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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 - K

 

 

 

 

(Mark One)

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the f iscal year ended December 27, 2014

 

or

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to

Commission file number 001 - 33170

PICTURE 1

NETLIST, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware
State or other jurisdiction of incorporation or organization

95-4812784
(I.R.S. employer Identification No.)

175 Technology Drive, Suite 150

Irvine, CA 92618  

(Address of principal executive offices) (Zip Code)

(949) 435 - 0025

(Registrant s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class

Name of each exchange on which registered

Common Stock, par value $0.001 per share

The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

Indicate by check mark if the registrant is a well - known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes   No 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   No 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S - T ( §  232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   No 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S - K is not contained herein, and will not be contained, to the best of registrant s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10 - K or any amendment to this Form 10 - K .  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non - accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer,   accelerated filer and smaller reporting company in Rule 12b - 2 of the Exchange Act.

 

 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer
(Do not check if a
smaller reporting company)

Smaller reporting company

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

The aggregate market value of the registrant s common stock held by non - affiliates, based on the closing price of the registrant s common stock as reported on Th e NASD AQ Global Market on June 2 8 ,   201 4 , the last business day of the registrant s most recently completed second fiscal quarter, was approximately $ 45.4     million. For purposes of this calculation, it has been assumed that all shares of the registrant s common stock held by directors, executive officers and shareholders beneficially owning five percent or more of the registrant s common stock are held by affiliates. The treatment of these persons as affiliates for purposes of this calculation is not conclusive as to whether such persons are, in fact, affiliates of the registrant.

The number of shares outstanding of the registrant s common stock, as of the latest practicable date:

Common Stock, par value $0.001 per share

50,347,488   shares   outstanding at February 2 8 , 201 5

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the registrant’s Annual Meeting of Stockholders for 201 5   have been incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 


 

Table of Contents

 

TABLE OF CONTENTS

 

 

 

 

Page

PART I  

 

 

 

Item 1  

Business

 

2

Item 1A  

Risk Factors

 

9

Item 2  

Properties

 

31

Item 3  

Legal Proceedings

 

31

PART II  

 

 

 

Item 5  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

32

Item 7  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

34

Item 8  

Financial Statements and Supplementary Data

 

47

Item 9  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

47

Item 9A  

Controls and Procedures

 

48

Item 9B  

Other Information

 

48

 

 

 

 

PART III  

 

 

 

Item 10  

Directors, Executive Officers and Corporate Governance

 

49

Item 11  

Executive Compensation

 

49

Item 12  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

49

Item 13  

Certain Relationships and Related Transactions, and Director Independence

 

49

Item 14  

Principal Accounting Fees and Services

 

49

PART IV  

 

 

 

Item 15  

Exhibits, Financial Statement Schedules

 

50

SIGNATURES  

 

 

53

 

 

 

 

INDEX TO EXHIBITS

 

 

 

 

 

 

 

 

 

 


 

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Unless the context otherwise requires, references to the “Company,” “Netlist,” “we,” “us” or “our” refer to Netlist, Inc. and its subsidiaries.

 

The registered trademarks of Netlist, Inc. and its subsidiaries include: HyperCloud® and NVvault™.  Other trademarks used in this Report are the property of their respective owners.

 

This Annual Report on Form 10-K includes “forward ‑looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward ‑looking statements relate to expectations concerning matters that are not historical facts, and are generally identified by words such as “believe”, “expect”, “anticipate”, “estimate”, “intend”, “strategy”, “may”, “will likely” and similar words or phrases. A forward ‑looking statement is neither a prediction nor a guarantee of future events or circumstances, and our actual results could differ materially and adversely from those expressed in any forward ‑looking statement.  These forward ‑looking statements are all based on currently available market, operating, financial and competitive information and assumptions and are subject to various risks and uncertainties that are difficult to predict.  Important information regarding factors that could cause actual results to differ materially from such expectations is disclosed in this Report, including, without limitation, information under the caption “ Risk Factors ”.  These risks and uncertainties include, but are not limited to risks associated with the launch and commercial success of our products, programs and technologies; the success of product partnerships; continuing development, qualification and volume production of HyperVault™, EXPRESSvault™, NVvault™, HyperCloud ® and VLP Planar-X RDIMM; the timing and magnitude of the continued decrease in sales to our key customer; our ability to leverage our NVvault™ and EXPRESSvault™ technology in a more diverse customer base; our need to raise additional capital and our ability to obtain financing; the rapidly-changing nature of technology; risks associated with intellectual property, including patent infringement litigation against us as well as the costs and unpredictability of litigation over infringement of our intellectual property and the possibility of our patents being reexamined or reviewed by the United States Patent and Trademark Office (“USPTO”) or the Patent Trial and Appeal Board (“PTAB”); volatility in the pricing of DRAM ICs and NAND; changes in and uncertainty of customer acceptance of, and demand for, our existing products and products under development, including uncertainty of and/or delays in product orders and product qualifications; delays in our and our customers’ product releases and development; introductions of new products by competitors; changes in end-user demand for technology solutions; our ability to attract and retain skilled personnel; our reliance on suppliers of critical components and vendors in the supply chain; fluctuations in the market price of critical components; evolving industry standards; and the political and regulatory environment in the People’s Republic of China (“PRC”).  Given these risks, uncertainties and other important factors, you should not place undue reliance on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date made. Except as required by law, we do not undertake any obligation to revise or update any forward ‑looking statements for any reason.

 

PART I

 

Item 1.  Business

 

Overview

 

We design, manufacture and sell a wide variety of high performance, logic ‑based memory subsystems for the global datacenter, storage and high ‑performance computing markets. Our memory subsystems consist of combinations of dynamic random access memory integrated circuits (“DRAM ICs” or “DRAM”), NAND flash memory (“NAND”), application ‑specific integrated circuits (“ASICs”) and other components assembled on printed circuit boards (“PCBs”). We primarily market and sell our products to leading original equipment manufacturer (“OEM”) customers, hyperscale datacenter operators and storage vendors. Our solutions are targeted at applications where memory plays a key role in meeting system performance requirements. We leverage a portfolio of proprietary technologies and design techniques, including combining discrete semiconductor technologies from third parties such as DRAM and NAND flash to function as one, efficient planar design, and alternative packaging techniques to deliver memory subsystems with persistence, high density, small form factor, high signal integrity, attractive thermal characteristics, reduced power consumption and low cost per bit. Our NVvault™ product is the first to offer both DRAM and NAND in a standard form factor memory subsystem as a persistent dual ‑in line memory module (“DIMM”) in mission critical applications. Our HyperCloud ® technology incorporates our patented rank multiplication and load reduction technologies. We also have pending and

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issued patents covering fundamental aspects of hybrid memory DIMM designs that incorporate combinations of DRAM and/or NAND flash, such as our NVvault™ product.  We are focused on monetizing our patent portfolio through our products business and, where appropriate, through licensing arrangements with third parties that wish to incorporate our patented technologies in their products.

 

We were incorporated in Delaware in June 2000 and commenced operations in September 2000.  Our principal executive offices are located at 175 Technology Drive, Suite 150, Irvine, California 92618 and our telephone number at that address is (949) 435-0025. Our website address is http://www.netlist.com. The information contained on our website is not incorporated by reference into, and does not form any part of, this Annual Report on Form 10-K. We have included our website address as a factual reference and do not intend it to be an active link to our website.

 

Intellectual Property and Licensing

 

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. We plan to license specific, custom designs to our customers, charging royalties at a fixed amount per product or a percentage of sales. More generally, we intend to vigorously defend and monetize our intellectual property through licensing arrangements and, where necessary, enforcement actions against those entities using our patented solutions in their products. Royalties resulting from these patent monetization efforts can be structured in a variety of ways, including but not limited to one-time paid up licenses or on-going royalty arrangements. We expect to generate a portion of our revenues with these types of licensing arrangements.

 

As of December 27, 2014 , we had   54 U.S. and foreign patents issued and 3 3 U.S. and foreign patent applications pending. Assuming that they are properly maintained, our patents will expire at various dates between 2022 and 2029 . Our issued patents and patent applications relate to the use of custom logic in high performance memory subsystems, PCB design, layout and packaging techniques. 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 to be important factors in developing and maintaining our competitive position. Accordingly, we believe that our business is not materially dependent upon any one claim in any of our existing patents or pending patent applications.

 

Litigation & Patent Reexamination

 

We own numerous patents and continue to enlarge and strengthen our patent portfolios which cover different aspects of our technology innovations with various claim scopes. We plan to generate revenue by selling or licensing our technology, and intend to vigorously enforce our patent rights against infringers. We dedicate substantial resources in protecting our intellectual property, including efforts to defend our patents against challenges made by way of reexamination and review proceedings at the USPTO and PTAB. These activities are likely to continue for the foreseeable future, without any guarantee that any ongoing or future patent protection and litigation activities will be successful. We also are subject to litigation claims that we have infringed on the intellectual property of others, against which we intend to defend vigorously.

 

Our Products

 

NVvault™ Family

 

We were the first to develop and market memory subsystems that incorporate both DRAM and NAND in a single NVvault™ persistent DIMM solution. NVvault™ was originally used for mission critical backups during power interruption in Redundant Array of Independent Disks (“RAID”) and main memory. NVvault™ has moved beyond its original application to a variety of other applications, including hyperscale computing for cloud, big data, on-line banking and other real time applications where NVvault™ is also used as a data accelerator. We are working to further

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enhance the capabilities of our NVvault™ technology in these new applications, and we are also seeking to expand our customer base through the integration of NVvault™ into leading storage motherboards. NVvault™ is incorporated in our EXPRESSvault™ PCIe solution for both acceleration and backup in storage applications.  Our NVvault™ product line consists primarily of battery-free and battery-powered flash backed cache memory subsystems targeting RAID storage, application acceleration and mission critical data integrity. NVvault™ battery-free provides server and storage OEMs a solution for enhanced datacenter fault recovery. Our NVvault™ products have historically been sold primarily to Dell, for incorporation in its PERC 7 server products. Following Intel’s launch of its Romley platform in the first quarter of 2012, we experienced a steady decline in NVvault™ sales to Dell. There were no sales of NVvault™ products to Dell in the year ended December 27, 2014 and sales were $5.5 million in year ended December 28, 2013. We expect no future demand from Dell for our DDR2 NVvault™.  We continue to pursue qualifications with other potential significant customers within the industry and we are currently working to remedy our ongoing supply chain disruptions, however, our efforts to expand our qualifications and manage our supply chain may not result in significant revenues from the sale of NVvault™ family products.

 

For the years ended December 27, 2014 and December 28, 2013, our NVvault™ non-volatile RDIMM used in cache-protection and data logging applications, including our NVvault™ battery-free, the flash-based cache system, accounted for approximately 44% and 39% of total net sales, respectively.

 

HyperCloud ®

 

Our HyperCloud ® technology incorporates our patented rank multiplication technology, which increases memory capacity and our patented load reduction technology, which increases memory bandwidth. We expect that these patented technologies will make possible improved levels of performance for memory intensive datacenter applications and workloads, including enterprise virtualization, cloud computing infrastructure, business intelligence real- time data analytics, and high performance computing .

 

Specialty Memory Modules and Flash-Based Products

 

The remainder of our revenues are primarily from OEM sales of specialty memory modules and flash-based products, the majority of which are utilized in data center and industrial applications. When developing custom modules for an equipment product launch, we engage with our OEM customers from the earliest stages of new product definition, providing 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 speed, capacity and signal integrity, small form factor, attractive thermal characteristics and low cost per bit. Revenues from our specialty modules and flash-based products are subject to fluctuation as a result of the life cycles of the products into which our modules are incorporated. Our ability to continue to generate revenues from specialty memory modules and flash-based products is dependent on our ability to qualify our products on new platforms as current platforms reach the end of their lifecycles, and on the state of the global economy.  

 

Technology

 

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

 

IC Design Expertise.  We have designed special algorithms that can be implemented in stand-alone integrated circuits or integrated into other functional blocks in ASICs. We utilize these algorithms in the HyperCloud ® chipset to incorporate rank multiplication and load reduction functionality. We also incorporate these algorithms in our NVvault™ product line of RDIMMS.

 

NVvault™.  We were the first to develop and market memory subsystems that incorporate both DRAM and NAND flash in a single NVvault™ persistent DIMM solution. NVvault™ combines the best attributes of DRAM,

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including speed, durability and reliability with high densities, lower power and lowest costs provided by NAND. This combination enables us to provide application acceleration and mission critical backup during power interruption for cloud infrastructure, virtualization, analytics and database applications. NVvault™ is incorporated in our EXPRESSvault™ PCIe solution for both acceleration and backup in storage applications.

 

Proprietary PCB Designs.     We utilize advanced techniques to optimize electronic signal strength and integrity within a PCB. These techniques include the use of 8-layer or 10-layer boards, matching conductive trace lengths, a minimized number of conductive connectors, or vias, and precise load balancing to, among other benefits, 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.

 

Very Low Profile Designs.  We were the first company to create memory subsystems in a form factor of less than one inch in height. We believe our proprietary board design technology is particularly useful in the 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.

 

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 also develop and use proprietary heat spreaders to enhance the thermal management characteristics of our memory subsystems.

 

Customers

 

During our 2014 fiscal year we primarily marketed and sold our products to leading OEMs in the server, storage and communications markets. 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.  Net sales to our three largest customers, Dell, IBM and Nimble Storage, Inc., represented approximately 20%, 14% and 19% of our net sales in 2014, respectively.  Dell and IBM represented approximately 45% and 15% of our net sales in 2013, respectively. Net sales to some of our OEM customers include memory modules that are qualified by us directly with the OEM customer and sold to electronic manufacturing services providers (“EMSs”), for incorporation into products manufactured exclusively for the OEM customer or, in some instances, to facilitate credit and logistics.  These net sales to EMSs have historically fluctuated period to period as a portion of the total net sales to the OEM customers.  Net sales to Hon Hai Precision Industry Co. Ltd., an EMS operating under the trade name of Foxconn that purchases memory modules from us for incorporation into products manufactured exclusively for Dell, represented approximately 77% and 74% of net sales to Dell for 2014 and 2013, respectively.  Net sales to Kingston Technology, an EMS manufacturer for IBM, represented approximately 46% and 29% of net sales to IBM for 2014 and 2013, respectively. For further information regarding our sales to our OEM customer base, please refer to Note 10 of Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Report.  

 

We expect that our key customers or other large OEMs will no longer continue to account for a substantial portion of our net sales in 201 4 and in the foreseeable future. The composition of major customers and their respective contributions to our net sales have varied and will likely continue to vary from period to period as our OEMs progress through the life cycle of the products they produce and sell.  For example, we have experienced a   significant decline in sales of our NVvault™ sales to Dell following its launch of servers incorporating Intel’s Romley platform.  We expect that after product in the supply chain is consumed, sales of NVvault™ products for incorporation into PERC 7 servers will be minimal.  This reduction in sales is expected to continue to have a significant impact on our revenue and gross profit.  

 

Our sales are made primarily pursuant to standard purchase orders that may be rescheduled on relatively short notice. Customers are generally allowed limited rights of return for up to 30 days, except for sales of excess inventories, which contain no right-of-return privileges. Estimated returns are provided for at the time of sale based on historical

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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.

 

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 within our expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on us, requiring additional warranty reserves, and adversely affecting our gross profit and gross margins.

 

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.

 

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 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.

 

For additional information regarding our net sales from external customers by geographic area, refer to Note 11 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.

 

Manufacturing

 

We manufacture substantially all of our products at our facility in Suzhou in the People’s Republic of China (the “PRC”) . 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 facilities are 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 acquire components and materials such as ASICs, DRAM ICs and NAND directly from integrated circuit manufacturers and assemble them into finished subsystems. We believe that one of our key strengths is the efficient procurement and management of components for our subsystems, which benefits our customers in the form of lower costs and increased product availability. We have a limited number of suppliers, including Arrow Electronics which comprised more than 10% of our total purchases in 2014 and SK Hynix Semiconductor America (“SK Hynix”) and Samsung Semiconductor, Inc. (“Samsung”) each of which comprised more than 10% of our total purchases in 2013. For further information regarding our supplier concentrations, refer to Note 10 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.  We have developed strong supplier relationships with these and other key DRAM IC and NAND 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 multiple manufacturers of DRAM ICs and NAND. The flexibility to choose from several DRAM IC and NAND providers allows us to minimize product cost and maximize product availability. We schedule production based on purchase order commitments and anticipated orders. We release raw materials to the manufacturing floor by means of an on-line shop floor control system, which allows for internal quality analysis, direct access to inventory information and

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production floor material tracking. We have a flexible manufacturing workforce which allows us to manage unforecasted demand. In addition, in order to mitigate inventory risks, we have the capability to sell excess quantities of certain component inventories of DRAM ICs and NAND to distributors and other users of memory integrated circuits.    

 

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 supplier factory audits and use our internal test and inspection systems to verify that purchased components and materials meet our specifications. Our supplier quality program and incoming material quality control program are important aspects of our overall manufacturing process.

 

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 which require that all of our memory subsystems 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 assemblies.

 

We are certified in ISO 9001:200 8 Quality Management Systems and ISO 14001:2004 Environmental Management Standards .

 

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.  We face competition from DRAM suppliers, including SK Hynix, Samsung and Micron for many of our products, including NVvault and HyperCloud ® . Our primary competitors for the rest of our product lines are mainly memory module providers such as STEC, SMART Modular Technologies, Inc., AgigA Tech, SanDisk,   and Viking Interworks, a division of Sanmina-SCI Corporation.  We also face potential direct or indirect competition from logic suppliers such as Inphi, IDT, Montage, Diablo Technologies and Texas Instruments. As we enter new markets and pursue additional applications for our products, we may face competition from a larger number of competitors that produce solutions utilizing similar or competing technologies.

 

Certain 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 that 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 integrated circuits may be able to manufacture competitive products at lower costs by leveraging internal efficiencies, or could choose to reduce our supply of memory integrated circuits, 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 value-add product introductions;

 

·

design characteristics and performance;

 

·

quality and reliability;

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·

track record of volume delivery;

 

·

credibility with the customer;

 

·

fulfillment capability and flexibility; and

 

·

price.

 

We believe that we compete favorably with respect to these factors. However, 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 constantly changing and therefore continuous development of new technology, processes and product innovation is mandatory to be successful as a leading supplier. We believe that the continued and timely development of new products and improvement of existing products are critical to maintaining our competitive position. Our team of engineers focuses on developing custom semiconductor logic devices, hybrid memory, DRAM and NAND flash products with innovative packaging solutions, improved electrical signal integrity and thermal characteristics that enhances reliability over the life of the system and achieves higher speeds and lowers power consumption. Also, our engineers incorporate various new techniques and methodologies for testing as well as new processes for manufacturing our products.

 

Our engineering staff closely engages with our customers and their engineering teams at early stages in their system development. This collaboration allows our engineers to understand the customer’s system architecture, power budget, operating environment such as air flow and operating temperature and any mechanical constraints. Our engineers use this information to provide guidance and solutions to implement optimum memory subsystems to our customers. An important aspect of our research and development effort is to understand the challenges faced by our customers and provide cost effective solutions that satisfy their requirements by utilizing our industry knowledge, proprietary technologies and technical expertise.

 

We use advanced design tools in development of our products that allow us to model behavior of a signal trace on our memory modules as well as airflow and thermal profiles of all components in the system. These design tools enable real-time simulation for signal integrity and behavioral modeling of our designs using the Input/Output Buffer Information Specification (“IBIS”) and Simulation Program with Integrated Circuit Emphasis (“SPICE”) models of our suppliers’ components. These simulation tools help us reduce or eliminate electronic signal reflections, clock skews, signal jitter and noise which can reduce system performance and reliability. These efforts allow our engineers to develop optimum thermal solutions for our customer base.

 

We believe that to remain competitive we must continue to focus on developing advanced memory technologies. We have invested significant resources in the design of custom semiconductor logic devices. These logic devices are integrated into our next-generation memory subsystems in order to improve their performance. Logic devices in our NVvault™ hybrid memory product enable DRAM and flash memory to be efficiently combined for the purposes of accelerating system performance and providing mission critical back up. The development of these semiconductor devices are an important part of our overall effort to maintain a strong competitive position in our industry based on advanced memory technologies.

 

Our customers typically do not separately compensate us for design and engineering work involved in developing application ‑specific products for them.  Our total expenditures for research and development were approximately $ 4.8 million and $ 4.5 million for 2014 and 2013, respectively.

 

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Employees

 

At December 27, 2014, we had approximately 114 employees (including 79 regular employees and 35 temporary employees). Approximately 35 of the regular employees were located in the U.S., and approximately 44 were located in the PRC. We had 47 employees in operations, 16 employees in research and development, 9 employees in sales and marketing, and 7 employees engaged in other administrative functions. 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.

 

General Information

 

We maintain a website at www.netlist.com (this uniform resource locator, or URL, is an inactive textual reference only and is not intended to incorporate our website into this Form 10 - K). We file reports with the Securities and Exchange Commission ( SEC ), and make available, free of charge, on or through our website, our annual reports on Form 10 - K, quarterly reports on Form 10 - Q, current reports on Form 8 - K, proxy and information statements and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act ), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our website also contains copies of our corporate governance policy, code of business conduct and ethics, insider trading policy and whistleblower policy, as well as copies of the charters for our audit committee, compensation committee and nominating and corporate governance committee.

 

Item 1A.  Risk Factors

 

You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects.  The risks described below 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. If any of the events described below were to occur, our financial condition, our ability to access capital resources, our results of operations and/or our future growth prospects could be materially and adversely affected and the market price of our common stock could decline. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this Report, including our consolidated financial statements and related notes.

 

Risks related to our business

 

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 supplement:

 

·

adverse developments in litigation we are pursuing for infringement of our intellectual property and potential forfeiture of bonds relating to such developments;

 

·

disputes regarding intellectual property rights and the possibility of our U.S. patents being reexamined or reviewed by the USPTO and PTAB or our foreign patents being subjected to invalidation proceedings with their respective authorities ;

 

·

the costs and management attention diversion associated with litigation and any appeals we may pursue;

 

·

general economic conditions, including the possibility of a prolonged period of limited economic growth in the U.S. and Europe; disruptions to the credit and financial markets in the U.S., Europe and elsewhere;

 

·

our inability to develop new or enhanced products that achieve customer or market acceptance in a timely manner, including our HyperCloud ® memory module, our NVvault TM and Hypervault family of products and our flash ‑ based memory products;

 

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·

our failure to maintain the qualification of our products with our current customers or to qualify current and future products with our current or prospective customers in a timely manner or at all;

 

·

the timing of actual or anticipated introductions of competing products or technologies by us or our competitors, customers or suppliers;

 

·

our ability to procure an adequate supply of key components, particularly DRAM ICs and NAND f lash;

 

·

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 customers’ failure to pay us on a timely basis;

 

·

costs, inefficiencies and supply risks associated with outsourcing portions of the design and the manufacture of integrated circuits;

 

·

our ability to absorb manufacturing overhead if our revenues decline or vary from our projections;

 

·

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

 

·

dependence on large suppliers who are also competitors and whose manufacturing priorities may not support our production schedules;

 

·

changes in the prices of our products or in the cost of the materials that we use to build our products, including fluctuations in the market price of DRAM ICs and NAND;

 

·

our ability to effectively operate our manufacturing facility in the PRC;

 

·

manufacturing inefficiencies associated with the start ‑up of new manufacturing operations, new products and initiation of volume production or disruption due to power outages, natural disasters or other factors;

 

·

our failure to produce products that meet the quality requirements of our customers;

 

·

the loss of any of our key personnel;

 

·

changes in regulatory policies or accounting principles;

 

·

our ability to adequately manage or finance internal growth or growth through acquisitions;

 

·

the effect of our investments and financing arrangements on our liquidity; and

 

·

the other factors described in this “Risk Factors” section and elsewhere in this prospectus supplement.

