, then in any such event the fees and expenses of the Indemnitee's counsel shall be at the expense of the Company.
        9.     Liability Insurance.     
        (a)     Maintenance of D&O Insurance.     The Company shall, so long as the Indemnitee shall continue to serve as an agent of the Company and thereafter so long as the Indemnitee shall be subject to any possible proceeding by reason of the fact that the Indemnitee was an agent of the Company, subject to Section 9(c) below, promptly obtain and maintain in full force and effect D&O Insurance in reasonable amounts from established and reputable insurers.
        (b)     Rights and Benefits.     In all policies of D&O Insurance, the Indemnitee shall be named as an insured in such a manner as to provide the Indemnitee the same rights and benefits as are
5

accorded to the most favorably insured of the Company's directors, if the Indemnitee is a director; or of the Company's officers, if the Indemnitee is not a director of the Company but is an officer; or of the Company's key employees, if the Indemnitee is not a director or officer but is a key employee.
        (c)     Limitation on Required Maintenance of D&O Insurance.     Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain D&O Insurance if the Company determines in good faith that such insurance is not reasonably available, the premium costs for such insurance are disproportionate to the amount of coverage provided, the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or the Indemnitee is covered by similar insurance maintained by a subsidiary of the Company.
        10.     Exceptions.     
        (a)     Certain Matters.     Any provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement to indemnify the Indemnitee on account of any proceeding with respect to (i) remuneration paid to the Indemnitee if it is determined by final judgment or other final adjudication that such remuneration was in violation of law; (ii) which final judgment is rendered against the Indemnitee for an accounting of profits made from the purchase or sale by the Indemnitee of securities of the Company pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934, as amended, or similar provisions of any federal, state or local statute; or (iii) which (but only to the extent that) it is determined by final judgment or other final adjudication that the Indemnitee's conduct was in bad faith, knowingly fraudulent or deliberately dishonest. For purposes of the foregoing sentence, a final judgment or other adjudication may be reached in either the underlying proceeding or action in connection with which indemnification is sought or a separate proceeding or action to establish rights and liabilities under this Agreement.
        (b)     Claims Initiated by the Indemnitee.     Any provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement to indemnify or advance expenses to the Indemnitee with respect to proceedings or claims initiated or brought voluntarily by the Indemnitee and not by way of defense, except with respect to proceedings brought to establish or enforce a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145, but such indemnification or advancement of expenses may be provided by the Company in specific cases if the Board of Directors of the Company finds it to be appropriate.
        (c)     Insurance Payments.     Notwithstanding any other provision of this Agreement, the Company shall not be obligated to indemnify the Indemnitee for expenses, judgments, fines, ERISA excise taxes or penalties which have been paid directly to the Indemnitee by D&O Insurance; provided, however, that if, for any reason whatsoever, all or part of such payment is rescinded and the Indemnitee has to return all or part of such payment, the indemnification obligations of the Company under this Agreement shall apply to the full amount of such returned payment.
        (d)     Unauthorized Settlements.     Any provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement to indemnify the Indemnitee under this Agreement for any amounts paid in settlement of a proceeding effected without the Company's written consent. Neither the Company nor the Indemnitee shall unreasonably withhold consent to any proposed settlement; provided, however, that the Company may in any event decline to consent to (or to otherwise admit or agree to any liability for indemnification hereunder in respect of) any proposed settlement if the Company determines in good faith (pursuant to Section 7(c) above) that the Indemnitee is not or ultimately will not be entitled to indemnification hereunder.
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        (e)     Securities Act Liabilities.     Any provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement to indemnify the Indemnitee or otherwise act in violation of any undertaking appearing in and required by the rules and regulations promulgated under the Securities Act of 1933, as amended (the "Act") in any registration statement filed with the SEC under the Act. The Indemnitee acknowledges that paragraph (h) of Item 512 of Regulation S-K currently generally requires the Company to undertake in connection with any registration statement filed under the Act to submit the issue of the enforceability of the Indemnitee's rights under this Agreement in connection with any liability under the Act on public policy grounds to a court of appropriate jurisdiction and to be governed by any final adjudication of such issue. The Indemnitee specifically agrees that any such undertaking shall supersede the provisions of this Agreement and to be bound by any such undertaking.
        11.     Nonexclusivity.     The provisions for indemnification and advancement of expenses set forth in this Agreement shall not be deemed exclusive of any other rights which the Indemnitee may have (i) under any provision of law, the Company's Certificate of Incorporation or Bylaws, (ii) in any court in which a proceeding is brought, (iii) by the vote of the Company's stockholders or disinterested directors, or (iv) under other agreements or otherwise, both as to action in the Indemnitee's official capacity and to action in another capacity while occupying his position as an agent of the Company, and the Indemnitee's rights hereunder shall continue after the Indemnitee has ceased acting as an agent of the Company and shall inure to the benefit of the heirs, executors and administrators of the Indemnitee. Any provision herein to the contrary notwithstanding, the Company may provide, in specific cases, the Indemnitee with full or partial indemnification if the Board of Directors of the Company determines that such indemnification is appropriate.
        12.     Subrogation.     In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of the Indemnitee, who, at the request and expense of the Company, shall execute all papers required and shall do everything that may be reasonably necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to bring suit to enforce such rights.
        13.     Interpretation of Agreement.     It is understood that the parties hereto intend this Agreement to be interpreted and enforced so as to provide indemnification to the Indemnitee to the fullest extent now or hereafter permitted by law.
        14.     Severability.     If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever, (a) the validity, legality and enforceability of the remaining provisions of the Agreement (including without limitation, all portions of any paragraphs of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby; and (b) to the fullest extent possible, the provisions of this Agreement (including, without limitation, all portions of any paragraph of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable and to give effect to Section 13 hereof.
        15.     Modification and Waiver.     No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. The indemnification rights afforded to the Indemnitee hereby are contract rights and may not be diminished, eliminated or otherwise affected by amendments to the Certificate of Incorporation or Bylaws of the Company or by other agreements.
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        16.     Successors and Assigns.     The terms of this Agreement shall bind, and shall inure to the benefit of, the successors and assigns of the parties hereto.
        17.     Notice.     Except as otherwise provided herein, any notice or demand which, by the provisions hereof, is required or which may be given to or served upon the parties hereto shall be in writing and, if by telegram, telecopy or telex, shall be deemed to have been validly served, given or delivered when sent, if by personal delivery, shall be deemed to have been validly served, given or delivered upon actual delivery and, if mailed, shall be deemed to have been validly served, given or delivered three business days after deposit in the United States mails, as registered or certified mail, with proper postage prepaid and addressed to the party or parties to be notified at the addresses set forth on the signature page of this Agreement (or such other address(es) as a party may designate for itself by like notice).
        18.     Governing Law.     This Agreement shall be governed exclusively by and construed according to the laws of the State of Delaware, as applied to contracts between Delaware residents entered into and to be performed entirely within Delaware.
        19.     Entire Agreement.     This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, understandings and negotiations, written and oral, between the parties with respect to the subject matter of this Agreement.
        20.     Survival of Rights.     The Company shall require any successor to the Company (whether direct or indirect, by purchase, merger, consolidation or otherwise) or to all, substantially all, or a substantial part of the business or assets of the Company, by written agreement in form and substance satisfactory to the Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
        21.     Conflict With Other Laws.     Notwithstanding anything to the contrary in this Agreement, if any provision of this Agreement, including, but not limited to, the requirement to advance attorneys' fees to Indemnitee as provided herein, violates any provision of the Sarbanes-Oxley Act of 2002 or any rule or regulation promulgated thereunder, or any other law or rule, then the Company shall have no obligation to comply with such provision.
        22.     Counterparts; Facsimile Signatures.     This Agreement may be executed in one or more counterparts, each of which shall constitute an original, but all of which together shall constitute one instrument. Signatures transmitted via facsimile shall be deemed originals for purposes of this Agreement.
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        IN WITNESS WHEREOF, the parties hereto have entered into this Agreement effective as of the date first above written.