 

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. In one or more future periods, our results of operations may fall below the expectations of securities analysts and investors. In that event, the market price of our common stock would likely decline. In addition, the market price of our common stock may fluctuate or decline regardless of our operating performance.

 

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

 

Since the inception of our business in 2000, we have only experienced one fiscal year (2006) with profitable results. In order to regain profitability, or to achieve and sustain positive cash flows from operations in the future, we must further reduce operating expenses and/or increase our revenues and gross margins. Although we have in the past engaged in a series of cost reduction actions, and believe that we could reduce our current level of expenses through elimination or reduction of strategic initiatives, such expense reductions alone may not make us profitable or allow us to sustain profitability if it is achieved. Our ability to achieve profitability will depend on increased revenue growth from, among other things, our ability to monetize our intellectual property, increased demand for our memory subsystems and related product offerings, as well as our ability to expand into new and emerging markets. We may not be successful in achieving the necessary revenue growth or the expected expense reductions. Moreover, we may be unable to sustain past or expected future expense reductions in subsequent periods. We may not achieve profitability or sustain such profitability, if achieved, on a quarterly or annual basis in the future.

 

Any failure to achieve profitability could result in increased capital requirements and pressure on our liquidity position. We believe our future capital requirements will depend on many factors, including our levels of net sales, the timing and extent of expenditures to support sales, marketing, research and development activities, the expansion of manufacturing capacity both domestically and internationally and the continued market acceptance of our products. Our capital requirements could result in our having to, or otherwise choosing to, seek additional funding through public or private equity offerings or debt financings. Such funding may not be available on terms acceptable to us, or at all, either of which could result in our inability to meet certain of our financial obligations and other related commitments.

 

Our future capital needs are uncertain, and we may need to raise additional funds, which may not be available on acceptable terms or at all.

 

We believe our existing cash balances, borrowing availability under our bank credit facility with Silicon Valley Bank (“SVB”), borrowing availability under our loan agreement with Fortress Credit Opportunities I LP (“Fortress”), an affiliate of Fortress Investment Group LLC and successor to DBD Credit Funding LLC, net of cash expected to be used in operations , will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need significant additional capital, which we may seek to raise through, among other things, public and private equity offerings and debt financings. 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 and patent infringement litigation, the expansion of manufacturing capacity both domestically and internationally and the continued market acceptance of our products. Additional funds may not be available on terms acceptable to us, 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 adequate working capital is not available when needed, we may be required to significantly modify our business model and operations to reduce spending to a sustainable level. It could cause us to be unable to execute our business plan, take advantage of future opportunities, or respond to competitive pressures or customer requirements. It may also cause us to delay, scale back or eliminate some or all of our research and development programs, or to reduce or cease operations.

 

We do not currently intend to pay dividends on our common stock, and any return to investors is expected to come, if at all, only from potential increases in the price of our common stock.

 

At the present time, we intend to use available funds to finance our operations. Accordingly, while payment of dividends rests within the discretion of our board of directors, no cash dividends on our common shares have been declared or paid by us and we have no intention of paying any such dividends in the foreseeable future. Any return to investors is expected to come, if at all, only from potential increases in the price of our common stock.

 

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We have incurred a material amount of indebtedness to fund our operati ons, the terms of which require that we pledge substantially all of our assets as security and that we agree to share certain patent monetization revenues that may accrue in the future.  Our level of indebtedness and the terms of such indebtedness, could adversely affect our operations and liquidity.

 

We have incurred debt secured by all of our assets under our credit facilities and term loans with Fortress and SVB. Our credit facility with Fortress is secured by a first-priority security interest in our intellectual property assets (other than certain patents and related assets relating to the NVvault™ product line) and a second priority security interest in substantially all of our other assets. Our credit facility with SVB is secured by a first priority security interest in all of our assets other than our intellectual property assets, to which SVB has a second priority security interest. The credit facility with Fortress contains customary representations, warranties and indemnification provisions, as well as affirmative and negative covenants that, among other things restrict our ability to:

 

·

incur additional indebtedness or guarantees;

 

·

incur liens;

 

·

make investments, loans and acquisitions;

 

·

consolidate or merge

 

·

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

 

·

alter our business;

 

·

engage in transactions with affiliates; and

 

·

pay dividends or make distributions.

 

The credit facilities also include events of default, including, among other things, payment defaults, breaches of representations, warranties or covenants, certain bankruptcy events, and certain material adverse changes. If we were to default under either credit facility and were unable to obtain a waiver for such a default, interest on the obligations would accrue at an increased rate. In the case of a default, the lenders could accelerate our obligations under the credit agreements and exercise their rights to foreclose on their security interests, which would cause substantial harm to our business and prospects.

 

Incurrence and maintenance of this debt could have material consequences, such as:

 

·

requiring us to dedicate a portion of our cash flow from operations and other capital resources to debt service, thereby reducing our ability to fund working capital, capital expenditures, and other cash requirements;

 

·

increasing our vulnerability to adverse economic and industry conditions;

 

·

limiting our flexibility in planning for, or reacting to, changes and opportunities in, our business and industry, which may place us at a competitive disadvantage; and

 

·

limiting our ability to incur additional debt on acceptable terms, if at all.

 

Concurrently with the execution of the credit facility with Fortress, we entered into a Monetization Letter Agreement (as amended, the “Letter Agreement”), which provides, among other things, that Drawbridge Special Opportunities Fund LP (“Drawbridge”) may be entitled to share in certain monetization revenues that we may derive in the future related to our patent portfolio.  We amended the Letter Agreement on February 17, 2015. Monetization revenues subject to this arrangement include revenues recognized during the seven year term of the Letter Agreement

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from net amounts actually paid to us or our subsidiaries in connection with any assertion of, agreement not to assert, or license of, our patent portfolio, including revenues arising from litigation. Monetization revenues subject to the arrangement also include the value attributable to our patent portfolio in any sale of the Company during the seven year term, subject to a maximum amount. The Letter Agreement also requires that we use commercially reasonable efforts to pursue opportunities to monetize our patent portfolio during the term of the Letter Agreement, provided that we are under no obligation to pursue any such opportunities that we do not deem to be in our best interest in our reasonable business judgment. Notwithstanding the foregoing, there can be no assurance that we will be successful in these efforts, and we may expend resources in pursuit of monetization revenues that may not result in any benefit to us. Moreover, the revenue sharing obligation will reduce the benefit we receive from any monetization transactions, which could adversely affect our operating results and would reduce the amounts payable to our stockholders in the event of a sale transaction.

 

Our revenues and results of operations have been substantially dependent on NVvault™ and we may be unable to replace revenue lost from the rapid decline in prior generation NVvault™ sales to Dell.

 

For the fiscal years ended December 27, 2014 and December 28, 2013, our NVvault™ non ‑volatile RDIMM used in cache ‑protection and data logging applications, including our NVvault™ battery ‑free, the flash ‑based cache system, accounted for approximately 44% and 39% of total net sales, respectively. Following Intel’s launch of its Romley platform in the first quarter of 2012, we have experienced a rapid decline in NVvault™ sales to Dell, and we recognized no NVvault™ sales to Dell in the fiscal year ended December 27, 2014, as compared to $5.5 million in the year ended December 28, 2013. We expect no future demand from Dell for our DDR2 NVvault™. In order to leverage our NVvault™ technology and diversify our customer base, and to secure one or more new key customers other than Dell, we continue to pursue additional qualifications of NVvault™ with other OEMs and to target customer applications such as online transaction processing (“OLTP”), virtualization, big data analytics, high speed transaction processing, high performance database, and in ‑memory database applications. We also introduced EXPRESSvault™ in March 2011, and we continue to pursue qualification of next generation DDR3 NVvault™ with customers. Our future operating results will depend on our ability to commercialize these NVvault™ product extensions, as well as other products such as HyperCloud ® and HyperVault and other high ‑density and high-performance solutions. HyperVault is still under development and may require substantial additional investment. We may not be successful in expanding our qualifications or in marketing any new or enhanced products.

 

We are subject to risks relating to our focus on developing our HyperCloud ® and NVvault™ products and lack of market diversification.

 

We have historically derived a substantial portion of our net sales from sales of our high performance memory subsystems for use in the server market. We expect these memory subsystems to continue to account for a portion of our net sales in the near term, although we may be unable to meet customer demand for our HyperCloud ® or NVvault™ products in future periods if we experience disruptions in the supply of raw materials. We believe that continued market acceptance of these products or derivative products that incorporate our core memory subsystem technology for use in servers is critical to our success.

 

We have invested a significant portion of our research and development budget into the design of ASIC and hybrid devices, including the HyperCloud ® memory subsystem, introduced in November 2009, as well as our NVvault family of products. These designs and the products they are incorporated into are subject to increased risks as compared to our legacy products. For example:

 

·

we are dependent on a limited number of suppliers for both the DRAM ICs and the ASIC devices that are essential to the functionality of the HyperCloud ® memory subsystem, and we have experienced supply chain disruptions and shortages of DRAM and flash required to create our HyperCloud ® , NVvault and Planar X VLP products as a result of business issues that are specific to our suppliers or the industry as a whole;

 

·

we may be unable to achieve new qualifications or customer or market acceptance of the HyperCloud ® memory subsystem or other new products, or achieve such acceptance in a timely manner;

 

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·

the HyperCloud ® memory subsystem or other new products may contain currently undiscovered flaws, the correction of which would result in increased costs and time to market; and

 

·

we are required to demonstrate the quality and reliability of the HyperCloud ® memory subsystem or other new products to our customers, and are required to qualify these new products with our customers, which requires a significant investment of time and resources prior to the receipt of any revenue from such customers.

 

We experienced a longer qualification cycle than anticipated with our HyperCloud ® memory subsystems, and as a result, we have not generated significant HyperCloud ® product revenues to date relative to our investment in the product. We entered into collaborative agreements with both IBM and HP pursuant to which these OEMs qualified the 16GB and 32GB versions of HyperCloud ® for use with their products. While we and each of the OEMs committed financial and other resources toward the collaboration, the efforts undertaken with each of these collaborative agreements have not resulted in significant product margins for us to date relative to our investment in developing and marketing these products. We must secure an adequate supply of DRAM in order to continue to sell our HyperCloud ® product in future periods and, even assuming we are successful in maintaining an adequate supply, we cannot provide any assurances that we will achieve sufficient revenues or margins from our HyperCloud ® products.

 

Additionally, 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 use a small number of custom ASIC, DRAM ICs and NAND suppliers and are subject to risks of disruption in the supply of custom ASIC, DRAM ICs and NAND.

 

Our ability to fulfill customer orders or produce qualification samples is dependent on a sufficient supply of DRAM ICs and NAND, which are essential components of our memory subsystems. We are also dependent on a sufficient supply of custom ASIC devices to produce our HyperCloud ® memory modules. There are a relatively small number of suppliers of DRAM ICs and NAND, and we purchase from only a subset of these suppliers. We have no long ‑term DRAM or NAND supply contracts.

 

From time to time, shortages in DRAM ICs and NAND have required some suppliers to limit the supply of their DRAM ICs and NAND. We have experienced supply chain disruptions and shortages of DRAM and flash required to create our HyperCloud ® , NVvault and Planar X VLP products, and we are continually working to secure adequate supplies of DRAM and flash necessary to fill customers’ orders for our products in a timely manner. If we are unable to obtain a sufficient supply of DRAM ICs or NAND flash 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 and, even assuming we are successful in resolving supply chain disruptions, we may not be able to replace any lost business with new customers, and we may lose market share to our competitors.

 

Additionally, we could face obstacles in moving production of our ASIC components away from our current design and production partners. Our dependence on a small number of suppliers and the lack of any guaranteed sources of ASIC components, DRAM and NAND supply expose us to several risks, including the inability to obtain an adequate supply of these important components, price increases, delivery delays and poor quality.

 

Historical declines in customer demand and our revenues caused us to reduce our purchases of DRAM ICs and NAND. Such fluctuations could occur in the future. Should we not maintain sufficient purchase levels with some suppliers, our ability to obtain supplies of raw materials may be impaired due to the practice of some suppliers to allocate their products to customers with the highest regular demand.

 

Our customers qualify the ASIC components, DRAM ICs and NAND 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

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customers. This would disrupt our supplies of ASIC components, DRAM ICs and NAND and reduce the number of suppliers available to us, and may require that we qualify a new supplier. If our suppliers are unable to produce qualification samples on a timely basis or at all, we could experience delays in the qualification process, which could have a significant impact on our ability to sell that product.

 

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 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 or retain third party designers, develop the product, identify and eliminate design flaws, and manufacture the product in production quantities either in-house or through third-party manufacturers. 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 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.

 

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 nine months or longer and is often subject to delays. In addition to qualification of specific products, some of our customers may also require us to undergo a technology qualification if our product designs incorporate innovative technologies that the customer has not previously encountered. Such technology qualifications often take substantially longer than product qualifications and can take over a year to complete. 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.

 

In addition, because the qualification process is both product specific and platform specific, our existing customers sometimes require us to re-qualify 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 architectures to current generation

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architectures, we must design and qualify new products for use by those customers. In the past, the process of design and qualification has taken up to nine 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 from such customer.

 

Likewise, when our memory and NAND flash component vendors discontinue production of components, it may be necessary for us to design and qualify new products for our customers. Such customers may require of us or we may decide to purchase an estimated quantity of discontinued memory components necessary to ensure a steady supply of existing products until products with new components can be qualified. Purchases of this nature may affect our liquidity. Additionally, our estimation of quantities required during the transition may be incorrect, which could adversely impact our results of operations through lost revenue opportunities or charges related to excess and obsolete inventory.

 

We must devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualify our products with prospective customers in anticipation of sales. Significant delays in the qualification process, such as those experienced with our HyperCloud ® product, could result in an inability to keep up with rapid technology change or new, competitive technologies. If we delay or do not succeed in qualifying a product with an existing or prospective customer, we will not be able to sell that product to that customer, which may result in our holding excess and obsolete inventory and harm our operating results and business.

 

Sales to a limited number of customers represent a significant portion of our net sales and the loss of, or a significant reduction in sales to, any one of these customers could materially harm our business.

 

Sales to certain of our OEM customers have historically represented a substantial majority of our net sales. Approximately 20 %, 14 % and 19 % of our net sales in the fiscal   year ended December 27, 2014 were to three of our customers. Approximately 45 % and 15 % of our nets sales in the fiscal year ended December  28, 2013 were to two of our customers. The composition of major customers and their respective contributions to our net sales have varied and will likely continue to vary from period to period as our OEMs progress through the life cycle of the products they produce and sell. We do not have long-term agreements with our OEM customers, or with any other customer. Any one of these customers could decide at any time to discontinue, decrease or delay their purchase of our products. In addition, the prices that these customers pay for our products could change at any time. The loss of any of our OEM customers, or a significant reduction in sales to any of them, could 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 our customers’ continued sales of servers and other computing systems that incorporate our memory subsystems and our customers’ continued incorporation of our products into their systems. Because of these and other factors, net sales to these customers may not continue and the amount of such net sales may not 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. 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. As we describe in more detail elsewhere in this Report, we have experienced a significant decline in sales of NVvault™ to our key customer, Dell, and we did not have any sales of NVvault™ to Dell during the fiscal   year ended December  27, 2014. This loss of sales to Dell has had a significant impact on our revenues and gross profit.

 

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 and successfully maintain these relationships, our financial results will be largely dependent on these customers’ sales and business results.

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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. In a drive to reduce costs and assure supply of their memory module demand, our OEM customers may endeavor to design JEDEC standard DRAM modules into their new products. Although we also manufacture JEDEC modules, this trend could reduce the demand for our higher priced customized memory solutions which in turn would have a negative impact on our financial results. In addition, customers deploying custom memory solutions today may in the future choose to adopt a JEDEC standard, and the adoption of a JEDEC standard module instead of a previously custom module might allow new competitors to participate in a share of our customers’ memory module business that previously belonged to us.

 

If our OEM customers were to adopt JEDEC standard modules, our future business may be limited to identifying the next generation of high performance memory demands of OEM customers and developing solutions 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.

 

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

 

We participate in a highly competitive market, 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. 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.

 

In addition to the competition we face from DRAM and logic suppliers such as SK Hynix, Samsung, Micron, Inphi and IDT, 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 and 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. Further, some of our significant suppliers are also competitors, many of whom have the ability to manufacture competitive products at lower costs as a result of their higher levels of integration.

 

We also face competition from manufacturers of DIMMs operating on the memory channel that employ NAND flash either alone or in combination with DRAM. For example, manufacturers such as Micron, AgigA Tech, Smart Modular, Viking, and SK Hynix offer NVDIMM products that compete with our NVvault™ NVDIMM. The ULLtraDIMM product manufactured by SanDisk also uses NAND flash on the memory channel and competes with NVDIMMs from Netlist and other manufacturers. NVDIMMs and the ULLtraDIMM will also compete with our future products that combine DRAM and NAND flash on the memory channel, such as our HyperVault™ product.

 

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 competitive products that may render our technologies obsolete or uncompetitive.

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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. As of De cember 27, 2014, we had 54 U.S. and foreign patents issued and over 34 pending applications worldwide. 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 the PRC, where we have established a 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 the USPTO or our foreign patents being subjected to invalidation proceedings with their respective authorities, or by a court or circumvented by others, we could face increased competition with regard to our products and be unable to execute on our strategy of monetizing our intellectual property. Increased competition or an inability to monetize our intellectual property could significantly harm our business, our operating results and prospects. Currently five of our patents are the subject of inter partes reexamination proceedings with the USPTO, or appeals therefrom, and we cannot assure you that any of these proceedings will result in an outcome favorable to us.

 

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

 

As is common to the semiconductor industry, we have experienced substantial litigation regarding patent and other intellectual property rights. Lawsuits claiming that we are infringing others’ intellectual property rights have been and may in the future be brought against us, and we are currently defending against claims of invalidity in the USPTO.

 

The process of obtaining and protecting patents is inherently uncertain. In addition to the patent issuance process established by law and the procedures of the USPTO, we must comply with JEDEC administrative procedures in protecting our intellectual property within its industry standard setting process. These procedures evolve over time, are subject to variability in their application, and may be inconsistent with each other. Failure to comply with JEDEC’s administrative procedures could jeopardize our ability to claim that our patents have been infringed.

 

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By making use of new technologies and entering new markets there is an increased likelihood that others might allege that our products infringe on their intellectual property rights. Litigation is inherently uncertain, and an adverse outcome in existing or any future litigation 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 manufacturing and/or selling products, or using certain processes, that are claimed to be infringing a third party’s intellectual property;

 

·

pay damages (which in some instances may be three times actual damages), including 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.

 

If any adverse ruling in any such matter occurs, any resulting limitations in our ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, financial condition and results of operations.

 

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.

 

Our business strategy also includes litigating claims against others, including our competitors, customers and former employees, to enforce our intellectual property, 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. We cannot assure you that current or future infringement claims by or against third parties or claims for indemnification by customers or end users of our products resulting from infringement claims will not be asserted in the future or that such assertions or claims will not materially adversely affect our business, financial condition or results of operations.

 

As a result of the unfavorable outcome in connection with the litigation against Diablo Technologies, Inc., for controller chips used by SanDisk Corporation in its high ‑speed ULLtraDIMM SSD product line, we may expend significant resources to pursue an appeal in the case, which may not be resolved in a timely manner nor yield a more favorable outcome. Moreover, the expenses associated with the matter, including the bond that may now be subject to forfeiture, may materially adversely affect our financial condition and operating results.

 

We may become involved in non-patent related litigation and administrative proceedings that may materially adversely affect us.

 

From time to time, we may become involved in various legal proceedings relating to matters incidental to the ordinary course of our business, including commercial, product liability, employment, class action, whistleblower and

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other litigation and claims, and governmental and other regulatory investigations and proceedings. Such matters can be time-consuming, divert management’s attention and resources and cause us to incur significant expenses. Furthermore, because litigation is inherently unpredictable, the results of these actions could have a material adverse effect on our business, results of operations and financial condition.

 

Our operating results may be adversely impacted by worldwide economic and political uncertainties and specific conditions in the markets we address, including the cyclical nature of and volatility in the memory market and semiconductor industry.

 

Adverse changes in domestic and global economic and political conditions have made it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and they have caused and could continue to cause U.S. and foreign businesses to slow spending on our products and services, which would further delay and lengthen sales cycles. In addition, sales of our products are dependent upon demand in the computing, networking, communications, printer, storage and industrial markets. These markets 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 and may result in reduced willingness of potential licensees to enter into license agreement with us.

 

We may experience substantial period-to-period fluctuations in future operating results due to factors affecting the computing, networking, communications, printers, storage and industrial markets. A decline or significant shortfall in demand in any one of these markets could have a material adverse effect on the demand for our products. As a result, our sales will likely decline during these periods. In addition, because many of our costs and operating expenses are relatively fixed, if we are unable to control our expenses adequately in response to reduced sales, our gross margins, operating income and cash flow would be negatively impacted.

 

During challenging economic times our customers may face issues gaining timely access to sufficient credit, which could impair their ability to make timely payments to us. If that were to occur, we may be required to increase our allowance for doubtful accounts and our days sales outstanding would be negatively impacted. Furthermore, our vendors may face similar issues gaining access to credit, which may limit their ability to supply components or provide trade credit to us. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery, worldwide, or in the memory market and related semiconductor industry. If the economy or markets in which we operate do not continue to improve or if conditions worsen, our business, financial condition and results of operations will likely be materially and adversely affected. Additionally, the combination of our lengthy sales cycle coupled with challenging macroeconomic conditions could compound the negative impact on the results of our operations.

 

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, and any failure to optimally calibrate our production capacity and inventory levels to meet customer demand could adversely affect our revenues, gross margins and earnings.

 

We make significant decisions regarding the levels of business that we will seek and accept, production schedules, component procurement commitments, personnel needs and other resource requirements, based on our estimates of customer requirements. We do not have long-term purchase agreements with our customers. Instead, our customers often 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. The short-term nature of commitments by many of our customers, the fact that our customers may cancel or defer purchase orders for any reason, and the possibility of unexpected changes in demand for our customers’ products each reduce our ability to accurately estimate future customer requirements for our products. 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. We attempt to forecast the demand for the DRAM ICs, NAND, 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.

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Our production expense and component purchase 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. If we overestimate customer demand, we may have excess raw material inventory of DRAM ICs and NAND. If there is a subsequent decline in the prices of DRAM ICs or NAND, the value of our inventory will fall. As a result, we may need to write-down the value of our DRAM IC or NAND inventory, which may result in a significant decrease in our gross margin and financial condition. Also, to the extent that we manufacture products in anticipation of future demand that does not materialize, or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our finished goods inventory. In the past, we have had to write-down inventory due to obsolescence, excess quantities and declines in market value below our costs. 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 we underestimate customer demand, we may not have sufficient inventory of DRAM ICs and NAND on hand to manufacture enough product to meet that demand. We also may not have sufficient manufacturing capacity at any given time to meet our customers’ demands for rapid increases in production. These shortages of inventory and capacity will lead to delays in the delivery of our products, and we could forego sales opportunities, lose market share and damage our customer relationships.

 

Declines in our average sales prices, driven by volatile prices for DRAM ICs and NAND, among other factors, may result in declines in our revenues and gross profit.

 

Our industry is competitive and historically has been characterized by declines in average sales price, based in part on the market price of DRAM ICs and NAND, which have historically constituted a substantial portion of the total cost of our memory subsystems. Our average sales prices may decline due to several factors, including overcapacity in the worldwide supply of DRAM and NAND memory components as a result of worldwide economic conditions, increased manufacturing efficiencies, implementation of new manufacturing processes and expansion of manufacturing capacity by component suppliers.

 

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 and NAND during that period. If the market prices for DRAM ICs and NAND increase, we generally cannot pass the price increases 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 decrease. Alternatively, if there are declines in the price of DRAM ICs and NAND, we may need to reduce our selling prices for subsequent purchase orders, which may result in a decline in our expected net sales.

 

In addition, since a large percentage of our sales are to a small number of customers that are primarily distributors and large OEMs, these customers have exerted, and we expect they will continue to exert, pressure on us to make price concessions. If not offset by increases in volume of sales or the sales of newly-developed products with higher margins, decreases in average sales prices would likely have a material adverse effect on our business and operating results.

 

Our production expense and component purchase 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. If we overestimate customer demand, we may have excess raw material inventory of DRAM ICs and NAND. If there is a subsequent decline in the prices of DRAM ICs or NAND, the value of our inventory will fall. As a result, we may need to write-down the value of our DRAM IC or NAND inventory, which may result in a significant decrease in our gross margin and financial condition. Also, to the extent that we manufacture products in anticipation of future demand that does not materialize, or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our finished goods inventory. In the past, we have had to write-down inventory due to obsolescence, excess

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quantities and declines in market value below our costs. 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 we underestimate customer demand, we may not have sufficient inventory of DRAM ICs and NAND on hand to manufacture enough product to meet that demand. We also may not have sufficient manufacturing capacity at any given time to meet our customers’ demands for rapid increases in production. These shortages of inventory and capacity will lead to delays in the delivery of our products, and we could forego sales opportunities, lose market share and damage our customer relationships.

 

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 even if we are able to sell these products to another customer, our margin on such products may be reduced.

 

A prolonged disruption of our manufacturing facility could have a material adverse effect on our business, financial condition and results of operations.

 

We maintain a manufacturing facility in the PRC for producing most of our products, which allows us to utilize our materials and processes, protect our intellectual property and develop the technology for manufacturing. A prolonged disruption or material malfunction of, interruption in or the loss of operations at our manufacturing facility, or the failure to maintain a sufficient labor force at such facility, could require us to rely on third parties for our manufacturing needs, which generally increases our manufacturing costs and decreases our profit margins, and could limit our capacity to meet customer demand and delay new product development until a replacement facility and equipment, if necessary, were found. The replacement of the manufacturing facility could take an extended amount of time before manufacturing operations could restart. The potential delays and costs resulting from these steps could have a material adverse effect on our business, financial condition and results of operations.  In July 2014, our PRC facility suffered water damage as a result of heavy rain and floods, which forced us to temporarily halt manufacturing at our PRC facility while necessary repairs or replacements were made to our PRC facility and to certain of our manufacturing equipment.  This incident caused us to incur additional expenses as we shifted our manufacturing activities to a third-party manufacturing facility in the PRC to enable us to mitigate the disruption in shipments to our customers. While we believe we have contained the disruptions we expect that our relationships with our key customers could be materially harmed if we incur additional manufacturing disruptions in the future. We are currently processing this incident as a claim with our insurer but there can be no assurance that we will recover our losses from our insurer. We are unable to provide assurances that similar events will not occur in the future or that we will be able to secure alternative manufacturing capabilities if manufacturing at our PRC facility is disrupted.

 

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, to lower our costs and to otherwise remain competitive. 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.

 

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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. 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.

 

We depend on third-parties to design and manufacture custom components for some of our products.

 

Significant customized components, such as ASICs, that are used in some of our products such as HyperCloud ® are designed and manufactured by third parties. The ability and willingness of such third parties to perform in accordance with their agreements with us is largely outside of our control. If one or more of our design or manufacturing partners fails to perform its obligations in a timely manner or at satisfactory quality levels, our ability to bring products to market or deliver products to our customers, as well as our reputation, could suffer. In the event of any such failures, we may have no readily available alternative source of supply for such products, since, in our experience, the lead time needed to establish a relationship with a new design and/or manufacturing partner is at least 12 months, and the estimated time for our OEM customers to re-qualify our product with components from a new vendor ranges from four to nine months. We cannot assure you that we can redesign, or cause to have redesigned, our customized components to be manufactured by a new manufacturer in a timely manner, nor can we assure you that we will not infringe on the intellectual property of our current design or manufacture partner when we redesign the custom components, or cause such components to be redesigned by a new manufacturer. A manufacturing disruption experienced by our manufacturing partners, the failure of our manufacturing partners to dedicate adequate resources to the production of our products, the financial instability of our manufacturing or design partners, or any other failure of our design or manufacturing partners to perform according to their agreements with us, would have a material adverse effect on our business, financial condition and results of operations.

 

We have many other risks due to our dependence on third-party manufacturers, including: reduced control over delivery schedules, quality, manufacturing yields and cost; the potential lack of adequate capacity during periods of excess demand; limited warranties on products supplied to us; and potential misappropriation of our intellectual property. We are dependent on our manufacturing partners to manufacture products with acceptable quality and manufacturing yields, to deliver those products to us on a timely basis and to allocate a portion of their manufacturing capacity sufficient to meet our needs. Although our products are designed using the process design rules of the particular manufacturers, we cannot assure you that our manufacturing partners will be able to achieve or maintain acceptable yields or deliver sufficient quantities of components on a timely basis or at an acceptable cost. Additionally, we cannot assure you that our manufacturing partners will continue to devote adequate resources to produce our products or continue to advance the process design technologies on which the qualification and manufacturing of our products are based.

 

If our products do not meet the quality standards of our customers, we may be forced to stop shipments of products until the quality issues are resolved.

 

Our customers require our products to meet strict quality standards. Should our products not meet such standards, our customers may discontinue purchases from us until we are able to resolve the quality issues that are causing us to not meet the standards. Such “quality holds” could have a significant adverse impact on our revenues and operating results.

 

If our products are defective or are used in defective systems, we may be subject to warranty, 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 warranty and 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.

 

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Although we generally attempt to contractually limit our exposure to incidental and consequential damages, if these contract provisions are not enforced or are unenforceable or if liabilities arise that are not effectively limited, we could incur substantial costs in defending or settling product liability claims.

 

Warranty and 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, we may determine that it is in our best interest to accept product returns in circumstances where we are not contractually obligated to do so in order to maintain good relations with our customers. Accepting product returns may negatively impact our operating results.

 

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 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.

 

We are also developing products to enter new markets. Similar to our current products, we may use components in these new products that contain the intellectual property of third parties. While we plan to exercise precautions to avoid infringing on the intellectual property rights of third parties, we cannot assure you that disputes will not arise.

 

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.

 

The flash memory market is constantly evolving and competitive, and we may not have rights to manufacture and sell certain types of products utilizing emerging flash formats, or we may be required to pay a royalty to sell products utilizing these formats.

 

The flash-based storage market is constantly undergoing rapid technological change and evolving industry standards. Many consumer devices, such as digital cameras, PDAs and smartphones, are transitioning to emerging flash memory formats, such as the Memory Stick, and xD Picture Card formats, which we do not currently manufacture and do not have rights to manufacture. Although we do not currently serve the consumer flash market, it is possible that certain OEMs may choose to adopt these higher-volume, lower-cost formats. This could result in a decline in demand, on a relative basis, for other products that we manufacture such as CompactFlash, SD and embedded USB drives. If we decide to manufacture flash memory products utilizing emerging formats such as those mentioned, we will be required to secure licenses to give us the right to manufacture such products that may not be available at reasonable rates or at all. If we are not able to supply flash card formats at competitive prices or if we were to have product shortages, our net sales could be adversely impacted and our customers would likely cancel orders or seek other suppliers to replace us.

 

Our indemnification obligations for the infringement by our products of the intellectual property rights of others could require us to pay substantial damages.

 

As is common in the industry, we currently have in effect a number of agreements in which we have agreed to defend, indemnify and hold harmless our customers and suppliers from damages and costs which may arise from the infringement by our products of third-party patents, trademarks or other proprietary rights. The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorneys’ fees. Our insurance does not cover intellectual property infringement. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We may periodically have to respond to claims and litigate these types of indemnification obligations. Although our suppliers may bear responsibility for the intellectual

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property inherent in the components they sell to us, they may lack the financial ability to stand behind such indemnities. Additionally, it may be costly to enforce any indemnifications that they have granted to us. Accordingly, any indemnification claims by customers could require us to incur significant legal fees and could potentially result in the payment of substantial damages, both of which could result in a material adverse effect on our business and results of operations.

 

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.

 

To date, we have been highly dependent on the experience, relationships and technical knowledge of certain key employees. 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 any of these key employees other than Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board. We maintain “Key Man” life insurance on Chun K. Hong; however, we do not carry “Key Man” life insurance on any of our other key employees.

 

Our future success also depends on our ability to attract, retain and motivate highly skilled engineering, manufacturing, and 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 increase our operating expenses.

 

Historically, a significant portion of our workforce has 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.

 

We rely on third-party manufacturers’ representatives and the failure of these manufacturers’ representatives to perform as expected could reduce our future sales.

 

We sell some of our products to customers through manufacturers’ representatives. We are unable to predict the extent to which our manufacturers’ representatives will be successful in marketing and selling our products. Moreover, many of our manufacturers’ representatives also market and sell other, potentially competing products. Our representatives may terminate their relationships with us at any time. Our future performance will also depend, in part, on our ability to attract additional manufacturers’ representatives that will be able to market and support our products effectively, especially in markets in which we have not previously distributed our products. If we cannot retain our current manufacturers’ representatives or recruit additional or replacement manufacturers’ representatives, our sales and operating results will be harmed.

 

The operation of our manufacturing facility in the PRC could expose us to significant risks.

 

Since 2009, most of our world-wide manufacturing production has been performed at our manufacturing facility in the PRC. Language and cultural differences, as well as the geographic distance from our headquarters in Irvine, California, further compound the difficulties of running a manufacturing operation in the PRC.  Our management has limited experience in creating or overseeing foreign operations, and the ongoing management of our PRC facility may require our management team to divert substantial amounts of their time, particularly if we encounter operational difficulties or manufacturing disruptions at our PRC facility.  We may not be able to maintain control over product

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quality, delivery schedules, manufacturing yields and costs. Furthermore, the costs related to having excess capacity have in the past and may in the future continue to have an adverse impact on our gross margins and operating results.

 

We manage a local workforce that may subject us to regulatory uncertainties. Changes in the labor laws of the PRC could increase the cost of employing the local workforce. The increased industrialization of the PRC, as well as general economic and political conditions in the PRC, could also increase the price of local labor. Any or all combination of these factors could negatively impact the cost savings we currently enjoy from having our manufacturing facility in the PRC.

 

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 have set up a manufacturing facility in the PRC. Selling and manufacturing in foreign countries subjects us to additional risks not present with our domestic operations. We are operating in business and regulatory environments in which we have limited previous experience. We will need to continue to overcome language and cultural barriers to effectively conduct our operations in these environments. In addition, the economies of the PRC 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.

 

In the future, some of our net sales may be denominated in Chinese Renminbi (“RMB”). The Chinese government controls the procedures by which RMB is converted into other currencies, and conversion of RMB generally requires government consent. As a result, RMB 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 RMB 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.

 

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 international sales are subject to other risks, including regulatory risks, tariffs and other trade barriers, timing and availability of export licenses, political and economic instability, difficulties in accounts receivable collections, difficulties in managing distributors, lack of a significant local sales presence, difficulties in obtaining governmental approvals, compliance with a wide variety of complex foreign laws and treaties and potentially adverse tax consequences. In addition, the U.S. or foreign countries may implement quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products, leading to a reduction in sales and profitability in that country.

 

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

 

Due to the geographic concentration of our manufacturing operations in our PRC facility, and the operations of certain of our suppliers, a disruption resulting from equipment failure, power failures, quality control issues, human error, government intervention or natural disasters, including earthquakes and floods like those that have struck Japan and Thailand, respectively, 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.  In July 2014, our PRC facility suffered water damage as a result of heavy rain and floods, which forced us to temporarily halt manufacturing at our PRC facility while necessary repairs or replacements were made to our PRC facility and to certain of our manufacturing equipment.  This incident caused us to incur additional expenses as we shifted our manufacturing activities to a third-party manufacturing facility in the PRC to enable us to mitigate the disruption in shipments to our customers. While we believe we have contained the disruptions we expect that our relationships with our key customers could be materially harmed if we incur additional manufacturing disruptions in the future. We are currently processing this incident as a claim with our insurer. We are unable to provide assurances that similar events will not occur in the future or that we will be able to secure alternative manufacturing capabilities if manufacturing at our PRC facility is disrupted.

 

Difficulties with our global information technology systems, and/or unauthorized access to such systems, could harm our business.

 

Any failure or malfunctioning of our global information technology system, errors or misuse by system users, difficulties in migrating standalone systems to our centralized systems, or inadequacy of the system in addressing the needs of our operations, could disrupt our ability to timely and accurately manufacture and ship products, which could have a material adverse effect on our business, financial condition and results of operations.   Any such failure, errors, misuse or inadequacy could also disrupt our ability to timely and accurately process, report and evaluate key operations metrics and key components of our results of operations, financial position and cash flows.  Any such disruptions would likely divert our management and key employees’ attention away from other business matters.  Any disruptions or difficulties that may occur in connection with our global information technology system could also adversely affect our ability to complete important business process, such as the evaluation of our internal control over financial reporting and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002.

 

In connection with our daily business transactions, we store data about our business, including certain customer data, on our global information technology systems.  While our systems are designed with security measures to prevent unauthorized access, third parties may gain unauthorized access to our systems.  This unauthorized access could take the form of intentional misconduct by computer hackers, employee error, employee malfeasance or otherwise.  Additionally, third parties may attempt to fraudulently induce employees or customers into disclosing sensitive information such as user names, passwords or other information, in order to gain access to our information technology system for the purpose of sabotage, or to access our data, including our and our customers’ intellectual property and other confidential business information.  Because the techniques used to obtain unauthorized access to information technology systems evolve frequently and generally are not recognized until successful, we may be unable to anticipate these techniques or to implement adequate preventative measures.  Any security breach could result in disruption to our business, misappropriation or loss of data, loss of confidence in us by our customers, damage to our reputation, legal liability and a negative impact on our sales.

 

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. In particular, some of our manufacturing processes may require us to handle and dispose of hazardous materials from time to time. For example, in the past our manufacturing operations have used lead-based solder in the assembly of our products. Today, we use lead-free soldering technologies in our manufacturing processes, as this is required for products entering the European Union. We could incur substantial costs, including

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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.

 

Regulations related to “conflict minerals” may cause us to incur additional expenses and could limit the supply and increase the cost of certain metals used in manufacturing our products.

 

In August 2012, the SEC adopted a rule requiring disclosures of specified minerals, known as conflict materials, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by public companies.  The rule requires companies to verify and disclose whether or not such minerals originate from the Democratic Republic of Congo or an adjoining country.  To comply with this rule, we are required to conduct a reasonable country of origin each year and, depending on the results of that inquiry, we may be required to exercise due diligence on the source and chain of custody of conflict minerals contained in our products.  Such due diligence must conform to a nationally or internationally recognized due diligence framework.  We are required to file a disclosure report with the SEC in May of each year relating to the preceding calendar year.  In addition, commencing with the disclosure report relating to the 2015 calendar year, to the extent that we are required to exercise due diligence on the source and chain of custody of conflict minerals, we will be required to obtain an independent private sector audit of our disclosure report and underlying due diligence measures.

 

The due diligence activities required to determine the source and chain of custody of minerals contained in our products are time consuming and may result in significant costs.  Due to the size and complexity of our supply chain, we face significant challenges in verifying the origins of the minerals used in our products.  Further, this rule could affect the availability in sufficient quantities and at competitive prices of certain minerals used in the manufacture of our products, including tantalum, tin, gold and tungsten.  There may be only limited number of sources of “conflict-free” minerals, which could result in increased material and component costs, as well as additional costs associated with potential changes to our products, processes or sources of supply.

 

If we are unable to sufficiently verify the origin of the minerals used in our products through the due diligence measures that we implement, or if we are unable to obtain an audit report each year that concludes that our due diligence measures are in conformity with the criteria set forth in the relevant due diligence framework.  Our reputation could be harmed.  In addition, we may not be able to satisfy customers who require that our products be certified as “conflict-free” which could place us at a competitive disadvantage.

 

Our internal controls over financial reporting may not be effective, which could have a significant and adverse effect on our business.

 

Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, which we collectively refer to as Section 404, require us to evaluate our internal controls over financial reporting to allow management to report on those internal controls as of the end of each year. 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 matters 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 stock price.

 

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

 

Any future growth may strain our resources, management information and telecommunication systems, and operational and financial controls. To manage future growth effectively, including any expansion of volume in our manufacturing facility in the PRC, we must be able 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. As a result, they may not be able to provide the guidance necessary to manage future growth or maintain future 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.

 

We may be unsuccessful in establishing and operating an intellectual property based business.

 

We do not at this time have an intellectual property (IP)-based licensing business and may never succeed in developing such a business. As we are currently in a products-based business model, we may be unsuccessful in developing an IP-based licensing business.  The establishment of this new business may be more difficult or costly than expected and require additional personnel, investments and may be a significant distraction for management. In connection with our IP-based licensing business, our licenses and royalties revenue may be uncertain from period to period, and we may be unable to attract new licensing customers which would materially and adversely affect our results of operations. Our ability to increase our license revenue will depend on a variety of factors, including the performance, quality, breadth and depth of our current and future IP, as well as our sales and marketing capabilities. Once secured, license revenue may be negatively affected by factors within and outside our control, including reductions in our customers’ sales prices, sales volumes and the terms of such licenses.

 

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, but not limited to:

 

·

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 dilute 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

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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.

 

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

 

As of February  28, 20 15 , approximately 12 . 6 % of our outstanding common stock was held by affiliates, including 11.3 % held by Chun K. Hong, our chief executive officer and chairman of our board of directors. As a result, Mr. Hong has the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and 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 Mr. Hong .

 

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.

 

Our certificate of incorporation and bylaws 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 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 are included in our certificate of incorporation and bylaws, each as amended:

 

·

our board of directors is 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 is prohibited;

 

·

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

 

·

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

 

In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation 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, and of Delaware law, could make it more difficult for stockholders or potential acquirers 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.

 

The price of and volume in trading of our common stock has and may continue to fluctuate significantly.

 

Our common stock has been publicly traded since November 2006. The price of our common stock and the trading volume of our shares are volatile and have in the past fluctuated significantly. There can be no assurance as to the prices at which our common stock will trade in the future or that an active trading market in our common stock will be sustained in the future. The market price at which our common stock trades may be influenced by many factors, including but not limited to, the following:

 

·

our operating and financial performance and prospects, including our ability to achieve and sustain profitability in the future;

 

·

investor perception of us and the industry in which we operate;

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·

the availability and level of research coverage of and market making in our common stock;

 

·

results of litigation;

 

·

changes in earnings estimates or buy/sell recommendations by analysts;

 

·

sales of our newly issued common stock or other securities associated with our shelf registration statement declared effective by the SEC on October 18, 2011 and our new registration statement on Form S-3 (Registration No. 333-199446) which we have filed but which has not yet been declared effective by the SEC, or the perception that such sales may occur;  

 

·

general financial and other market conditions; and

 

·

changing and recently volatile domestic and international economic conditions.

 

In addition, shares of our common stock and the public stock markets in general have experienced, and may continue to experience, extreme price and trading volume volatility. These fluctuations may   adversely affect the market price of our common stock and a stockholder's ability to sell their shares into the market at the desired time or at the desired price.

 

In 2007, following a drop in the market price of our common stock, securities litigation was initiated against us. Given the historic volatility of our industry, we may become engaged in this type of litigation in the future. Securities litigation is expensive and time-consuming.

 

Item 2.  Properties

 

Our corporate headquarters is located in approximately 8, 203 square feet of space in Irvine, California, under a lease that expires in October 2016 . We also cu rrently lease approximately 42,2 00 square feet of space for our manufacturing facility in the PRC. This lease expires in March 201 7 .

 

We believe that our current facilities are adequate for our current and expected operations for the next twelve months and that additional space can be obtained if needed.

 

Item 3.  Legal Proceedings

 

The information set forth in the section entitled Litigation and Patent Reexaminations under Note  7 of Notes to Consolidated Financial Statements, included in P art IV, Item 15 of this Report is incorporated herein by reference.

 

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PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securitie s

 

Our common stock began trading on The NASDAQ Global Market under the trading symbol “NLST” on November 30, 2006, and was not publicly traded prior to that date. The following table sets forth the high and low sale prices for our common stock on the NASDAQ Global Market for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

    

High

    

Low

 

 

 

 

 

 

 

 

 

Year Ended December 27, 2014

 

 

 

 

 

 

 

Fourth Quarter

 

$

1.23 

 

$

0.57 

 

Third Quarter

 

 

1.59 

 

 

0.95 

 

Second Quarter

 

 

2.15 

 

 

0.93 

 

First Quarter

 

 

2.41 

 

 

0.70 

 

 

 

 

 

 

 

 

 

Year Ended December 28, 2013

 

 

 

 

 

 

 

Fourth Quarter

 

$

1.05 

 

$

0.53 

 

Third Quarter

 

 

1.20 

 

 

0.75 

 

Second Quarter

 

 

1.29 

 

 

0.51 

 

First Quarter

 

 

0.87 

 

 

0.61 

 

 

As of February 28, 2015 there were approximately 10 holders of record of our shares of common stock.

 

We entered into a Loan and Security Agreement (“Loan Agreement”), on July 18, 2013, with Fortress Credit Opportunities I LP (the “Lender”), an affiliate of Fortress Investment Group LLC as successor to DBD Credit Funding LLC. In connection with the Loan Agreement, the Company issued to an affiliate of Lender, seven-year warrants (the “Warrants”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at a per share price of $1.00, of which 989,011 shares were exercisable immediately on a cash or cashless basis in whole or in part. Pursuant to the Warrants, (i) 329,670 shares subject to the Warrants would become exercisable upon the achievement of certain performance milestones relating to intellectual property matters (the “IP Monetization Milestones”) and (ii) the remaining 329,670 shares subject to the Warrants would become exercisable upon the Company’s receipt of proceeds from the second tranche of the Loan Agreement upon achievement of the IP Monetization Milestones (the “IP Milestone Term Loan”).

 

On February 17, 2015, we entered into that certain Second Amendment to the Loan Agreement (the “Loan Agreement Amendment”) with Lender. In connection with the Loan Agreement Amendment, we cancelled the Warrants and issued new warrants (the “New Warrants”) in substantially the same form as the Warrants (which were cancelled in connection with the issuance of the New Warrants) other than to remove the restrictions upon exercise contained in the Warrants with respect to an aggregate of 659,340 shares of the Company’s Common Stock thereunder relating to the achievement by the Company of the IP Monetization Milestones and the borrowing by the Company of amounts under the IP Milestone Term Loans.

 

The Warrants and New Warrants were issued in private placement transactions that were exempt from registration under Section 4(2) of the Securities Act of 1933.

 

 

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.

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Securities Authorized for Issuance under Equity Compensation Plans

 

Our board of directors and stockholders previously approved our Amended and Restated 2000 Equity Incentive Plan and our Amended and Restated 2006 Equity Incentive Plan. Except as listed in the table below, as of December 27, 2014 , we do not have any equity based plans, including individual compensation arrangements that have not been approved by our stockholders. The following table provides information as of December 27, 2014 with respect to our equity compensation plans:

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

Number of securities

 

 

 

 

 

 

 

 

remaining available for

 

 

 

Number of securities

 

Weighted‑average

 

future issuance under

 

 

 

to be issued upon exercise

 

exercise price of

 

equity compensation plans

 

 

 

of outstanding options,

 

outstanding options,

 

(excluding securities

 

Plan Category

    

warrants and rights

    

warrants and rights

    

reflected in column (a))

     

 

 

(a)

 

(b)

 

(c)

 

 

 

 

 

 

 

 

 

 

Equity compensation plans approved by security holders

 

7,234,566 

 

$

2.40 

 

244,698 

(1)

Equity compensation plans not approved by security holders

 

 

 

 

 

Total

 

7,234,566 

 

$

2.40 

 

244,698 

 

 


(1)

Subject to certain adjustments, on December 27, 2014 , we currently are able to issue a maximum of 7,805,566 shares of common stock pursuant to awards granted under our Amended and Restated 2006 Equity Incentive Plan. That maximum number will automatically increase on the first day of each calendar year by the lesser of (i) 5.0% of the number of shares of common stock that are issued and outstanding as of the first day of the calendar year, and (ii) 1,200,000 shares of common stock, subject to adjustment for certain corporate actions.

 

See Note  8 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report, for additional information on equity compensation plans.

 

Depar ture of Director  

 

On March 23, 2015, Thomas Lagatta notified the Company that he would not stand for re-election to the Board of Directors at the 2015 Annual Meeting of Stockholders.  Mr. Lagatta will remain on the Board until the date of the Annual Meeting.  Mr. Lagatta’s decision reflects his desire to focus more of his time as CEO of Numecent, Inc. and was not the result of any disagreement regarding the Company’s operations, policies or practices.

 

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Item 7.  Management s Discussion and Analysis of Financial Condition and Results of Operation s

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this Form 10 - K .

 

This report contains forward-looking statements regarding future events and our future performance.  These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those expected or projected.  These risks and uncertainties include, but are not limited to risks associated with the launch and commercial success of our products, programs and technologies; the success of product partnerships; continuing development, qualification and volume production of HyperVault, EXPRESSvault™, NVvault™, HyperCloud® and VLP Planar-X RDIMM; the timing and magnitude of the continued decrease in sales to one of our key customers; our ability to leverage our NVvault™ and EXPRESSvault™ technology into a more diverse customer base; our need to raise additional capital and our ability to obtain financing when necessary; the rapidly-changing nature of technology; risks associated with intellectual property, including patent infringement litigation against us as well as the costs and unpredictability of litigation over infringement of our intellectual property and the possibility of our patents being reexamined or reviewed by the USPTO and PTAB; volatility in the pricing of DRAM ICs and NAND; changes in and uncertainty of customer acceptance of, and demand for, our existing products and products under development, including uncertainty of and/or delays in product orders and product qualifications; delays in our and our customers’ product releases and development; introductions of new products by competitors; changes in end-user demand for technology solutions; our ability to attract and retain skilled personnel; our reliance on suppliers of critical components and vendors in the supply chain; fluctuations in the market price of critical components; evolving industry standards; and the political and regulatory environment in the PRC.  Other risks and uncertainties are described under the heading “Risk Factors” in Part I, Item IA of this Annual Report on Form 10-K.  Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.

 

Overview

 

We design, manufacture and sell a wide variety of high performance, logic-based memory subsystems for the global datacenter, storage and high-performance computing markets. Our memory subsystems consist of combinations of dynamic random access memory integrated circuits (“DRAM ICs” or “DRAM”), NAND flash memory (“NAND”), application-specific integrated circuits (“ASICs”) and other components assembled on printed circuit boards (“PCBs”). We primarily market and sell our products to leading original equipment manufacturer (“OEM”) customers, hyperscale datacenter operators and storage vendors.  Our solutions are targeted at applications where memory plays a key role in meeting system performance requirements. We leverage a portfolio of proprietary technologies and design techniques, including combining discrete semiconductor technologies from third parties such as DRAM and NAND flash to function as one, efficient planar design, and alternative packaging techniques to deliver memory subsystems with persistence, high density, small form factor, high signal integrity, attractive thermal characteristics, reduced power consumption and low cost per bit. Our NVvault™ product is the first to offer both DRAM and NAND in a standard form factor memory subsystem as a persistent dual-in line memory module (“DIMM”) in mission critical applications.  Our HyperCloud ® technology incorporates our patented rank multiplication and load reduction technologies. We also have pending and issued patents covering fundamental aspects of hybrid memory DIMM designs that incorporate combinations of DRAM and/or NAND flash, such as our NVvault™ product.  We are focused on monetizing our patent portfolio through our products business and, where appropriate, through licensing arrangements with third parties that wish to incorporate our patented technologies in their products.

 

Our high performance memory subsystems are developed in part using our proprietary technologies, 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. We intend to vigorously defend and monetize our intellectual property through licensing arrangements and, where necessary, enforcement actions against those entities using our patented solutions in their products.  We may seek injunctive relief in the course of enforcing our intellectual property rights in certain instances, and in other instances we may enter into settlement or license agreements, which can be structured in a

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variety of ways, including one-time paid up licenses or on-going royalty arrangements.  However, our efforts may not result in significant revenues from these monetization efforts.

 

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. Three customer s represented approximately 20%, 14 %   and 19% of our net sales in 201 4 and two cu stomers represented approximate ly 45 % and 15 % of our net sales in 201 3.  

 

Key Business Metrics

 

The following describes certain line items in our consolidated 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 generally range up to 30 days. We generally do not have long-term sales agreements with our customers. Although OEM customers typically provide us with non-binding forecasts of future product demand over specific periods of time, they generally place 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 and NAND. 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 and NAND to distributors and other users of memory ICs. Component inventory sales are a relatively small percentage of net sales as a result of our efforts to diversify both our customer   and product line bases. This diversification effort has also allowed us   to use   components in a wider range of memory subsystems. We expect that component inventory sales will continue to represent a minimal portion of our net sales in future periods.

 

Cost of Sales.     Our cost of sales includes the cost of materials, labor and other manufacturing costs, depreciation and amortization of equipment, inventory valuation provisions, stock-based compensation, and occupancy costs and other allocated fixed costs. The DRAM ICs and NAND 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 and NAND. We attempt to pass through such DRAM IC and NAND flash memory cost fluctuations to our customers by frequently renegotiating pricing prior to the placement of their purchase orders. However, the sales prices of our memory subsystems can also fluctuate due to competitive situations unrelated to the pricing of DRAM ICs and NAND, which affects gross margins. In addition, we have experienced shortages of DRAM and flash required for our HyperCloud® and NVvault products from time to time, which can cause disruptions in our revenues and gross profits. In addition, the gross margin on our sales of any excess component DRAM IC and NAND inventory is much lower than the gross margin on our sales of our memory subsystems. As a result, fluctuations in DRAM IC and NAND inventory sales as a percentage of our overall sales could impact our overall gross margin. We assess the valuation of our inventories on a quarterly basis and record a provision to cost of sales as necessary to reduce inventories to the lower of cost or net realizable value.

 

Research and Development.  Research and development expense consists primarily of employee and independent contractor compensation and related costs, stock ‑based compensation, non-recurring engineering fees, computer ‑aided design software licenses, reference design development costs ,   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 compensate us for design and engineering work involved in developing application ‑specific products for them. All research and development costs are expensed as incurred .   W e anticipate that research and development expenditures will increase in future periods as we seek to expand new product opportunities, increase our activities related to new and emerging markets and continue to develop additional proprietary technologies.

 

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Intellectual Property Legal Fees . Intellectual Property Legal Fees consists of legal fees incurred for patent filings and protection. We anticipate that intellectual property legal fees will increase in future periods as we seek to protect our patent portfolio.

 

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 effort is directed at building relationships with OEMs and other customers 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. In order to conserve capital resources in light of the year over year revenue decline, we have reduced our selling, general and administrative expenditures by eliminating headcount and other related expenses.

 

Provision for Income Taxes.   The federal statutory rate was 3 5 % for fiscal year 2014 and 2013.  Our effective tax rate differs from the statutory rate due to the company providing a full valuation allowance against net deferred tax assets, and accordingly did not recognize an income tax benefit related to losses incurred.

 

Recent Developments

 

Public Offering of Common Stock

 

On February 24, 2015, we completed a registered firm commitment underwritten public offering (“2015 Offering”) of shares of our common stock. In the 2015 Offering, we issued and sold to Craig-Hallum Capital Group LLC (the “Underwriter”) 8,846,154 shares of common stock pursuant to an underwriting agreement, dated as of February 19, 2015, by and between us and the Underwriter, at a price of $1.209 per share, including 1,153,846 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of common stock to cover over-allotments. The price per share to the public in the 2015 Offering was $1.30 per share. The net proceeds from the 2015 Offering were approximately $10.4 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

Amendments to Loan Agreement and Monetization Letter Agreement

 

On February 17, 2015, we entered into that certain Second Amendment to Loan and Security Agreement with Fortress Credit Opportunities I LP (the “Lender”), an affiliate of Fortress Investment Group LLC and successor to DBD Credit Funding LLC (the “Loan Agreement Amendment”). The Loan Agreement Amendment amended certain terms of that certain Loan and Security Agreement, dated as of July 18, 2013, by and between us and the Lender (as amended, the “Loan Agreement”), which provides for certain tranched term loans and revolving loans from the Lender to us. Among other things, the Loan Agreement Amendment (1) removes conditions to the availability of the second tranche of term loans under the Loan Agreement (the “IP Milestone Term Loans”) which previously required us to achieve certain performance milestones relating to intellectual property matters (the “IP Monetization Milestones”) and (2) required the Lender to lend us all amounts under the IP Milestone Term Loans on February 17, 2015. In connection with the Loan Agreement Amendment, we paid a facility fee of $60,000 to the Lender and an amendment and restructuring fee equal to $20,000. We are obligated to annually pay to the Lender a fully earned, non-refundable management and monitoring fee of $20,000.

 

Concurrent with the execution of the Loan Agreement Amendment, (1) we and Drawbridge Special Opportunities Fund LP, a Delaware limited partnership and an affiliate of the Lender (“Drawbridge”), entered into that certain First Amendment to Monetization Letter Agreement (the “Letter Agreement Amendment”) and (2) we issued to Drawbridge a new warrant certificate (the “New Warrant Certificate”) in replacement of the original warrant certificate (the “Original Warrant Certificate”) we previously issued to Drawbridge on July 18, 2013 in connection with the execution of the Loan Agreement. The Letter Agreement Amendment amends certain terms of that certain Monetization Letter Agreement, dated as of July 18, 2013, with Drawbridge (the “Letter Agreement”), which provides, subject to certain limitations and restrictions, that Drawbridge may be entitled to share in certain of our monetization revenues related to our patent portfolio (“Patent Monetization Revenues”). The Letter Agreement Amendment (1) adds certain

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patents relating to our NVvault TM     product line to the patent portfolio from which Patent Monetization Revenues can be derived, (2) subject to certain limitations and restrictions, allows Drawbridge to share in Patent Monetization Revenues arising in connection with certain litigation and (3) modifies the percentages and maximum amounts that Drawbridge may be entitled to under the Letter Agreement with respect to Patent Monetization Revenues. The New Warrant Certificate is in substantially the same form as the Original Warrant Certificate (which was cancelled in connection with the issuance of the New Warrant Certificate) other than to remove the restrictions upon exercise contained in the Original Warrant Certificate with respect to an aggregate of 659,340 shares of our Common Stock under the Original Warrant Certificate relating to our achieving the IP Monetization Milestones and our borrowing of amounts under the IP Milestone Term Loans.

 

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

 

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

 

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

 

Fair Value of Financial Instruments.     Our financial instruments consist principally of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and debt instruments.  The fair value of our cash equivalents is determined based on quoted prices in active markets for identical assets or Level 1 inputs. We recognize transfers between Levels 1 through 3 of the fair value hierarchy at the beginning of the reporting period.  We believe that the carrying values of all other financial instruments approximate their current fair values due to their nature and respective durations.

 

Allowance for Doubtful Accounts.     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 evaluate the collectability of accounts receivable based on a combination of factors. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized receivable to the amount that we reasonably believe will be collected. For all other customers, we record allowances for doubtful accounts based

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primarily on the length of time the receivables are past due based on the terms of the originating transaction, the current business environment and our historical experience. Uncollectible accounts are charged against the allowance for doubtful accounts when all cost effective commercial means of collection have been exhausted.  Generally, our 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 collectability 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 an average cost basis which approximates actual cost on a first - in, first - out basis and includes raw materials, labor and manufacturing overhead. At each balance sheet date, we evaluate ending inventory quantities on hand and record a provision for excess quantities and obsolescence. Among other factors, we consider historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. In addition, we consider changes in the market value of DRAM ICs and NAND in determining the net realizable value of our raw material inventory. Once established, any write downs are considered permanent adjustments to the cost basis of our 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. In addition, should the market value of DRAM ICs or NAND decrease significantly, we may be required to lower our selling prices to reflect the lower current cost of our raw materials. If such price decreases reduce the net realizable value of our inventories to less than our cost, we would be required to recognize additional expense in our cost of sales in the same period. Although we make every reasonable effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand, technological developments or the market value of DRAM ICs or NAND could have a material effect on the value of our inventories and our reported operating results.

 

Deferred Financing Costs, Debt Discount and Detachable Debt-Related Warrants .   Costs incurred to issue debt are deferred and included in debt issuance costs in the accompanying consolidated balance sheet. We amortize debt issuance costs over the expected term of the related debt using the effective interest method. Debt discounts related to the relative fair value of any warrants issued in conjunction with the debt are recorded as a reduction to the debt balance and accreted over the expected term of the debt to interest expense using the effective interest method.

 

Impairment of Long - Lived Assets.  We evaluate the recoverability of the carrying value of long - lived assets held and used in our operations for impairment on at least an annual basis or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When such factors and circumstances exist, we compare the projected undiscounted future net cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. 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 exceeds the estimated fair value of the asset. The fair value of the asset or asset group is based on market value when available, or when unavailable, on discounted expected cash flows.

 

Warranty Reserve.  We offer product warranties 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 the warranty period at no cost to the customer. Warranties are not offered on

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sales of excess inventory. 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 consistent between periods and within our expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on us, requiring additional warranty reserves, and adversely affecting our gross profit and gross margins.

 

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

 

In accordance with ASC Topic 718, employee and director stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period.  Given that stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Our estimated average forfeiture rates are based on historical forfeiture experience and estimated future forfeitures.

 

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

 

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

 

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

 

Income Taxes.  Deferred tax assets and liabilities are recognized to reflect the estimated future tax effects of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the condensed consolidated financial statements, calculated at enacted tax rates for expected periods of realization. We regularly review our deferred tax assets for recoverability and establish a valuation allowance, when determined necessary, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. Because we have operated at a loss for an extended period of time, we did not recognize deferred tax assets related to losses incurred in 201 4 or 201 3 .  In the future, if we realize a deferred tax asset

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that currently carries a valuation allowance, we may record an income tax benefit or a reduction to income tax expense in the period of such realization.

 

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

 

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

 

Interest expense . Interest expense consists primarily of interest associated with our loan agreement with Fortress, an affiliate of Fortress Investment Group LLC and successor DBD Credit Funding, LLC, including fees related to the term loans, accretion of debt discount and amortization of debt issuance costs.  We recognize accretion of debt discount and amortization of interest costs using the effective interest method.

 

Results of Operations

 

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

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

    

December 27,

    

December 28,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net sales

 

100 

%  

100 

%  

Cost of sales

 

79 

 

87 

 

Gross profit

 

21 

 

13 

 

Operating expenses:

 

 

 

 

 

Research and development

 

25 

 

20 

 

Intellectual property legal fees

 

32 

 

 

Selling, general and administrative

 

35 

 

27 

 

Total operating expenses

 

93 

 

56 

 

Operating loss

 

(72)

 

(43)

 

Other expense, net:

 

 

 

 

 

Interest expense, net

 

(8)

 

(4)

 

Other income, net

 

-

 

-

 

Total other expense, net

 

(8)

 

(4)

 

Loss before provision for income tax

 

(80)

 

(47)

 

Provision for income taxes

 

-

 

-

 

Net loss

 

(80)

%  

(47)

%  

 

40


 

Year Ended December 27, 2014 Compared t o the Year Ended December 28, 2013 Net Sales, Cost of Sales and Gross Profit.

 

The following table presents net sales, cost of sales and gross profit for the years ended December 27, 2014 and December 28, 2013 (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

19,195 

 

$

23,048 

 

$

(3,853)

 

(17)

%

Cost of sales

 

 

15,231 

 

 

19,943 

 

 

(4,712)

 

(24)

%

Gross profit

 

$

3,964 

 

$

3,105 

 

$

859 

 

28 

%

Gross margin

 

 

20.7% 

 

 

13.5% 

 

 

7.2 

%

 

 

 

Net Sales.   The decrease in net sales for 2014 as compared with 2013 resulted primarily from decreases of approximately (i) $3.2 million in sales of NVvault™ non-volatile cache systems to Dell, (ii) $2.2 million of PERC sales to Dell, (iii) $2.0 million of VLP sales (iv) $0.8 million in sales of Planar X and (v) $0.7  million of flash sales. These decreases were partially offset by an increase of $4.9 million in sales of NVvault™ and EXPRESSvault™ sales to customers other than Dell.

 

Approximately 61% of our NVvault™ sales were made to Dell in 2013. Since Intel’s launch of its Romley platform in the first quarter of 2012, we experienced a rapid decline in DDR2 NVvault™ sales to Dell. We expect that future sales of NVvault™ products for incorporation into PERC 7 servers will be minimal.  This reduction in sales has had a significant impact on our revenue and gross profit.  We expect an increasing percentage of our revenue to come from sales of DDR3 NVvault, EXPRESSvault™ and flash to a more diverse customer base.

 

Gross Profit and Gross Margin.     The increase in gross profits for 2014 as compared to 2013 is primarily the result of a change in our product mix, as we experienced increased sales of NVvault™ (a relatively higher margin product) to customers other than Dell in the fiscal year ended December 27, 2014.

 

Research and Development.

 

The following table presents research and development expenses for the years ended December 27, 2014 and December 28, 2013   (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

4,835 

 

$

4,568 

 

$

267 

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The increase in research and development expense for 201 4 as compared to 201 3 resulted primarily from increases of $ 0 .4 million in professional and outsid e services partially offset by a decrease of approximately $0.1 million in headcount costs and related overhead and travel expenses .

 

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Intellectual Property Legal Fees.

 

The following table presents intellectual property legal fees for the years ended December 27, 2014 and December 28, 2013 (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intellectual property legal fees

 

$

6,138 

 

$

2,115 

 

$

4,023 

 

190 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The increase in intellectual property legal fees for 2014 as compared to 2013 resulted from increase in legal fees incurred to protect our intellectual property.

 

Selling, General and Administrative.

 

The following table presents selling, general and administrative expenses for the years ended December 27, 2014 and December 28, 2013 (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

$

6,796 

 

$

6,267 

 

$

529 

 

%

 

Selling, general and administrative expenses increased by approximately $0.5 million in 2014 as compared to 2013.  These increases were primarily due to an increase of $0.7 million in headcount costs, commissions and related overhead and travel expenses offset by decreases of (i) $0.1 million in advertising and product evaluation expenses and (ii) $0.1 million primarily related to outside consultants and sales representatives.

 

Other Expense , Net .

 

The following table presents other expense, net for the years ended December 27, 2014 and December 28, 2013 (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

$

(1,574)

 

$

(932)

 

$

(642)

 

69 

%

Other income, net

 

 

 -

 

 

20 

 

 

(20)

 

(100)

%

Total other expense, net

 

$

(1,574)

 

$

(912)

 

$

(662)

 

73 

%

 

The increases in interest expense for 2014 as compared to 2013 is primarily due to twelve months of interest expense on the outstanding principal balances in 2014 versus six months in 2013 along with the amortization of debt discount and debt issuance costs associated with our term debt pursuant to our loan agreement with Fortress Credit Opportunities I LP (“Fortress”) as successor to DBD Credit Funding, LLC , which we received on July 18, 2013.

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Income Tax Provision.

 

The followi ng table presents the provision for income taxes for the years ended December 27, 2014 and December 28, 2013 (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

 

 

%

 

 

    

2014

    

2013

    

Change

    

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

 

$

(7)

 

(78)

%

 

The federal statutory rate was 35% for 201 4 and 201 3 .  In both 201 4 and 201 3 , we continued to provide a full valuation allowance against our net deferred tax assets, which consist primarily of net operating loss carry-forwards.  In 201 4 and 201 3 , our effective tax rate differed from the 35% statutory rate primarily due to the valuation allowance on newly generated loss carry-forwards.  For further discussion see Note  6 to the Consolidated Financial Statements included in Part IV, Item 15 of this Report.

 

Liquidity and Capital Resources

 

We have historically financed our operations primarily through issuances of equity and debt securities and cash generated from operations. We have also funded our operations with a revolving line of credit and term loans under our bank credit facility and capitalized lease oblig ations.

 

Working Capital and Cash and Cash Equivalents.

 

The following table presents working capital and cash and cash equivalents (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

Working capital

 

$

7,907 

 

$

10,647 

 

Cash and cash equivalents(1)

 

$

11,040 

 

$

6,701 

 

 


(1)

Included in working capital

 

Our working capital decreased in 2014 primarily as a result of reductions of (i) accounts receivable of approximately $3.8 million and (ii) inventory levels by approximately $0.7 million offset by (i) the increase in the current portion of long term debt of $2.2 million and (ii) an increase of cash and cash equivalents and restricted cash of $4.0 million.

 

As a result of the completion of the 2015 Offering described above, and the receipt of net proceeds of approximately $10. 4 million, our working capital as of the date of this Annual Report is materially higher than it was as of December 27, 2014 .

 

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Cash Provided and Used in the Years Ended December 27, 2014 and December 28, 2013 .

 

The following table summarizes our cash flows for the periods indicated (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Net cash provided by (used in):

 

 

 

 

 

 

 

Operating activities

 

$

(6,401)

 

$

(4,021)

 

Investing activities

 

 

(138)

 

 

330 

 

Financing activities

 

 

10,878 

 

 

2,637 

 

Net change in cash and cash equivalents

 

$

4,339 

 

$

(1,054)

 

 

Operating Activities.  Net cash used in operating activities for the year ended December 27, 2014 was primarily the result of a net loss of approximately $ 15.4  million offset by  (i) approximately $ 5.0  million in net cash provided by changes in operating assets and liabilities, primarily accounts receivable, restricted cash, accounts payable, accrued payroll and related liabilities and inventory and (ii) approximately $ 4.0 million in net non-cash operating expenses, mainly comprised of depreciation and amortization, amortization of debt discount and debt issuance costs and stock- based compensation.    

 

Net cash used in operating activities for the year ended December 28, 2013 was primarily the result of a net loss of approximately $10.8 million offset by (i) approximately $3.1 million in net cash provided by changes in operating assets and liabilities, primarily accounts receivable, restricted cash, accounts payable, accrued payroll and related liabilities and inventory and (ii) approximately $3.7 million in net non-cash operating expenses, mainly comprised of depreciation and amortization, amortization of debt discount and debt issuance costs, capitalized payment in kind interest and stock-based compensation.    

 

Accounts receivable decreased by approximately $ 3. 8  million at December 27, 2014 , compared with December 28, 2013 , primarily as a result of a   decrease in our net sales of $ 5.2 million in the fourth quarter of 201 4 as compared with the fourth quarter of 201 3 .  

 

Inventories decreased by approximately $0.7 million, primarily because we utilized inventory on hand to support our sales.

 

Investing Activities.     Net cash used in investing activities for the year ended December 27, 2014 was primarily the result of the purchase of $0.1 million of property and equipment. Net cash provided by investing activities for the year ended   December 28, 2013   was primarily the result of our sale of an auction rate security resulting in proceeds of $0.4 million.

 

Financing Activities.    

 

Net cash provided by financing activities for the year ended December 27 , 2014 was primarily the result of our February 2014 Public Offering, which raised net proceeds of approximately $10. 3 million and our receipt of an aggregate of approximately $0.8 million in proceeds from the partial exercise of an outstanding warrant for the purchase of our common stock and the exercise of employee stock options in February 2014.    

 

Net cash provided by financing activities for the year ended December 28, 2013 was primarily the result of (i) net proceeds from a term loan with Fortress of $2.5 million, described below under the caption Capital Resources and (ii) $1.2 million in net proceeds from the sale of 1,098,902 shares of our common stock through a registered public offering, described below under the caption Capital Resources, offset by repayment of bank debt, capital leases and other notes payable of $1.0 million.  

 

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Capital Resources .

 

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

 

In May 2012, Silicon Valley Bank consolidated our outstanding term loans and extended additional credit, resulting in a combined balance of $3.5 million (the “Consolidated Term Loan”). The Consolidated Term Loan was payable in 36 installments of $97,222, beginning December 2012, with interest at a rate of prime plus 2.50%. Interest was payable monthly from the date of funding through final payoff of the loan.  On July 18, 2013, as part of our amendment of the SVB Credit Agreement and following our receipt of additional loan financing obtained through Fortress Credit Opportunities I LP as successor to DBD Credit Funding, LLC, as further described below, the term loan and outstanding interest was paid in full.    

 

Prior to the May 2012 amendment, the SVB Credit Agreement contained an overall sublimit of $10.0 million to collateralize our contingent obligations under letters of credit and other financial services. Amounts outstanding under the overall sublimit reduced the amount available pursuant to the SVB Credit Agreement. As a result of the May  2012 amendment, letters of credit and other financial services were no longer subject to borrowing base sublimits and did not reduce the amount that could be borrowed under the revolving line of credit. The July 18, 2013 amendment requires letters of credit to be secured by cash. At December 27, 2014 , letters of credit in the amount of $ 0 . 7  million were outstanding.

 

Following its amendment on July 18, 2013, the SVB Credit Agreement permits the debt financing and security interests contemplated under our Loan Agreement with Fortress (described below) and releases certain patents and related assets from the collateral subject to SVB’s security interest under the SVB Credit Agreement. Additionally, pursuant to the SVB Credit Agreement, advances under the revolving line now accrue interest at a rate equal to SVB’s most recently announced “prime rate” plus 2.75%. The SVB Credit Agreement also relaxed our tangible net worth covenant and waived certain events of default in connection therewith. Certain reporting requirements under the SVB Credit Agreement were modified while certain reserves with respect to the borrowing base and the availability of revolving loans were removed.  On September 30, 2014, the SVB Credit Agreement was amended again to further modify our tangible net worth covenant and to extend the maturity date of our revolving line under the SVB Credit Agreement to September 29, 2015.

 

We made no borrowings under the Silicon Valley Bank line of credit in the year s ended December 27, 2014 and December 27, 2013 .  At December 27, 2014 and December 28, 2013 we had borrowing availability of approximately $ 0.9 million and $ 4.0 million, respectively.    

 

Loan Agreement with Fortress Credit Opportunities I LP

 

Concurrent with our amendment of the SVB Credit Agreement, on July 18, 2013, we entered into a loan and security agreement (as amended, the “Loan Agreement”), with Fortress Credit Opportunities I LP, a Delaware limited liability company (“Fortress”), as successor to DBD Credit Funding  LLC, providing for up to $10 million in term loans and up to $5 million in revolving loans.  The term loans are available in an initial $6 million tranche (the “Initial Term Loan”) with a second tranche in the amount of $4 million becoming available upon achievement of certain performance milestones relating to intellectual property matters (the “IP Monetization Milestones” and such second tranche loan, “IP Milestone Term Loan”). The $5 million in revolving loans are available at Fortress’s discretion and subject to customary conditions precedent.  The $6 million Initial Term Loan was fully drawn at closing on July 18, 2013. Proceeds from the Initial Term Loan were used in part to repay our existing consolidated term loan with Silicon Valley Bank. The remainder of such funds are available to fund our ongoing working capital needs. On February 17, 2015, we amended the Loan Agreement to accelerate the availability of the term loan and we borrowed the remaining $4 million in term loans.  

 

The loans bear interest at a stated fixed rate of 11.0% per annum.  Until the last business day of February 2015, the payments on the term loans are interest-only at a cash rate of 7.0% per annum and a payment-in-kind deferred cash

45


 

interest rate of 4.0%, which payment-in-kind interest is capitalized semi-annually, beginning with December 31, 2013.  Beginning with the last business day of February 2015, the term loans are amortized with 65% of the principal amount due in equal monthly installments over the following seventeen (17) months with a balloon payment equal to 35% of the remaining principal amount of the term loans, plus accrued interest, being payable on July 18, 2016 (the "Maturity Date").  Term loan payments, including the $4 million borrowed on February 17, 2015, of approximately $370,000 are due monthly through June 18, 2016, with the remaining amount of approximate ly $4.3 million due on July 18, 2016.

 

Monetization Letter Agreement

 

Concurrently with the execution of the Loan Agreement, the Company and Drawbridge Special Opportunities Fund LP (“Drawbridge”) entered into a Monetization Letter Agreement (as amended, the “Letter Agreement”).  In connection with the amendment to the Loan Agreement, we also amended the Letter Agreement on February 17, 2015.  The Letter Agreement provides, among other things, that DBD may be entitled to share in certain monetization revenues that we may derive in the future related to our patent portfolio (the “Patent Portfolio”).  The Patent Portfolio does not include certain patents relating to the NVvault™  product line.  Monetization revenues subject to this arrangement include revenues recognized during the seven year term of the Letter Agreement from amounts (whether characterized as settlement payments, license fees, royalties, damages, or otherwise) actually paid to us or our subsidiaries in connection with any assertion of, agreement not to assert, or license of, the Patent Portfolio (in whole or in part) either (A) in consideration of the grant of a license or covenant not sue, or other immunity with respect to the Patent Portfolio, or (B) as a damages award with respect to such assertion of the Patent Portfolio, less certain legal fees and expenses (subject to a cap on such fees and expenses).  Monetization revenues also include the value attributable to the Patent Portfolio in any sale of the Company during the seven year term, subject to a maximum amount payable to Drawbridge.  The Letter Agreement also requires that the we use commercially reasonable efforts to pursue opportunities to monetize the Patent Portfolio during the term of the Letter Agreement, provided that we are under no obligation to pursue any such opportunities that we do not deem to be in our best interest.  Notwithstanding the foregoing, there can be no assurance that we will be successful in these efforts, and we may expend resources in pursuit of monetization revenues that may not result in any benefit to us.

 

Sales Agreement with Ascendiant Capital

 

On November 21, 2011, we entered into a sales agreement with Ascendiant as sales agent. The sales agreement with Ascendiant expired on November 21, 2013.  Prior to its expiration, we were able to issue and sell shares of our common stock having an aggregate offering price of up to $10.0 million. During the term of the agreement, we received net proceeds of approximately $6.2 million, including approximately $3.9 million raised through the sale of approximately 1,312,669 shares during the year ended December 29, 2012 and approximately $0.2 million through the sale of 240,373 shares during the year ended December 28, 2013.

 

July 2013 Equity Financing

 

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

 

February 2014 Public Offering of Common Stock

 

On February 11, 2014, we completed a registered firm commitment underwritten public offering (the “2014 Offering”) of shares of our common stock.  In the 2014 Offering, we issued and sold to Craig-Hallum Capital Group

46


 

LLC (the “Underwriter”) 8,680,775 shares of common stock pursuant to an underwriting agreement, dated as of February 6, 2014, by and between the Company and the Underwriter, at a price of $1.2115 per share, including 1,132,275 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of common stock to cover over-allotments.  The price per share to the public in the 2014 Offering was $1.30 per share.  The net proceeds from the 2014 Offering were approximately $10. 3 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

February 2015 Public Offering of Common Stock

 

On February 24, 2015, we completed a registered firm commitment underwritten public offering of shares of our common stock (the “2015 Offering”). In the 2015 Offer ing, we issued and sold to the Underwriter 8,846,154 shares of common stock pursuant to an underwriting agreement, dated as of February 19, 2015, by and between the Company and the Underwriter, at a price of $1.209 per share, including 1,153,846 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of common stock to cover over-allotments. The price per share to the public in the 2015 Offering was $1.30 per share. The net proceeds from the 2015 Offering were approximately $10.4 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

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

 

We believe our existing cash balances (including proceeds from the 2015 Offering), borrowing availability under our new bank credit facility, borrowing availability under the SVB Credit Agreement , net of cash expected to be used in operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Should we need additional capital, we may seek to raise capital through, among other things, public and private equity offerings and debt financings. 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. Additional funds may not be available on terms acceptable to us, or at all. If adequate working capital is not available when needed, we may be required to significantly modify our business model and operations to reduce spending to a sustainable level. It could cause us to be unable to execute our business plan, take advantage of future opportunities, or respond to competitive pressures or customer requirements. It may also cause us to delay, scale back or eliminate some or all of our research and development programs, or to reduce or cease operations.

 

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.

 

Item 8.  Financial Statements and Supplementary Dat a

 

The financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Annual Report.

 

Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosur e

 

None.

 

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Table of Contents

Item 9A.  Controls and Procedure s

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a - 15(e) under the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC s rules and forms, and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

 

Management s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 27, 2014 based on the criteria set forth in the 1992   Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 27, 2014.

 

This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management s report was not subject to attestation by our independent registered public accoun ting firm pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management s report in this Annual Report.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting during the fourth quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Inherent Limitations on Internal Control

 

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost - effective control system, misstatements due to error or fraud may occur and not be detected.

 

In addition, projections of any evaluation of effectiveness to future periods are subject to risks that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

 

I tem 9B.  Other Informatio n

 

None .

 

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Table of Contents

PART II I

 

Certain information required by this Part III is omitted from this Annual Report as we expect to file our definitive Proxy Statement for our Annual Meeting of Stockholders pursuant to Regulation 14A of the Exchange Act not later than 120 days after the end of the fiscal year covered by this Annual Report, and certain information included in the Proxy Statement is incorporated herein by reference.

 

Item 10.  Directors, Executive Officers and Corporate Governanc e

 

We incorporate by reference herein the sections entitled “Election Of Directors,” “Board Of Directors; Audit Committee Financial Expert,” “Other Information—Section 16(a) Beneficial Ownership Reporting Compliance” and “Information Concerning our Executive Officers” in our Proxy Statement.

 

We have adopted a “Code of Business Conduct and Ethics” that applies to all employees, including our executive officers. A copy of the Code of Business Conduct and Ethics is posted on our Internet site at www.netlist.com . In the event that we make any amendment to, or grant any waivers of, a provision of the Code of Business Conduct and Ethics that applies to the principal executive officer, principal financial officer, or principal accounting officer that requires disclosure under applicable rules promulgated under the Securities Act or Exchange Act, we intend to disclose such amendment or waiver and the reasons there for on our Internet site.

 

Item 11.  Executive Compensatio n

 

The information required by this Item is incorporated herein by reference to the section entitled “Executive Compensation” and “Directors’ Compensation” in our Proxy Statement.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matter s

 

The information required by this Item is incorporated herein by reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in our Proxy Statement.   The information set forth in the section entitled “Securities Authorized for Issuance Under Equity Compensation Plans” included in Part II, Item 5 of this Report is incorporated herein by reference.

 

Item 13.  Certain Relationships and Related Transactions, and Director Independenc e

 

The information required by this Item is incorporated herein by reference to the section entitled “Transactions with Related Persons” in our Proxy Statement.

 

Item 14.  Principal Accounting Fees and Service s

 

The information required by this Item is incorporated herein by reference to the section entitled “Auditors, Audit Fees and Auditor Independence” and “Director Independence” in our Proxy Statement.

 

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Table of Contents

PART IV  

 

Item 15.  Exhibits, Financial Statement Schedule s

 

(a)(1)  All financial statements filed as part of this report.

 

 

(a)(2)  Exhibits

 

3.1

 

Restated Certificate of Incorporation of Netlist, Inc. (incorporated by reference to exhibit 3.1 of the registration statement on Form S-1 of the registrant (No. 333-136735) filed with the Securities and Exchange Commission (the “SEC”) on October 23, 2006)

 

 

 

3.2

 

Amended and Restated Bylaws of Netlist, Inc. (incorporated by reference to exhibit number 3.1 of the registrant’s Current Report on Form 8-K filed with the SEC on December 20, 2012)

 

 

 

10.1#

 

Amended and Restated 2000 Equity Incentive Plan of Netlist, Inc. (incorporated by reference to exhibit 10.7 of the registration statement on Form S-1 of the registrant (No. 333-136735) filed with the SEC on October 23, 2006)

 

 

 

10.2#

 

Employment Agreement, dated September 5, 2006, by and between Netlist, Inc. and Chun K. Hong (incorporated by reference to exhibit 10.13 of the registration statement on Form S-1 of the registrant (No. 333-136735) filed with the SEC on September 27, 2006)

 

 

 

10.3#

 

Amended and Restated 2006 Equity Incentive Plan of Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 12, 2010)

 

 

 

10.4#

 

Form of Restricted Stock Award Agreement issued pursuant to the 2006 Equity Incentive Plan of Netlist, Inc. (incorporated by reference to exhibit 10.2 of the Quarterly Report on Form 10-Q of the registrant filed with the SEC on May 17, 2010)

 

 

 

10.5

 

Loan and Security Agreement, dated as of October 31, 2009, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Current Report on Form 8-K filed with the SEC on November 2, 2009)

 

 

 

10.6

 

Intercompany Subordination Agreement, dated as of October 31, 2009, by and among Silicon Valley Bank, Netlist, Inc., and Netlist Technology Texas, L.P. (incorporated by reference to exhibit 10.2 of the registrant’s Current Report on Form 8-K filed with the SEC on November 2, 2009)

 

 

 

10.7

 

Guarantor Security Agreement entered into as of October 31, 2009, by and between Silicon Valley Bank and Netlist Technology Texas LP (incorporated by reference to exhibit 10.3 of the registrant’s Current Report on Form 8-K filed with the SEC on November 2, 2009)

 

 

 

10.8

 

Intellectual Property Security Agreement entered into as of October 31, 2009 by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.4 of the registrant’s Current Report on Form 8-K filed with the SEC on November 2, 2009)

10.9

 

Amendment to Loan Documents entered into as of March 24, 2010, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 17, 2010)

50


 

 

 

 

10.10

 

Amendment to Loan Documents entered into as of June 30, 2010, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.2 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 12, 2010)

 

 

 

10.11

 

Amendment to Loan Documents entered into as of September 30, 2010, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 17, 2010)

 

 

 

10.12

 

Amendment to Loan Documents entered into as of May 11, 2011, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 12, 2011)

 

 

 

10.13

 

Amendment to Loan Documents entered into as of August 10, 2011, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 15, 2011)

 

 

 

10.14

 

Amendment to Loan Documents entered into as of May 14, 2012, by and between Silicon Valley Bank and Netlist, Inc. (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 15, 2012)

 

 

 

10.15

 

Forbearance to Loan and Security Agreement, dated March 27, 2013, by and between Netlist, Inc. and Silicon Valley Bank (incorporated by reference to exhibit 10.32 of the registrant’s Annual Report on Form 10-K for the fiscal year ended December 29, 2012 filed with the SEC on March 29, 2013)  

 

 

 

10.16

 

Loan and Security Agreement, dated July 18, 2013 , by and between Netlist, Inc. and DBD Credit Funding LLC (incorporated by reference to exhibit 10.1 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)  

 

 

 

10.17*

 

Monetization Letter Agreement, dated July 18, 2013 , by and between Netlist, Inc. and Drawbridge Special Opportunities Fund LP (incorporated by reference to exhibit 10.2 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)

 

 

 

10.18

 

Intellectual Property Security Agreement, dated July 18, 2013 , by and between Netlist, Inc. and DBD Credit Funding LLC (incorporated by reference to exhibit 10.3 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)

 

 

 

10.19

 

Stock Purchase Warrant, issued by Netlist, Inc. on July 18, 2013 to Drawbridge Special Opportunities Fund LP (incorporated by reference to exhibit 10.4 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)

 

 

 

10.20

 

Subordination Agreement, dated July 18, 2013, among Netlist, Inc., Netlist Electronics (Suzhou) Co., Ltd., Netlist HK Limited and DBD Credit Funding LLC (incorporated by reference to exhibit 10.5 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)

 

 

 

10.21

 

Amendment to Credit Agreement, dated July 18, 2013, between Netlist, Inc. and Silicon Valley Bank (incorporated by reference to exhibit 10.6 of the registrant’s Quarterly Report on Form 10-Q filed with the SEC on November 12, 2013)

 

 

 

10.22

 

Securities Purchase Agreement, dated July 17, 2013, between Netlist, Inc. and the purchaser identified therein (incorporated by reference to exhibit 10.1 of the registrant’s Current Report on Form 8-K filed with the SEC on July 18, 2013)

 

 

 

51


 

10.23

 

Form of Warrant issued pursuant to the Securities Purchase Agreement, dated July 17, 2013 (incorporated by reference to exhibit 4.1 of the registrant’s Current Report on Form 8-K filed with the SEC on July 18, 2013)

 

 

 

10.24+

 

Amendment to Loan Documents, dated September 30, 2014, between Netlist, Inc. and Silicon Valley Bank

 

 

 

14.1+

 

Code of Business Conduct and Ethics

 

 

 

21.1

 

Subsidiaries of Netlist, Inc.

 

 

 

23+

 

Consent of KMJ Corbin & Company LLP

 

 

 

24.1+

 

Power of Attorney (included on the signature page in this Part IV of this report)

 

 

 

31.1+

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

31.2+

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

32+

 

Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS+

 

XBRL Instance Document

 

 

 

101.SCH+

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL+

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB+

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE+

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF+

 

XBRL Taxonomy Extension Definition Linkbase Document

 


 

+

 

Filed herewith.

 

 

 

#

 

Management contract or compensatory plan or arrangement.

 

 

 

*

 

Confidential treatment has been granted with respect to portions of this exhibit pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934 and these confidential portions have been redacted from the document filed as an exhibit to this report.  A complete copy of this agreement, including the redacted terms, has been separately filed with the SEC.

 

(b)  Exhibits

 

See subsection (a)(2) above.

 

See subsection (a)(2) above.

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Table of Contents

 

 

SIGNATURE S

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date:  March 27, 2015

 

 

 

 

 

Netlist, Inc.

 

 

 

 

 

By:

/s/ Chun K. Hong

 

 

Chun K. Hong

 

 

President, Chief Executive Officer and

 

 

Chairman of the Board

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

 

Signature

    

Title

    

Date

 

 

 

 

 

/s/ Chun K. Hong

 

President, Chief Executive Officer and

 

 

Chun K. Hong

 

Chairman of the Board (Principal

 

March 27, 2015

 

 

Executive Officer)

 

 

 

 

 

 

 

/s/ Gail Sasaki

 

Vice President and Chief Financial

 

 

Gail Sasaki

 

Officer (Principal Financial Officer and

 

March 27, 2015

 

 

Principal Accounting Officer)

 

 

 

 

 

 

 

/s/ Charles F. Cargile

 

Director

 

March 27, 2015

Charles F. Cargile

 

 

 

 

 

 

 

 

/s/ Jun S. Cho

 

Director

 

March 27, 2015

Jun S. Cho

 

 

 

 

 

 

 

 

/s/ Thomas F. Lagatta

 

Director

 

March 27, 2015

Thomas F. Lagatta

 

 

 

 

 

 

 

 

/s/ Vincent Sheeran

 

Director

 

March 27, 2015

Vincent Sheeran

 

 

 

 

 

 

 

 

/s/ Blake A. Welcher

 

Director

 

March 27, 2015

Blake A. Welcher

 

 

 

 

 

 

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Table of Contents

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

    

Page

Report of Independent Registered Public Accounting Firm  

 

F - 2

Consolidated Balance Sheets  

 

F - 3

Consolidated Statements of Operations  

 

F - 4

Consolidated Statements of Stockholders’ Equity  

 

F - 5

Consolidated Statements of Cash Flows  

 

F - 6

Notes to Consolidated Financial Statements  

 

F - 7

 

 

F- 1


 

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIR M

 

Board of Directors and Stockholders

Netlist, Inc.

 

We have audited the accompanying consolidated balance sheets of Netlist, Inc. and subsidiaries (the “Company”) as of December 27, 2014 and December 28, 2013, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years 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 audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 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 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 audits provide 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 27, 2014   and December 28, 2013 , and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ KMJ Corbin & Company LLP

Costa Mesa, California

March 27 , 201 5

F- 2


 

Table of Contents

NETLIST, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheet s

 

(in thousands, except par value)

 

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

11,040 

 

$

6,701 

 

Restricted cash

 

 

700 

 

 

1,100 

 

Accounts receivable, net of allowance for doubtful accounts of $61 (2014) and $72 (2013)

 

 

1,091 

 

 

4,866 

 

Inventories

 

 

1,880 

 

 

2,620 

 

Prepaid expenses and other current assets

 

 

988 

 

 

823 

 

Total current assets

 

 

15,699 

 

 

16,110 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

393 

 

 

1,143 

 

Other assets

 

 

150 

 

 

422 

 

Total assets

 

$

16,242 

 

$

17,675 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

3,957 

 

$

3,795 

 

Accrued payroll and related liabilities

 

 

710 

 

 

635 

 

Accrued expenses and other current liabilities

 

 

420 

 

 

533 

 

Accrued engineering charges

 

 

500 

 

 

500 

 

Current portion of long-term debt, net of debt discount

 

 

2,205 

 

 

 -

 

Total current liabilities

 

 

7,792 

 

 

5,463 

 

Long-term debt, net of current portion and debt discount

 

 

3,632 

 

 

5,099 

 

Long-term warranty liability

 

 

99 

 

 

100 

 

Total liabilities

 

 

11,523 

 

 

10,662 

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

Preferred stock, $0.001 par value - 10,000 shares authorized; no shares issued and outstanding

 

 

 -

 

 

 -

 

Common stock, $0.001 par value - 90,000 shares authorized; 41,498 (2014) and 31,776 (2013) shares issued and outstanding

 

 

41 

 

 

31 

 

Additional paid-in capital

 

 

117,546 

 

 

104,469 

 

Accumulated deficit

 

 

(112,868)

 

 

(97,487)

 

Total stockholders' equity

 

 

4,719 

 

 

7,013 

 

Total liabilities and stockholders' equity

 

$

16,242 

 

$

17,675 

 

 

See accompanying notes to consolidated financial statements.

 

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NETLIST, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Net sales

 

$

19,195 

 

$

23,048 

 

Cost of sales(1)

 

 

15,231 

 

 

19,943 

 

Gross profit

 

 

3,964 

 

 

3,105 

 

Operating expenses:

 

 

 

 

 

 

 

Research and development(1)

 

 

4,835 

 

 

4,568 

 

Intellectual property legal fees

 

 

6,138 

 

 

2,115 

 

Selling, general and administrative(1)

 

 

6,796 

 

 

6,267 

 

Total operating expenses

 

 

17,769 

 

 

12,950 

 

Operating loss

 

 

(13,805)

 

 

(9,845)

 

Other expense, net:

 

 

 

 

 

 

 

Interest expense, net

 

 

(1,574)

 

 

(932)

 

Other income, net

 

 

 -

 

 

20 

 

Total other expense, net

 

 

(1,574)

 

 

(912)

 

Loss before provision for income tax

 

 

(15,379)

 

 

(10,757)

 

Provision for income taxes

 

 

 

 

 

Net loss

 

$

(15,381)

 

$

(10,766)

 

 

 

 

 

 

 

 

 

Net loss per common share:

 

 

 

 

 

 

 

Basic and diluted

 

$

(0.38)

 

$

(0.35)

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

Basic and diluted

 

 

40,304 

 

 

30,881 

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

56 

 

$

49 

 

Research and development

 

 

726 

 

 

588 

 

Selling, general and administrative

 

 

1,230 

 

 

1,032 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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NETLIST, INC. AND SUBSIDIARIES

 

Consolidated Statements of Stockholders Equity  

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series   A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred

 

 

 

 

 

 

Additional

 

 

 

 

Total

 

 

 

Stock

 

Common Stock

 

Paid-in

 

 

Accumulated

 

Stockholders'

 

 

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Deficit

    

Equity

 

Balance, December 29, 2012

 

 -

 

 -

 

30,348 

 

$

30 

 

$

100,403 

 

$

(86,721)

 

$

13,712 

 

Stock-based compensation

 

 -

 

 -

 

 -

 

 

 -

 

 

1,669 

 

 

 -

 

 

1,669 

 

Exercise of stock options

 

 -

 

 -

 

118 

 

 

 -

 

 

40 

 

 

 -

 

 

40 

 

Repurchase of common stock

 

 -

 

 -

 

(29)

 

 

 -

 

 

(14)

 

 

 -

 

 

(14)

 

Issuance of common stock, net

 

 -

 

 -

 

1,339 

 

 

 

 

1,156 

 

 

 -

 

 

1,157 

 

Estimated relative fair value of common stock warrants

 

 

 

 

 

 -

 

 

 -

 

 

1,215 

 

 

 

 

 

1,215 

 

Net loss

 

 -

 

 -

 

 -

 

 

 -

 

 

 -

 

 

(10,766)

 

 

(10,766)

 

Balance, December 28, 2013

 

 -

 

 -

 

31,776 

 

 

31 

 

 

104,469 

 

 

(97,487)

 

 

7,013 

 

Stock-based compensation

 

 -

 

 -

 

 

 

 

 -

 

 

2,012 

 

 

 -

 

 

2,012 

 

Exercise of stock options

 

 -

 

 -

 

303 

 

 

 -

 

 

153 

 

 

 -

 

 

153 

 

Repurchase of common stock

 

 -

 

 -

 

(12)

 

 

 -

 

 

(22)

 

 

 -

 

 

(22)

 

Issuance of common stock, net

 

 -

 

 -

 

8,681 

 

 

 

 

10,267 

 

 

 -

 

 

10,276 

 

Exercise of warrant

 

 -

 

 -

 

750 

 

 

 

 

667 

 

 

 -

 

 

668 

 

Net loss

 

 -

 

 -

 

 

 

 

 -

 

 

 

 

 

(15,381)

 

 

(15,381)

 

Balance, December 27, 2014

 

 -

 

 -

 

41,498 

 

$

41 

 

$

117,546 

 

$

(112,868)

 

$

4,719 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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NETLIST, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flow s

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(15,381)

 

$

(10,766)

 

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

882 

 

 

1,476 

 

Capitalized payment -in- kind interest

 

 

251 

 

 

111 

 

Amortization of debt discount and debt issuance costs

 

 

803 

 

 

366 

 

Realized  loss on sale of equipment

 

 

 

 

26 

 

Provision for bad debts

 

 

 -

 

 

25 

 

Stock-based compensation

 

 

2,012 

 

 

1,669 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

400 

 

 

(1,100)

 

Accounts receivable

 

 

3,775 

 

 

(1,457)

 

Inventories

 

 

740 

 

 

4,760 

 

Prepaid expenses and other current assets

 

 

32 

 

 

140 

 

Other assets

 

 

(44)

 

 

358 

 

Accounts payable

 

 

162 

 

 

428 

 

Accrued payroll and related liabilities

 

 

75 

 

 

(149)

 

Accrued expenses and other current liabilities

 

 

(114)

 

 

42 

 

Accrued engineering charges

 

 

 -

 

 

50 

 

Net cash used in operating activities

 

 

(6,401)

 

 

(4,021)

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Acquisition of property and equipment

 

 

(141)

 

 

(119)

 

Proceeds from sale of equipment

 

 

 

 

34 

 

Proceeds from maturities and sales of investments in marketable securities

 

 

 -

 

 

415 

 

Net cash  (used in) provided by investing activities

 

 

(138)

 

 

330 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from long- term loan, net of issuance costs

 

 

 -

 

 

2,483 

 

Payments on debt

 

 

(197)

 

 

(1,029)

 

Proceeds from public offering, net

 

 

10,276 

 

 

1,157 

 

Proceeds from exercise of equity awards, net of taxes remitted for restricted stock

 

 

799 

 

 

26 

 

Net cash provided by financing activities

 

 

10,878 

 

 

2,637 

 

Net change in cash and cash equivalents

 

 

4,339 

 

 

(1,054)

 

Cash and cash equivalents at beginning of year

 

 

6,701 

 

 

7,755 

 

Cash and cash equivalents at end of year

 

$

11,040 

 

$

6,701 

 

 

See accompanying notes to consolidated financial statements.

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NETLIST, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENT S

 

December 27, 2014

 

Note 1—Description of Business

 

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

 

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

 

Liquidity

 

The Company incurred net losses of approximately $15.4 million and $10.8 million for the years ended December 27, 2014 and December 28, 2013, respectively.

 

On February 11, 2014, the Company completed a registered firm commitment underwritten public offering (the “2014 Offering”) of shares of the Company’s common stock. In the 2014 Offering, the Company issued and sold to Craig-Hallum Capital Group LLC (the “Underwriter”) 8,680,775 shares of common stock pursuant to an underwriting agreement, dated as of February 6, 2014, by and between the Company and the Underwriter, at a price of $1.2115 per share, including 1,132,275 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of Common Stock to cover over-allotments. The price per share to the public in the 2014 Offering was $1.30 per share. The net proceeds from the 2014 Offering were approximately $10.3 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

On February 3, 2014, the Company issued 750,000 shares of common stock upon exercise of warrants at a purchase price of $0.89 per share, resulting in proceeds to the Company of $667,500.

 

On February 24, 2015, the Company completed a registered firm commitment underwritten public offering (the “2015 Offering”) of shares of the Company’s common stock. In the 2015 Offering, the Company issued and sold to the Underwriter 8,846,154 shares of common stock pursuant to an underwriting agreement, dated as of February 19, 2015, by and between the Company and the Underwriter, at a price of $1.209 per share, including 1,153,846 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of Common Stock to cover over-allotments. The price per share to the public in the 2015 Offering was $1.30 per share. The net proceeds from the 2015 Offering were approximately $10.4 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

If adequate working capital is not available when needed, the Company may be required to significantly modify its business model and operations to reduce spending to a sustainable level. Insufficient working capital could cause the Company to be unable to execute its business plan, take advantage of future opportunities, or respond to competitive

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pressures or customer requirements. It may also cause the Company to delay, scale back or eliminate some or all of its research and development programs, or to reduce or cease operations. While there is no assurance that the Company can meet its revenue forecasts, management anticipates that it can continue operations for at least the next twelve months.

 

Reclassifications

 

Intellectual property legal fees for the year ended December 28, 2013 are now reported under their own caption, separate from research and development expenses, in the accompanying consolidated statement of operations for the year ended December 28, 2013, in order to conform to the current period presentation.

 

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 (“U.S.”).

 

Principles of Consolidation

 

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

 

Fiscal Year

 

The Company operates under a 52 / 53 -week fiscal year ending on the Saturday closest to December 31. The 2014 and 2013 fiscal years ended on December 27, 2014 and December 28, 2013, respectively. Fiscal years 2014 and 2013 each consisted of 52 weeks.

 

Use of Estimates

 

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

 

Revenue Recognition

 

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

 

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

 

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

 

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

 

Cash and Cash Equivalents

 

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

 

Restricted Cash

 

Restricted cash of $0.7 million, as of December 27, 2014, consists of cash to secure three standby letters of credit.  On January 13, 2015, the Company restricted an additional $0.9 million to secure a bond associated with a lawsuit.

 

Fair Value of Financial Instruments

 

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

 

Allowance for Doubtful Accounts

 

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

 

Concentration of Credit Risk

 

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

 

The Company invests its cash equivalents primarily in money market mutual funds.  Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by

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management. At times, deposits held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation.

 

The Company’s trade accounts receivable are primarily derived from sales to 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 its credit evaluation process, relatively short collection terms, the high level of credit worthiness of its customers (see Note 10), foreign credit insurance and letters of credit issued in its favor.  Reserves are maintained for potential credit losses, and such losses historically have not been significant and have been within management’s expectations.

 

Inventories

 

Inventories are valued at the lower of actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on an average cost basis which approximates actual cost on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. At each balance sheet date, the Company evaluates its ending inventory quantities on hand and on order and records a provision for excess quantities and obsolescence. Among other factors, the Company considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. In addition, the Company considers changes in the market value of components in determining the net realizable value of its inventory. Once established, lower of cost or market write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.

 

Property and Equipment

 

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

 

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

 

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

 

Impairment of Long-Lived Assets

 

The Company evaluates the recoverability of the carrying value of long-lived assets held and used by the Company for impairment on at least an annual basis or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future net cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized to the extent the carrying value exceeds the estimated fair value of the asset. The fair value of the asset or asset group is based on market value when available, or when unavailable, on discounted expected cash flows. The Company’s management believes there is no impairment of long-lived assets as of December 27, 2014. 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.

 

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Warranty Reserve

 

The Company offers product warranties generally ranging from one to three years, depending on the product and negotiated terms of any purchase agreements with customers. Such warranties require the Company to repair or replace defective product returned to the Company during such warranty period a t no cost to the customer. Warranties are not offered on sales of excess component inventory. The Company records an estimate for warranty ‑related costs at the time of sale based on its historical and estimated product return rates and expected repair or replacement costs (see Note 3). Such costs have historically been within management’s expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on the Company, requiring additional warranty reserves, and could adversely affect the Company’s gross profit and gross margins.

 

Stock ‑Based Compensation

 

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

 

In accordance with ASC Topic 718, employee and director stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period.  Given that stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s estimated average forfeiture rates are based on historical forfeiture experience and estimated future forfeitures.

 

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

 

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

 

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

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stock- based compensation may increase to the extent that the Company grants additional common stock options or other stock-based awards.

 

Income Taxes

 

Deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at currently effective tax rates, of future deductible or taxable amounts attributable to events that have been recognized on a cumulative basis in the consolidated financial statements. A valuation allowance related to a net deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized.

 

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

 

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

 

Research and Development Expenses

 

Research and development expenditures are expensed in the period incurred.

 

Risks and Uncertainties

 

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

 

The Company invested a significant portion of its research and development budget into the design of ASIC and hybrid devices, including the HyperCloud® memory subsystem and NVvault family of products. These designs and the products they are incorporated into are subject to increased risks as compared to the Company’s legacy products. The Company may be unable to achieve customer or market acceptance of its products, or achieve such acceptance in a timely manner. The Company experienced a longer qualification cycle than anticipated with its HyperCloud® memory subsystems, and has experienced supply chain disruption and a shortage of DRAM and flash required to create the HyperCloud® memory subsystem and NVvault products.  As of December 27, 2014, Hypercloud has not generated significant revenue relative to the Company’s investment in the product.

 

The Company’s operations in the PRC are subject to various political, geographical and economic risks and uncertainties inherent to conducting business in the PRC. These include, but are not limited to, (i) potential changes in economic conditions in the region, (ii) managing a local workforce that may subject the Company to uncertainties or certain regulatory policies, (iii) changes in other policies of the Chinese governmental and regulatory agencies, and (iv) changes in the laws and policies of the U.S. government regarding the conduct of business in foreign countries, generally, or in the PRC, in particular. Additionally, the Chinese government controls the procedures by which its local currency, the Chinese Renminbi (“RMB”), is converted into other currencies and by which dividends may be declared or capital distributed for the purpose of repatriation of earnings and investments. If restrictions in the conversion of RMB or in the repatriation of earnings and investments through dividend and capital distribution restrictions are instituted, the Company’s operations and operating results may be negatively impacted. The liabilities of the Company’s subsidiaries in the PRC exceeded its assets as of December 27, 2014 and December 28, 2013.

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Foreign Currency Remeasurement

 

The functional currency of the Company’s foreign subsidiary is the U.S. dollar. Local currency financial statements are remeasured into U.S. dollars at the exchange rate in effect as of the balance sheet date for monetary assets and liabilities and the historical exchange rate for nonmonetary assets and liabilities. Expenses are remeasured using the average exchange rate for the period, except items related to nonmonetary assets and liabilities, which are remeasured using historical exchange rates. All remeasurement gains and losses are included in determining net loss.  Transaction gains and losses were not significant in 2014 and 2013.

 

Net Loss Per Share

 

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

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in FASB Topic 605, Revenue Recognition . The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016, and early adoption is prohibited. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Management has not yet selected a transition method and is currently assessing the impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern. The amendments in this update provide guidance in accounting principles generally accepted in the United States of America about management’s responsibilities to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The main provision of the amendments are for an entity’s management, in connection with the preparation of financial statements, to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management’s evaluation should be based on relevant conditions and events that are known or reasonably knowable at the date the consolidated financial statements are issued. When management identifies conditions or events that raise substantial doubt about an entity’s ability to continue as a going  concern, the entity should disclose information that enables users of the consolidated financial statements to understand all of the following: (1) principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans); (2) management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations; and (3) management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern or management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern. The amendments in this update are effective for interim and annual reporting periods after December 15, 2016 and early application is permitted. The Company is currently assessing this guidance for future implementation.

 

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Note 3—Supplemental Financial Information

 

Inventories

 

Inventories consist of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Raw materials

 

$

984 

 

$

1,737 

 

Work in process

 

 

23 

 

 

67 

 

Finished goods

 

 

873 

 

 

816 

 

 

 

$

1,880 

 

$

2,620 

 

 

Property and Equipment

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

 

 

 

 

 

 

 

 

Useful

 

 

December 27,

 

 

December 28,

 

 

    

Lives

    

2014

    

2013

 

 

 

 

 

 

 

 

 

 

 

Machinery and equipment

 

3 - 7 yrs.

 

$

8,956 

 

$

8,956 

 

Leasehold improvements

 

*

 

 

1,915 

 

 

1,873 

 

Furniture and fixtures

 

5 yrs.

 

 

367 

 

 

368 

 

Computer equipment and software

 

3 - 7 yrs.

 

 

3,490 

 

 

3,580 

 

 

 

 

 

 

14,728 

 

 

14,777 

 

Less accumulated depreciation and amortization

 

 

 

 

(14,335)

 

 

(13,634)

 

 

 

 

 

$

393 

 

$

1,143 

 

 


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

 

Warranty Liability

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

249 

 

$

235 

 

Estimated cost of warranty claims charged to cost of sales

 

 

116 

 

 

122 

 

Cost of actual warranty claims

 

 

(119)

 

 

(108)

 

Ending balance

 

 

246 

 

 

249 

 

Less current portion

 

 

(147)

 

 

(149)

 

Long-term warranty liability

 

$

99 

 

$

100 

 

 

 

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

 

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Computation of Net Loss Per Share

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share:

 

 

 

 

 

 

 

Numerator: Net loss

 

$

(15,381)

 

$

(10,766)

 

Denominator: Weighted-average common shares

 

 

 

 

 

 

 

outstanding, basic and diluted

 

 

40,304 

 

 

30,881 

 

Basic and diluted net loss per share

 

$

(0.38)

 

$

(0.35)

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Common share equivalents

 

 

277 

 

 

219 

 

 

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

 

Cash Flow Information

 

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

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

 

Interest

 

$

479 

 

$

484 

 

Income taxes

 

$

 

$

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

Debt financing of directors and officers insurance

 

$

198 

 

$

240 

 

Debt issuance costs associated with July 18, 2013 debt financing

 

$

 -

 

$

323 

 

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

 

$

 -

 

$

1,215 

 

Paydown of SVB term loan directly with proceeds from July 18, 2013 debt financing

 

$

 -

 

$

2,731 

 

 

 

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Note 4—Credit Agreements

 

Silicon Valley Credit Agreement

 

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

 

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

 

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

 

SVB Amendment requires letters of credit to be secured by cash, which is classified as restricted cash in the accompanying consolidated balance sheet. At December 27, 2014, letters of credit in the amount of $0.7  million were outstanding.

 

The following tables present details of interest expense related to borrowings on the line of credit with SVB, along with availability under our credit line with SVB (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Interest expense

 

$

79 

 

$

139 

 

 

 

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The following table presents details of the Company’s outstanding borrowings and availability under our line of credit with SVB:

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

Availability under the revolving line of credit

 

$

882 

 

$

4,042 

 

 

 

All obligations under the SVB Credit Agreement are secured by a first priority lien on the Company’s tangible and intangible assets, other than its intellectual property, which is subject to a first priority lien held by Fortress. The SVB Credit Agreement subjects the Company to certain affirmative and negative covenants, including financial covenants with respect to the Company’s liquidity and tangible net worth and restrictions on the payment of dividends. As of December 27, 2014, the Company was in compliance with its debt covenants.

 

Fortress Credit Opportunities I LP Loan and Security Agreement and Related Agreements

 

On July 18, 2013, the Company, entered into a loan agreement (“Loan Agreement”) with Fortress, an affiliate of Fortress Investment Group LLC and successor to DBD Credit Funding, LLC, providing for up to $10 million in term loans and up to $5 million in revolving loans.  The term loans are available in an initial $6 million tranche (the “Initial Term Loan”) with a second tranche in the amount of $4 million becoming available upon achievement of certain performance milestones relating to intellectual property matters (the “IP Monetization Milestones” and such second tranche loan, “IP Milestone Term Loan”). The $5 million in revolving loans are available at Fortress’s discretion and subject to customary conditions precedent.  The $6 million Initial Term Loan was fully drawn at closing on July 18, 2013. Proceeds from the Initial Term Loan were used in part to repay the Company’s existing Consolidated Term Loan with SVB. The remainder of such funds will be used to fund the Company’s ongoing working capital needs.  On February 17, 2015, subsequent to the Company’s fiscal year end, the Loan Agreement was amended to accelerate the availability of the term loan and the Company borrowed the remaining $4 million in term loans.

 

The loans bear interest at a stated fixed rate of 11.0% per annum.  Until the last business day of February 2015, the payments on the term loans are interest-only at a cash rate of 7.0% per annum and a payment-in-kind deferred cash interest rate of 4.0% , which payment-in-kind interest is capitalized semi-annually, beginning with December 31, 2013.  Beginning with the last business day of February 2015, the term loans are amortized with 65% of the principal amount due in equal monthly installments over the following seventeen (17) months with a balloon payment equal to 35% of the remaining principal amount of the term loans, plus accrued interest, being payable on July 18, 2016 (the "Maturity Date").  Term loan payments, including the $4 million borrowed on February 17, 2015, of approximately $370,000 are due monthly through June 18, 2016, with the remaining amount of approximately $4.3 million due on July 18, 2016.

 

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

 

In connection with the Loan Agreement, the Company paid certain facility, due diligence and legal fees of Fortress on the closing date and is obligated to pay a conditional facility fee upon satisfaction of the IP Monetization Milestones.  If the Company repays or prepays all or a portion of the term loans prior to maturity, the Company is obligated to pay Fortress a prepayment fee based on a percentage of the then outstanding principal balance being prepaid, equal to 2.0% if the prepayment occurs between July 18, 2015, or 0.0% if the prepayment occurs after July 18, 2015.

 

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

 

·

incur additional indebtedness or guarantees;

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·

incur liens;

 

·

make investments, loans and acquisitions;

 

·

consolidate or merge;

 

·

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

 

·

alter the business of the Company;

 

·

engage in transactions with affiliates; and

 

·

pay dividends or make distributions.

 

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

 

Concurrently with the execution of the Loan Agreement, the Company and Drawbridge Special Opportunities Fund LP (“Drawbridge”) entered into a Monetization Letter Agreement (as amended, the “Letter Agreement”).  In connection with the amendment to the Loan Agreement, the Company also amended the Letter Agreement on February 17, 2015.  The Letter Agreement provides, among other things, that DBD may be entitled to share in certain monetization revenues that we may derive in the future related to our patent portfolio (the “Patent Portfolio”).  The Patent Portfolio does not include certain patents relating to the NVvault™  product line.  Monetization revenues subject to this arrangement include revenues recognized during the seven year term of the Letter Agreement from amounts (whether characterized as settlement payments, license fees, royalties, damages, or otherwise) actually paid to the Company or its subsidiaries in connection with any assertion of, agreement not to assert, or license of, the Patent Portfolio (in whole or in part) either (A) in consideration of the grant of a license or covenant not sue, or other immunity with respect to the Patent Portfolio, or (B) as a damages award with respect to such assertion of the Patent Portfolio, less certain legal fees and expenses (subject to a cap on such fees and expenses).  Monetization revenues also include the value attributable to the Patent Portfolio in any sale of the Company during the seven year term, subject to a maximum amount payable to Drawbridge.  The Letter Agreement also requires that the Company use commercially reasonable efforts to pursue opportunities to monetize the Patent Portfolio during the term of the Letter Agreement, provided the Company are under no obligation to pursue any such opportunities that it do not deem to be in its best interest.  Notwithstanding the foregoing, there can be no assurance that the Comp an y will be successful in these efforts, and it may expend resources in pursuit of monetization revenues that may not result in any benefit to the Company.

 

Concurrently with the execution of the Loan Agreement, the Company issued to an affiliate of DBD a seven-year warrant (the “Warrant”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at an exercise price of $1.00 per share, of all warrants  are exercisable, as amended, immediately on a cash or cashless basis in whole or in part. In connection with the amendment to the Loan Agreement on February 17, 2015, the Company cancelled the Warrant and issued a new warrant in substantially the same form. The Warrant was issued in a private placement transaction that was exempt from registration under Section 4(2) of the Securities Act of 1933 (the “Securities Act”).

 

The Company accounted for the warrants as a debt discount and has valued them based on the relative fair value at approximately $1,215,000 , to be amortized over the term of the debt instrument, or three years, using the effective interest method.  For the years ended December 27, 2014 and December 28, 2013, the Company amortized approximately $487,000 and $203,000 respectively, as interest expense in the consolidated statements of operations.

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Concurrently with the execution of the Loan Agreement, the Company issued to an affiliate of DBD a seven-year warrant (the “Warrant”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at an exercise price of $1.00 per share, of all warrants  are exercisable, as amended, immediately on a cash or cashless basis in whole or in part. The Warrant was issued in a private placement transaction that was exempt from registration under Section 4(2) of the Securities Act of 1933 (the “Securities Act”). 

 

The Company accounted for the warrants as a debt discount and has valued them based on the relative fair value at approximately $1,215,000, to be amortized over the term of the debt instrument, or three years, using the effective interest method.  For the years ended December 27, 2014 and December 28, 2013, the Company amortized approximately $487,000 and $203,000 respectively, as interest expense in the consolidated statements of operations.

 

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

 

In connection with the amendment to the Loan Agreement on February 17, 2015, the Company modified their agreement with a consultant and agreed to pay a consulting fee of 3.5% of the $4,000,000 of additional principal loaned the Company.

 

During the years ended December 27, 2014 and December 28, 2013, the Company amortized approximately $316,000 and $135,000 respectively, as interest expense in the consolidated statements of operations.

 

Note 5—Debt

 

Debt consists of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Term Loan, Fortress, net of debt discount of $524 and $1,012  

 

 

5,837 

 

 

5,099 

 

Less current portion (including discount)

 

 

(2,205)

 

 

 -

 

 

 

$

3,632 

 

$

5,099 

 

 

As of December 27, 2014, maturities of long-term debt were as follows (in thousands):

 

 

 

 

 

 

 

Fiscal Year

 

 

 

 

2015

    

$

2,600 

 

2016

 

 

3,761 

 

Total payments on long-term debt

 

 

6,361 

 

Debt discount

 

 

(524)

 

Long-term debt

 

$

5,837 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Interest expense

 

$

1,495 

 

$

796 

 

 

 

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Note  6 —Income Taxes

 

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

 

 

 

 

 

 

 

 

 

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

Deferred tax assets:

 

 

 

 

 

 

 

Reserves and allowances

 

$

1,542 

 

$

1,460 

 

State taxes, net of federal income tax benefit

 

 

 

 

 

Depreciation and amortization

 

 

570 

 

 

505 

 

Other accruals

 

 

534 

 

 

447 

 

Compensatory stock options and rights

 

 

2,364 

 

 

2,024 

 

Other

 

 

24 

 

 

15 

 

Tax credit carryforwards

 

 

3,034 

 

 

3,048 

 

Operating loss carryforward

 

 

23,664 

 

 

19,157 

 

Foreign operating loss carryforward

 

 

1,604 

 

 

1,866 

 

Total deferred tax assets

 

 

33,338 

 

 

28,524 

 

Deferred tax liabilities:

 

 

 

 

 

 

 

Prepaid expenses

 

 

(96)

 

 

(379)

 

Basis difference in warrant value

 

 

(200)

 

 

(90)

 

Total deferred tax liabilities

 

 

(296)

 

 

(469)

 

Subtotal

 

 

33,042 

 

 

28,055 

 

 

 

 

 

 

 

 

 

Valuation allowance

 

 

(33,042)

 

 

(28,055)

 

 

 

$

 -

 

$

 -

 

 

The Company evaluates whether a valuation allowance should be established against its deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified.  As of December 27, 2014 and December 28, 2013, a valuation allowance of $33.0  million and $28.1  million, respectively, has been provided based on the Company’s assessment that it is more likely than not, that sufficient taxable income will not be generated to realize the tax benefits of the temporary differences. The valuation allowance increased by approximately $4.9 million and $2.5 million during the years ended December 27, 2014 and December 28, 2013, respectively, primarily related to the increase in the net operating loss carryforward.

 

At December 27, 2014, the Company had approximately $63.6  million of federal net operating loss (“NOL”) carryforwards which begin to expire in year 2029 , and approximately $37.7 million of state net operating loss carryforwards which begin to expire in year 2017 , and federal and state tax credit carryforwards of approximately $1.5  million and $1.6  million, respectively at December 27, 2014.  Federal tax credit carryforwards begin to expire in 2026 and state tax credits carry forward indefinitely.  In addition, the Company has approximately $6.4 million of operating loss carryforwards in the PRC and Taiwan and had $2.0 million of net operating losses expire at the end of the current year.

 

The deferred tax asset at December 27, 2014 does not include approximately $1.6 million and $1.8 million of excess tax benefits from employee stock option exercises that are a component of the federal and state net operating loss carryover, respectively. The Company’s stockholders’ equity balance will be increased if and when such excess tax benefits are ultimately realized.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

United States

 

$

(14,187)

 

$

(9,229)

 

Foreign

 

 

(1,192)

 

 

(1,528)

 

 

 

$

(15,379)

 

$

(10,757)

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Current:

 

 

 

 

 

 

 

Federal

 

$

 -

 

$

 -

 

State

 

 

 

 

 

Total current

 

 

 

 

 

Deferred:

 

 

 

 

 

 

 

Federal

 

 

(4,477)

 

 

(2,849)

 

State

 

 

(771)

 

 

1,071 

 

Foreign

 

 

262 

 

 

(672)

 

Change in valuation allowance

 

 

4,986 

 

 

2,450 

 

Total deferred

 

 

 -

 

 

 -

 

Income tax provision

 

$

 

$

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

U.S. federal statutory tax

 

 

35 

%  

 

35 

%

Valuation allowance

 

 

(30)

 

 

(27)

 

Loss from foreign subsidiary

 

 

(3)

 

 

(5)

 

Other

 

 

(2)

 

 

(3)

 

Effective income tax provision rate

 

 

%   

 

%

 

The Company files tax returns with federal, state and foreign jurisdictions. The Company is no longer subject to IRS or state examinations for periods prior to 2009 although certain carryforward attributes that were generated prior to 2009 may still be adjusted by the IRS.

 

The Company follows the policy to classify accrued interest and penalties as part of the accrued tax liability in the provision for income taxes. For the years ended December 27, 2014 and December 28, 2013, the Company did not recognize any interest or penalties related to unrecognized tax benefits.

 

The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 27, 2014 and December 28, 2013, the Company had no accrued interest and penalties related to uncertain tax matters.

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As of December 27, 2014, the Company had no uncertain tax positions that would be reduced as a result of a lapse of the applicable statute of limitations.

 

Note 7—Commitments and Contingencies

 

Leases

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

 

 

Rental expense, net

 

$

604 

 

$

774 

 

 

A summary of future minimum payments under operating lease commitments as of December 27, 2014 is as follows (in thousands):

 

 

 

 

 

 

 

 

 

Operating

 

Fiscal Year

 

Leases

 

2015

 

$

338 

 

2016

 

 

308 

 

2017

 

 

35 

 

Total minimum lease payments

 

$

681 

 

 

Litigation and Patent Reexaminations

 

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

 

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

 

Google Litigation

 

In May 2008, the Company initiated discussions with Google, Inc. (“Google”) based on information and belief that Google had infringed on a U.S. patent owned by the Company, U.S. Patent No. 7,289,386 (“the ‘386 patent”), which relates generally to technologies to implement rank multiplication in memory modules. Preemptively, Google filed a

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declaratory judgment lawsuit against the Company in the U.S. District Court for the Northern District of California (the “Northern District Court”), seeking a declaration that Google did not infringe the ‘386 patent and that the ‘386 patent was invalid. The Company filed a counterclaim for infringement of the ‘386 patent by Google. Claim construction proceedings were held in November 2009, and the Company prevailed on every disputed claim construction issue. In June 2010, the Company filed motions for summary judgment of patent infringement and dismissal of Google’s affirmative defenses. In May 2010, Google requested and was later granted an Inter Partes Reexamination of the ‘386 patent by the USPTO. The reexamination proceedings are described below. The Northern District Court granted Google’s request to stay the litigation pending result of the reexamination, and therefore has not ruled on the Company’s motions for summary judgment.

 

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

 

Inphi Litigation

 

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

 

SanDisk, Smart Modular, Smart Worldwide, and Diablo Litigations

 

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

 

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

 

On February 7, 2013, Smart Modular filed a response to the Office Action in the reexamination of the ‘295 patent. Thereafter, the Company and Smart Modular made various filings to address certain apparent defects contained in Smart Modular’s response. On March 13, 2013, the USPTO issued a Notice of Defective Paper, in which the USPTO found Smart Modular’s responses, both the initial filing and a supplemental filing, to be improper, and both responses were expunged from the record. The USPTO gave Smart Modular 15 days to submit another response, which Smart Modular submitted on March 26, 2013. The Company timely filed its comments on Smart Modular’s corrected response on April 25, 2013. The USPTO ultimately accepted Smart Modular’s corrected response on July 17, 2013.  On April 29, 2014, the USPTO issued an Action Closing Prosecution (“ACP”), confirming some claims and rejecting others.  Smart Modular filed a response to the ACP on May 29, 2014, and Netlist filed comments related to Smart Modular’s response on June 30, 2014.  Thus, the reexamination of the ‘295 patent remains pending and will continue in accordance with established procedures for reexamination proceedings.

 

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

 

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

 

On August 23, 2013, Netlist filed an amended complaint for patent infringement, antitrust violations and trade secret misappropriation against Smart Modular, Smart Storage Systems (“Smart Storage”), Smart Worldwide Holdings (“Smart Worldwide”) and Diablo Technologies (“Diablo”) in the Central District Court. Smart Storage was acquired by SanDisk Corporation (“SanDisk”) on August 22, 2013.  Netlist’s amended complaint alleges infringement of five Netlist patents by the defendants based on the manufacture and sale of the ULLtraDIMM memory module. Netlist’s complaint also alleges antitrust violations by Smart Modular and Smart Worldwide, contending that Smart Modular procured a patent (U.S. Patent No. 8,250,295) with blatant inequitable conduct at the USPTO, withheld the patent application leading to the patent from relevant JEDEC committees for more than eight years, sought to improperly enforce that patent against Netlist’s JEDEC-compliant HyperCloud® product by seeking a preliminary injunction against Netlist based on the patent, which was denied by the Eastern District Court, and made deceptive statements to the public about its lawsuit against Netlist. Netlist’s complaint also alleges trade secret misappropriation and trademark infringement against Diablo, claiming that Diablo misused Netlist trade secrets to create the ULLtraDIMM product for Smart Storage (now SanDisk), and that Diablo used Netlist’s HyperCloud® technology to create competing products.

 

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

 

In the Central District Court, Smart Modular and Smart Worldwide filed motions on September 13, 2013, to dismiss or sever various counts related to the ‘295 patent. On September 26, 2013, Diablo filed a motion to dismiss Netlist’s claims for trade secret misappropriation, breach of contract, and unfair competition. On October 29, 2013, Smart Modular and Diablo filed motions to dismiss or transfer the patent claims related to the ULLtraDIMM memory module. On November 26, 2013, the Central District Court: (i) severed and transferred the claims related to the ‘295 patent to the Eastern District Court, which were stayed by the Eastern District Court on March 7, 2014, along with the other ‘295 related claims pending results of the ‘295 reexamination; (ii) severed and transferred to the Northern District Court the patent claims related to the ULLtraDIMM memory module; (iii) issued an order to show cause why the

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remaining claims should not also be transferred to the Northern District Court; and (iv) held in abeyance Diablo’s pending motion to dismiss and motion for judgment on the pleadings. The parties filed briefs in response to the order to show cause, and then on December 23, 2013, the Central District Court ordered the remaining claims to be transferred to the Northern District Court. All of the claims from the amended complaint filed on August 23, 2013, in the Central District Court have now been transferred to either the Northern District Court or the Eastern District Court.

 

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

 

On January 21, 2014, Netlist filed a motion for leave to file a second amended answer and counterclaims in the Northern District Court to assert two additional patents, bringing the total to seven patents asserted against the ULLtraDIMM. Diablo did not oppose Netlist’s motion, and the parties filed a joint stipulation and proposed order on February 3, 2014, requesting an additional two months be added to the case schedule to account for the additional patents. On February 5, 2014, the Northern District Court granted Netlist’s motion to add the two patents and entered a new case schedule.  On February 12, 2014, the Northern District Court granted the parties’ joint stipulation dismissing Smart Modular without prejudice.  On April 7, 2014, the Northern District Court granted Netlist’s motion for leave to file a Second Amended Complaint in the patent case.

 

On March 21, 2014, Netlist filed a Second Amended Complaint against Diablo in the Northern District Court, Case No. 4:13-CV-05962 (the “trade secret case”), alleging, among other things, that in stealing Netlist’s proprietary HyperCloud® and DxD and LRD technologies, Diablo breached its contracts with Netlist, committed trademark violations, and misappropriated Netlist’s trade secrets.  Also on March 21, 2014, Netlist served Diablo with its Amended Trade Secret Disclosure, detailing approximately 60 trade secrets Netlist taught to Diablo in connection with the contracted and confidential work on the HyperCloud® project.  On April 9, 2014, Diablo filed a motion to dismiss Netlist’s Second Amended Trade Secret Complaint, as well as a motion for judgment on the pleadings.  That motion was heard by the Northern District Court on May 13, 2014, and on September 4, 2014, denied the motion with respect to all grounds except one, which Netlist did not contest.

 

On April 1, 2014, the Northern District Court denied Diablo’s motion to strike Netlist’s infringement contentions, finding that Netlist’s contentions did indeed satisfy the relevant requirements and, on April 7, 2014, granted Netlist’s motion to compel defendants to produce certain discovery materials related to the ULLtraDIMM.  Diablo filed a motion for relief from these two rulings, which was denied on April 8, 2014.  Also on April 7, 2014, the Northern District Court granted Netlist’s motion for issuance of Letters Rogatory to the Canadian courts requesting that summons be issued for two former Diablo employees living in Canada and named in the whistleblower letter to produce documents and to be deposed.  These depositions occurred in late August 2014.

 

On April 8, 2014, the Northern District Court granted Netlist’s motion to consolidate the patent related cases (Case Nos. 4:13-CV-05889-YGR and 4:13-CV-03901-YGR) and to coordinate discovery with the trade secret case (4:13-CV-05962-YGR), and denied Diablo’s motion to further consolidate the patent and trade secret cases.  On April 15, 2014, the Northern District Court granted the parties’ joint stipulation dismissing Smart Worldwide without prejudice.  On April 30, 2014, the Northern District Court denied Diablo’s request that Netlist’s Amended Trade Secret

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Disclosure and exhibits thereto be re-designated as “Confidential” from the current designation of “Highly Confidential — Attorneys’ Eyes Only”.

 

Between June 18 and June 24, 2014, SanDisk filed petitions in the USPTO requesting Inter Partes Review (“IPR”) of the five Netlist patents asserted in the August 23, 2013 amended complaint.  Diablo similarly filed petitions requesting IPR of the two Netlist patents added in the second amended answer filed on January 21, 2014.  Netlist filed patent owner preliminary responses to all of the petitions associated with the seven asserted Netlist patents.  The USPTO issued decisions on the petitions in December, 2014, denying the petitions in their entirety as to three patents (U.S. Patent Nos. 8,516,187; 8,301,833; 8,516,185), granting a partial institution on one patent (U.S. Patent No. 8,001,434), and instituting a review of all claims in three patents  (U.S. Patent Nos. 7,881,150; 8,081,536; 8,359,501).  Reviews will therefore proceed related to four Netlist patents (U.S. Patent Nos. 8,001,434; 7,881,150; 8,081,536; 8,359,501) in accordance with established procedures.

 

On August 23, 2014, Smart Modular also filed petitions in the USPTO requesting IPR of the five Netlist patents asserted in the August 23, 2013 amended complaint.  Netlist filed patent owner preliminary responses to all of the Smart Modular petitions in December, 2014.  On March 13, 2015, the USPTO issued decisions on the Smart Modular petitions, denying the petitions in their entirety as to the same three patents that survived the petitions filed by SanDisk in June, 2014 (U.S. Patent Nos. 8,516,187; 8,301,833; 8,516,185), and instituted additional reviews of the two other patents already under review (U.S. Patent No. 8,001,434; 8,359,501) that will proceed in accordance with established procedures.

 

SanDisk filed a motion on June 24, 2014, to stay the Northern District patent cases pending completion of the IPRs (Diablo later joined this motion).  Netlist filed its opposition to the motion to stay on July 10, 2014.  The Northern District Court heard oral arguments on the motion to stay in early August 2014, and issued an order on August 21, 2014, denying the motion without prejudice.  SanDisk renewed its motion to stay on January 20, 2015, which is currently being briefed by the parties. 

 

On October 6, 2014, Netlist filed a Motion for Preliminary Injunction in the Northern District Court trade secret suit, asking that Diablo and its partner SanDisk be immediately enjoined from any further manufacture or sale of the ULLtraDIMM module.  The Court granted in part Netlist’s motion on January 6, 2015, and entered a preliminary injunction halting the manufacture, use, sale, or distribution of the Diablo Rush and Bolt chips and any ULLtraDIMM module containing those chips, and advanced the trial date to March 9, 2015 on the trade secret misappropriation, breach of contract, and other related claims (4:13-CV-05962-YGR).  The trial commenced on schedule and continued for two weeks, with closing arguments on March 23, 2015.  Two days later the jury came back with a verdict finding for the defendant on the breach of contract, misappropriation of trade secret and inventorship counts, while finding for Netlist on the trademark and false advertising counts.  After the verdict, the court ordered briefing to determine the effect of the jury verdict on the preliminary injunction entered on July 6, 2015, and set a tentative date of April 10, 2015, to hear oral arguments on this issue.  Remaining post-verdict motions are to be filed within a month of the jury verdict. 

 

SanDisk and Diablo filed motions with the U.S. Court of Appeals for the Federal Circuit appealing the January 6, 2015, preliminary injunction and asking for expedited briefing and a stay of the preliminary injunction during the pendency of the appeals.  The Federal Circuit denied both requests for expedited briefing, denied Diablo’s request for a stay, but granted SanDisk’s narrower request for a stay of the preliminary injunction as to SanDisk’s existing inventory of enjoined products.  SanDisk’s and Diablo’s appeals of the preliminary injunction are proceeding in accordance with established procedures.  Diablo filed additional papers following the jury verdict in the trade secret case asking the Federal Circuit to transfer jurisdiction over the preliminary injunction back to the trial court in conjunction with the briefing ordered by the trial court on the issue of what effect the jury verdict will have on the preliminary injunction.  The Federal Circuit has not yet responded to this request. 

 

On March 25, 2015, a jury returned an unfavorable verdict in the Northern District Court trade secret suit. As a result, Netlist may forfeit the $900,000 bond posted earlier in the litigation.

 

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‘386 Patent Reexamination

 

As noted above, in May 2010, Google requested and was later granted an Inter Partes Reexamination of the ‘386 patent by the USPTO. In October 2010, Smart Modular requested and was later granted an Inter Partes Reexamination of the ‘386 patent. The reexaminations requested by Google and Smart Modular were merged by the USPTO into a single proceeding. In April 2011, a Non-Final Action was issued by the USPTO, rejecting all claims in the patent. In July 2011, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims in view of cited references. Both Google and Smart Modular filed their comments to the Company’s response in October 2011. In October 2012, the USPTO issued an ACP rejecting all 60 claims. The Company filed a response to the ACP on December 3, 2012. On June 21, 2013, the USPTO issued a Right of Appeal Notice (“RAN”) in which the examiner maintained his rejection of the claims. Netlist filed a notice of appeal on July 19, 2013. Google filed a notice of cross-appeal on August 2, 2013, and a cross-appeal brief on October 1, 2013. The Company filed an appeal brief and an amendment canceling some of the remaining claims on October 2, 2013 to further focus the issues on appeal. On February 24, 2014, the examiner entered the amendment canceling claims, withdrew the rejections related to those claims, but otherwise maintained the positions previously set forth in the RAN.  On September 24, 2014, the USPTO set a hearing date of November 19, 2014.  After the hearing, on February 25, 2015, the PTAB issued a decision affirming the Examiner’s rejections of the pending claims.  The Company has until March 25, 2015 to request for rehearing of the PTAB’s decision and can thereafter appeal to the Court of Appeals for the Federal Circuit.  Thus, the reexamination of the ‘386 patent remains pending and will continue in accordance with established procedures for merged reexamination proceedings and judicial appeals therefrom.

 

‘912 Patent Reexamination

 

As noted above, in April 2010, Inphi requested but was later denied an Inter Partes Reexamination of the ‘912 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘912 patent by the USPTO. In September 2010, the USPTO confirmed the patentability of all fifty-one claims of the ‘912 patent. In October 2010, Google and Smart Modular each filed and were later granted requests for reexamination of the ‘912 patent. In February 2011, the USPTO merged the Inphi, Google and Smart Modular ‘912 reexaminations into a single proceeding. In an April 2011 Non-Final Action in the merged reexamination proceeding, the USPTO rejected claims 1-20 and 22-51 and confirmed the patentability of claim 21 of the ‘912 patent. In July 2011, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi, Google, and Smart Modular filed their comments on the Company’s response in August 2011. In October 2011, the USPTO mailed a second Non-Final Action confirming the patentability of twenty claims of the ‘912 patent, including claims that were added in the reexamination process. In January 2012, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Google, Inphi and Smart Modular filed their comments to the Company’s response in February 2012. The USPTO determined that Smart Modular’s comments were defective, and issued a notice to Smart Modular to rectify and resubmit its comments. Smart Modular filed corrected comments and a petition for the USPTO to withdraw the notice in March 2012. The USPTO issued a non-final Office Action on November 13, 2012 maintaining the patentability of many key claims while rejecting some claims that were previously determined to be patentable. The Company filed a response to the Office Action on January 14, 2013. The requesters filed their comments on February 13, 2013.  On March 21, 2014, the USPTO issued an ACP, confirming the patentability of 92 claims and maintaining the rejection of 11 other claims.  On June 18, 2014, the USPTO issued a RAN, maintaining the substantive positions taken by the examiner in the ACP.  Smart Modular, Inphi and Google filed notices of appeal on July 16, July 18 and July 18, 2014, respectively.  Netlist filed a notice of cross-appeal on July 30, 2014.  Smart Modular, Inphi and Google filed their respective appeal briefs on September 16, September 30 and September 30, 2014.  Netlist filed its cross-appeal brief on September 30, 2014.  On January 14, 2015, the examiner maintained his positions previously set forth in the RAN.  The parties filed respective rebuttal briefs in February 2015.  The reexamination of the ‘912 patent remains pending and will continue in accordance with established procedures for merged reexamination proceedings.

 

‘627 Patent Reexamination

 

In September 2011, Smart Modular filed a request for reexamination of U.S. Patent No. 7,864,627 (“the ‘627 patent”) issued to the Company on January 4, 2011. The ‘627 patent is related to the ‘912 patent. In November 2011, the USPTO granted Smart Modular’s request for reexamination of the ‘627 patent and concurrently issued a Non-Final

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Action confirming the patentability of three claims. In February 2012, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Smart Modular filed its comments to the Company’s response in March 2012. The USPTO determined that Smart Modular’s comments were defective and issued a notice in April 2012 to Smart Modular to rectify and resubmit its comments. Smart Modular filed corrected comments and a petition for the USPTO to withdraw the notice in April 2012. The USPTO posted an Office Action on December 19, 2012, confirming one claim and rejecting the rest of the claims in the ‘627 patent. The Company filed a response to the Office Action on March 19, 2013. Smart Modular filed its comments on the Office Action on April 24, 2013. The USPTO issued another Non-Final Office Action on September 26, 2013, withdrawing certain rejections while adopting new rejections for certain of the pending claims. The Company responded to the Non-Final Office Action on November 26, 2013, by amending some of the claims and making arguments as to the validity of the rejected claims. On March 27, 2014, the USPTO issued an ACP, maintaining the claim rejections.  On June 27, 2014, the USPTO issued a RAN, maintaining the substantive positions taken by the examiner in the ACP.  Netlist filed a notice of appeal on July 28, 2014.  On October 14, 2014, the Company filed its appeal brief and, on November 13, 2014, Smart Modular filed its respondent’s brief. The reexamination of the ‘627 patent remains pending and will continue in accordance with established Inter Partes Reexamination procedures.

 

‘537 Patent Reexamination

 

As noted above, in April 2010, Inphi requested and was later denied an Inter Partes Reexamination of the ‘537 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘537 patent by the USPTO. In September 2010, the USPTO issued a Non-Final Action confirming the patentability of four claims. In October 2010, the Company responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi filed its comments on the Company’s response in January 2011. In June 2011, the USPTO issued an ACP, which reconfirmed the patentability of the four claims. In August 2010, the Company responded by amending some of the claims and making arguments as to the validity of the rejected claims. Inphi filed its comments to the Company’s response in September 2011. The USPTO issued a Right of Appeal Notice in February 2012, in which the claim rejections were withdrawn, thus confirming the patentability of all sixty (60) claims in view of all the previously submitted comments by both Inphi and the Company. Inphi filed a notice of appeal in March 2012 followed by an appeal brief in May 2012. In response, the USPTO issued a Notice of Defective Appeal Brief. Inphi filed a corrective appeal brief in late May 2012, and the Company filed its reply brief to the corrected Inphi appeal brief in early July 2012. The examiner responded to Inphi’s corrected appeal brief as well as the Company’s reply brief by Examiner’s Answer on April 16, 2013, in which he maintained his position confirming all sixty (60) claims. Inphi filed a rebuttal brief on May 16, 2013. Netlist filed a request for oral hearing on June 14, 2013. The Company and the examiner jointly defended the ‘537 patent in a hearing on November 20, 2013 before the Patent Trial and Appeal Board (“PTAB”) at the USPTO. On January 16, 2014, the PTAB issued a decision upholding the validity of all 60 claims, dismissing every single validity challenge raised by Inphi and affirming the examiner’s decision to allow the claims. On August 13, 2014, the PTAB denied Inphi’s request for rehearing and made its decision final for judicial review to Court of Appeals for the Federal Circuit (“CAFC”).  On October 15, 2014, Inphi filed a Notice of Appeal to the CAFC.  On February 3, 2015, Inphi filed an appellant’s brief in its appeal to the CAFC.  The reexamination of the ‘537 patent remains pending and will continue in accordance with established procedures for Inter Partes Reexamination and judicial appeals therefrom.

 

‘274 Patent Reexamination

 

As noted above, in April 2010, Inphi requested and was later denied an Inter Partes Reexamination of the ‘274 patent by the USPTO. In June 2010, Inphi submitted a new request and was later granted an Inter Partes Reexamination of the ‘274 patent by the USPTO. In September 2011, the USPTO issued a Non-Final Action, confirming the patentability of six claims. The Company has responded by amending or canceling some of the claims, adding new claims, and making arguments as to the validity of the rejected claims. Inphi filed its comments on the Company’s response in November 2011. The USPTO issued an ACP in March 2012, which confirmed the patentability of one hundred and four ( 104 ) claims in view of all the previously submitted comments by both Inphi and the Company. The USPTO subsequently issued a RAN in June 2012. This RAN triggered Inphi’s right as the losing party to file a notice of appeal and corresponding appeal brief, which Inphi filed when due. The Company responded to Inphi’s appeal brief by filing a reply brief in October 2012. The examiner responded to Inphi’s appeal brief and the reply brief by Examiner’s Answer on April 16, 2013, in which he maintained his position confirming the one hundred and four (104) claims. Inphi

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filed a rebuttal brief on May 16, 2013. Netlist filed a request for oral hearing on June 14, 2013. The Company and the USPTO examiner jointly defended the ‘274 patent in a hearing on November 20, 2013 before the PTAB, in accordance with established procedures for Inter Partes Reexamination. On January 16, 2014, the PTAB issued a decision affirming the examiner in part, but reversing the examiner on new grounds and rejecting the one hundred and four (104) claims.  On March 28, 2014, Netlist filed a Patent Owner’s Response Requesting to Reopen Prosecution along with certain claim amendments and arguments.  On June 26, 2014, the PTAB issued a decision granting-in-part Inphi’s request to modify the January 16, 2014, decision as to two of the rejected claims. The reexamination of the ‘274 patent remains pending and will continue in accordance with established procedures for Inter Partes Reexamination.

 

Other Contingent Obligations

 

During its normal course of business, the Company has made certain indemnities, commitments and guarantees pursuant to which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company’s customers and licensees in connection with the use, sales and/or license of Company products; (ii) indemnities to vendors and service providers pertaining to claims based on the Company’s negligence or willful misconduct; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware; (v) indemnities to Fortress Credit Opportunities I IP, successor to DBD Credit Funding LLC, and SVB pertaining to all obligations, demands, claims, and liabilities claimed or asserted by any other party in connection with transactions contemplated by the loan documents; and (vi) 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.

 

Note  8 —Stockholders’ Equity

 

Serial Preferred Stock

 

The Company’s authorized capital includes 10,000,000 shares of Serial Preferred Stock, with a par value of $0.001 per share.  No shares were outstanding at December 27, 2014 or December 28, 2013.

 

Common Stock

 

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

 

On July 17, 2013, the Company entered into a definitive securities purchase agreement for the sale of common stock and warrants in a registered public offering (“2013 Offering”) of its securities for gross proceeds of $1.0 million.  The 2013 Offering closed on July 19, 2013, and the Company received net proceeds of $960,000 after deducting commissions and offering costs.  The 2013 Offering resulted in the issuance 1,098,902 shares of the Company’s common stock and a warrant to purchase up to an aggregate of 1,098,902 shares of the Company’s common stock. The warrant is exercisable as of the date of its issuance, has a term of seven years, and an exercise price of $1.00 per share.  The exercise price and the number of warrant shares issuable upon exercise of warrant is subject to adjustment in the event of, among other things, certain transactions affecting the Company’s common stock (including without limitation stock splits and stock dividends), and certain fundamental transactions (including without limitation a merger or other sale-of-company transaction).  On February 3, 2014, the Company issued 750,000 shares of common stock upon exercise of such warrants at a purchase price of $0.89 per share, resulting in proceeds to the Company of $667,500 .

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Sale of Common Stock Pursuant to Securities Purchase Agreement s

 

On February 11, 2014, the Company completed the 2014 Offering of shares of the Company’s common stock. In the 2014 Offering, the Company issued and sold to Underwriter 8,680,775 shares of common stock pursuant to an underwriting agreement, dated as of February 6, 2014, by and between the Company and the Underwriter, at a price of $1.2115 per share, including 1,132,275 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of Common Stock to cover over-allotments. The price per share to the public in the 2014 Offering was $1.30 per share. The net proceeds from the 2014 Offering were approximately $10.3  million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

On February 24, 2015, the Company completed the 2015 Offering of shares of the Company’s common stock. In the 2015 Offering, the Company issued and sold to the Underwriter 8,846,154 shares of common stock pursuant to an underwriting agreement, dated as of February 19, 2015, by and between the Company and the Underwriter, at a price of $1.209   per share, including 1,153,846 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of Common Stock to cover over-allotments. The price per share to the public in the 2015 Offering was $1.30 per share. The net proceeds from the 2015 Offering were approximately $10.4  million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

Cancellation of Shares of Common Stock

 

During the fiscal years ended December 27, 2014 and December 28, 2013, the Company cancelled 10,015 and 19,575 shares of common stock, respectively, valued at approximately $21,000 and $14,000 , respectively, in connection with its obligation to holders of restricted stock to withhold the number of shares required to satisfy the holders’ tax liabilities in connection with the vesting of such shares.

 

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

 

Stock-Based Compensation

 

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

 

Subject to certain adjustments, as of December 27, 2014, the Company was authorized to issue a maximum of 7,805,566 shares of common stock pursuant to awards under the 2006 Plan. That maximum number will automatically increase on the first day of each subsequent calendar year by the lesser of (i)  5.0% of the number of shares of common stock that are issued and outstanding as of the first day of the calendar year, and (ii)  1,200,000 shares of common stock, subject to adjustment for certain corporate actions. At December 27, 2014, the Company had 244,698 shares available for grant under the 2006 Plan.  Options granted under the 2000 Plan and the 2006 Plan equity incentive plans primarily vest at a rate of at least 25% per year over four years and expire 10  years from the date of grant. Restricted stock awards vest in eight equal increments at intervals of approximately six months from the date of grant.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

 

 

Weighted-

 

Remaining

 

Aggregate

 

 

 

Number   of

 

Average

 

Contractual

 

Intrinsic

 

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Shares

 

Exercise

 

Life

 

Value

 

 

    

(in thousands)

    

Price

    

(in years)

    

(in thousands)

 

Options outstanding - December 29, 2012

 

 

4,752 

 

$

3.22 

 

 

 

 

 

 

 

Options granted

 

 

2,080 

 

 

0.77 

 

 

 

 

 

 

 

Options exercised

 

 

(118)

 

 

0.34 

 

 

 

 

 

 

 

Options cancelled

 

 

(877)

 

 

2.05 

 

 

 

 

 

 

 

Options outstanding - December 28, 2013

 

 

5,837 

 

 

2.58 

 

 

 

 

 

 

 

Options granted

 

 

2,115 

 

 

1.46 

 

 

 

 

 

 

 

Options exercised

 

 

(303)

 

 

0.51 

 

 

 

 

 

 

 

Options cancelled

 

 

(415)

 

 

1.57 

 

 

 

 

 

 

 

Options outstanding - December 27, 2014

 

 

7,234 

 

$

2.40 

 

 

6.3 

 

$

81 

 

Options exercisable - December 27, 2014

 

 

4,353 

 

$

3.03 

 

 

4.8 

 

$

73 

 

Options exercisable and expected to vest - December 27, 2014

 

 

6,802 

 

$

2.47 

 

 

4.8 

 

$

80 

 

 

The following table summarizes information about stock options outstanding and exercisable at December 27, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding

 

Options Exercisable

 

 

 

 

 

Weighted

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

 

Remaining

 

Weighted

 

 

 

Remaining

 

Weighted

 

 

 

Number   of

 

Contractual

 

Average

 

Number of

 

Contractual

 

Average

 

 

 

shares

 

Life

 

Exercise

 

shares

 

Life

 

Exercise

 

Exercise Price Range

    

(in thousands)

    

(in years)

    

Price

    

(in thousands)

    

(in years)

    

Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.20 - $1.00

 

2,328 

 

8.2 

 

$

0.74 

 

836 

 

7.2 

 

$

0.67 

 

$1.01 - $3.00

 

3,171 

 

6.2 

 

$

2.00 

 

2,015 

 

4.8 

 

$

2.11 

 

$3.01 - $5.00

 

840 

 

6.7 

 

$

3.57 

 

607 

 

6.5 

 

$

3.55 

 

$5.01 - $8.45

 

895 

 

1.6 

 

$

7.01 

 

895 

 

1.8 

 

$

7.01 

 

 

 

7,234 

 

6.3 

 

$

2.40 

 

4,353 

 

4.8 

 

$

3.03 

 

 

A summary of the Company’s restricted stock awards is presented below (shares in thousands):

 

 

 

 

 

 

 

 

 

 

 

Restricted Stock Outstanding

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

Average

 

 

 

 

 

 

Grant-Date

 

 

 

Number   of

 

Fair Value

 

 

    

Shares

    

per Share

 

Balance outstanding at December 29, 2012

 

 

158 

 

$

3.32 

 

Restricted stock granted

 

 

 -

 

 

 -

 

Restricted stock vested

 

 

(95)

 

 

3.39 

 

Restricted stock forfeited

 

 

(9)

 

 

3.49 

 

Balance outstanding at December 28, 2013

 

 

54 

 

$

3.17 

 

Restricted stock granted

 

 

 -

 

 

 -

 

Restricted stock vested

 

 

(50)

 

 

3.30 

 

Restricted stock forfeited

 

 

(2)

 

 

1.51 

 

Balance outstanding at December 27, 2014

 

 

 

$

1.51 

 

 

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The following table presents details of the assumptions used to calculate the weighted-average grant date fair value of common stock options granted by the Company:

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

Expected term (in years)

 

 

6.3 

 

 

6.4 

 

Expected volatility

 

 

124 

%

 

119 

%

Risk-free interest rate

 

 

1.86 

%

 

1.38 

%

Expected dividends

 

 

 -

 

 

 -

 

Weighted-average grant date fair value per share

 

$

1.29 

 

$

0.68 

 

Grant date fair value of options vested

 

$

1,842 

 

$

1,355 

 

Intrinsic value of options exercised (in thousands)

 

$

410 

 

$

46 

 

 

At December 27, 2014, the amount of unearned stock-based compensation currently estimated to be expensed from 201 5 through 201 7 related to unvested common stock options and restricted stock awards is approximately $2. 8 million, net of estimated forfeitures. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 2. 5   years. If there are any modifications or cancellations of the underlying unvested awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense or calculate and record additional expense.  Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional common stock options or other stock-based awards.

 

Concurrently with the execution of the Loan Agreement (see Note 4), the Company issued to Fortress as successor to an affiliate of DBD, a seven-year warrant (the “Warrant”) to purchase an aggregate of 1,648,351 shares of the Company’s common stock at an exercise price of $1.00 per share, of which all warrants are exercisable, as amended, on a cash or cashless basis in whole or in part. The Warrant was issued in a private placement transaction that was exempt from registration under Section 4(2) of the Securities Act of 1933 (the “Securities Act”).  In connection with the amendment to the Loan Agreement on February 17, 2015, we cancelled the Warrant and issued a new warrant in substantially the same form. The Company accounted for the warrants as a debt discount and has valued them based on the relative fair value of approximately $1,215,000 , to be amortized over the term of the debt instrument, or three years, using the effective interest method.  For the years ended December 27, 2014 and December 28, 2013, the Company amortized approximately $487,000 and $203,000 respectively, as interest expense in the consolidated statements of operations.

 

A summary of the warrant activity is presented below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

Number of

 

Average

 

 

 

Shares

 

Exercise

 

 

    

(in thousands)

    

Price

 

Warrants outstanding - December 29, 2012

 

 

2,275 

 

$

0.89 

 

Warrant granted

 

 

2,748 

 

 

1.00 

 

Warrants exercised

 

 

 -

 

 

 -

 

Warrants outstanding - December 28, 2013

 

 

5,023 

 

$

0.95 

 

 

 

 

 

 

 

 

 

Warrant granted

 

 

 -

 

 

 -

 

Warrants exercised

 

 

(750)

 

 

0.89 

 

Warrants outstanding - December 27, 2014

 

 

4,273 

 

$

0.96 

 

 

 

Note  9 —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

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the plan subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions and investment earnings. The Company may make matching contributions on the contributions of a participant on a discretionary basis. In fiscal 2012, the Company adopted a limited matching contribution policy and made approximately $ 0 .08   and $0.07 million in contributions to participants in this plan in the year s ended December 27, 2014 and December 28, 2013, respectively.

 

Note 1 0 —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 net sales as follows:

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

Customer A

 

20 

%

45 

%

Customer B

 

14 

%

15 

%

Customer C

 

19 

%

*

%

 


*        less than 10% of total net sales

 

Sales of the Company’s NVvault™ products represented 44 % and 39 % of net sales in 201 4   and 2013 .  

The Company’s accounts receivable are concentrated with three customer s at December 27, 2014 representing approximately 13 % ,   49% and 11% of aggregate gross receivables. At December 28, 2013,   one customer represented approximately 73 % 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 mitigates risk with foreign receivables by purchasing comprehensive foreign credit insurance.

 

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:

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

December 27,

 

December 28,

 

 

    

2014

    

2013

 

 

 

 

 

 

 

Supplier A

 

*

%  

12 

%

Supplier B

 

*

%  

13 

%

Supplier C

 

10 

%

*

 

 


*        less than 10% of total purchases

 

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  11 —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.

 

To date, a majority of the Company’s international sales relate to shipments of products to its U.S. customers’ international manufacturing sites or third ‑ party hubs. Net sales derived from shipments to international destinations, primarily to Hong Kong (including foreign subsidiaries of customers that are headquartered in the U.S.), represented approximately 33 % and 58 % of the Company’s net sales in 201 4 and 201 3 , respectively. All of the Company’s net sales to date have been denominated in U.S. dollars.

F- 33


 

Table of Contents

 

As of December 27, 2014 and December 28, 2013, approximately $0. 2 million and $ 0.6  million, respectively, of the Company’s long-lived assets, net of depreciation and amortization, were located outside the U.S., primarily in the PRC. Substantially all other long-lived assets were located in the U.S.

 

Note 1 2 —Subsequent Events

 

The Company has evaluated subsequent events through the filing date of this Annual Report on Form 10-K and determined that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosures in the notes thereto other than as discussed in the accompanying notes.

 

On February 24, 2015, the Company completed a registered firm commitment underwritten public offering  of shares of the Company’s common stock. In the 2015 Offering, the Company issued and sold to the Underwriter 8,846,154 shares of common stock pursuant to an underwriting agreement, dated as of February 19, 2015, by and between the Company and the Underwriter, at a price of $1.209   per share, including 1,153,846 shares resulting from the Underwriter’s exercise in full of its option to purchase additional shares of Common Stock to cover over-allotments. The price per share to the public in the 2015 Offering was $1.30 per share. The net proceeds from the 2015 Offering were approximately $10.4  million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

On February 17, 2015, the Loan Agreement with Fortress Credit Opportunities I LP, was amended to accelerate the availability of the term loan and the Company borrowed the remaining $4 million in term loans (see note 4).

 

Note 13—Quarterly Summary (Unaudited, in thousands except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

December 27,

 

September 27,

 

June 28,

 

March 29,

 

 

    

2014

    

2014

    

2014

    

2014

 

Net sales

 

$

2,516 

 

$

4,791 

 

$

4,887 

 

$

7,001 

 

Cost of sales

 

 

2,629 

 

 

3,678 

 

 

3,908 

 

 

5,016 

 

Gross profit (loss)

 

 

(113)

 

 

1,113 

 

 

979 

 

 

1,985 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

1,280 

 

 

1,445 

 

 

1,232 

 

 

878 

 

Intellectual property legal fees

 

 

2,419 

 

 

1,552 

 

 

1,070 

 

 

1,097 

 

Selling, general and administrative

 

 

1,611 

 

 

1,782 

 

 

1,781 

 

 

1,622 

 

Total operating expenses

 

 

5,310 

 

 

4,779 

 

 

4,083 

 

 

3,597 

 

Operating loss

 

 

(5,423)

 

 

(3,666)

 

 

(3,104)

 

 

(1,612)

 

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(393)

 

 

(393)

 

 

(393)

 

 

(395)

 

Other income (expense), net

 

 

 

 

 -

 

 

 

 

(11)

 

Total other expense, net

 

 

(388)

 

 

(393)

 

 

(387)

 

 

(406)

 

Loss before provision for income taxes

 

 

(5,811)

 

 

(4,059)

 

 

(3,491)

 

 

(2,018)

 

Provision for income taxes

 

 

 -

 

 

 -

 

 

 

 

 -

 

Net loss

 

$

(5,811)

 

$

(4,059)

 

$

(3,493)

 

$

(2,018)

 

Net loss per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

$

(0.14)

 

$

(0.10)

 

$

(0.08)

 

$

(0.05)

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

41,483 

 

 

41,472 

 

 

41,472 

 

 

36,881 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

December   28,

 

September 28,

 

June 29,

 

March 30,

 

 

    

2013

    

2013

    

2013

    

2013

 

Net sales

 

$

7,730 

 

$

4,289 

 

$

5,065 

 

$

5,964 

 

Cost of sales

 

 

5,831 

 

 

3,896 

 

 

4,818 

 

 

5,398 

 

Gross profit

 

 

1,899 

 

 

393 

 

 

247 

 

 

566 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

F- 34


 

Table of Contents

Research and development

 

 

938 

 

 

1,119 

 

 

1,070 

 

 

1,441 

 

Intellectual property legal fees

 

 

804 

 

 

522 

 

 

387 

 

 

402 

 

Selling, general and administrative

 

 

1,387 

 

 

1,554 

 

 

1,571 

 

 

1,755 

 

Total operating expenses

 

 

3,129 

 

 

3,195 

 

 

3,028 

 

 

3,598 

 

Operating loss

 

 

(1,230)

 

 

(2,802)

 

 

(2,781)

 

 

(3,032)

 

Other expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(390)

 

 

(324)

 

 

(88)

 

 

(130)

 

Other income (expense), net

 

 

28 

 

 

(8)

 

 

 

 

(7)

 

Total other expense, net

 

 

(362)

 

 

(332)

 

 

(81)

 

 

(137)

 

Loss before provision for income taxes

 

 

(1,592)

 

 

(3,134)

 

 

(2,862)

 

 

(3,169)

 

Provision for income taxes

 

 

 -

 

 

 

 

 

 

 

Net loss

 

$

(1,592)

 

$

(3,141)

 

$

(2,863)

 

$

(3,170)

 

Net loss per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

$

(0.05)

 

$

(0.10)

 

$

(0.09)

 

$

(0.10)

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

31,752 

 

 

31,268 

 

 

30,320 

 

 

30,205 

 

 

Each of the Company’s quarters in fiscal 2014 and 2013 is comprised of 13 weeks.

 

Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with the per share amounts for the year.

F- 35


Exhibit 10.24

 

A mendment to Loan DOCUMENTS

 

THIS AMENDMENT to Loan Documents (this   “Amendment”) is entered into as of September 30, 2014, by and between Silicon Valley Bank (“Bank” or “Silicon”) and NETLIST, INC., a Delaware corporation (“Borrower”).  Borrower’s chief executive office is located at 175