 	 	THE "COMPANY":

NETLIST, INC., A DELAWARE CORPORATION	

 	
By:	

 	
 	
Title:	
	
 	 	Address:	475 Goddard
Irvine, CA 92618	

 	
THE "INDEMNITEE":	

 	

Signature of the Indemnitee	

 	

Print or Type Name of the Indemnitee	

 	
Address:	

 	

	
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 FORM OF INDEMNITY AGREEMENT
 
Exhibit 16.1
August 18, 2006
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-7561
Dear Sirs/Madams:
We have read the statements made by Netlist Inc. (copy attached), which we understand will be filed with the Commission pursuant to regulation S-K item 304 as part of the Company's Form S-1 Registration Statement dated August 18, 2006, and have the following comments:
1.
We agree with the statements made in the first and third paragraphs.

2.
We have no basis on which to agree or disagree with the statements made in the second paragraph.
Yours truly,
/s/ Deloitte & Touche LLP

 
EXHIBIT 21.1
SUBSIDIARIES
        Except as otherwise indicated, each of the following is a wholly owned direct subsidiary of Netlist, Inc.:

Entity Name
	 	Jurisdiction of Organization
	
Netlist Holdings GP, Inc.	 	Texas	
Netlist Holdings LP, Inc.	 	Delaware	
Netlist Technology Texas, L.P.(1)	 	Texas	
Netlist International	 	Cayman Islands	

(1)
Ownership interest is held ninety-nine percent by Netlist Holdings LP, Inc. and one percent by Netlist Holdings GP, Inc.

 
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EXHIBIT 23.1
  CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
        We consent to the use in this Registration Statement on Form S-1 of our report dated May 11, 2006 relating to the consolidated financial statements of Netlist, Inc. and subsidiaries appearing in the Prospectus, which is part of this Registration Statement, and of our report dated May 11, 2006 relating to the consolidated financial statement schedule appearing elsewhere in this Registration Statement.
        We also consent to the reference to us under the heading "Experts" in such Prospectus.
/s/ Corbin & Company, LLP
Irvine, California
August 18, 2006

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 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
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EXHIBIT 23.2
  CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
        We consent to the use in this Registration Statement on Form S-1 of our report dated March 1, 2006 relating to the consolidated financial statements of Netlist, Inc. and subsidiaries appearing in the Prospectus, which is part of this Registration Statement, and of our report dated March 1, 2006 relating to the financial statement schedule appearing elsewhere in this Registration Statement.
        We also consent to the reference to us under the heading "Experts" in such Prospectus.
/s/ Deloitte & Touche LLP
Costa Mesa, California
August 18, 2006

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 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM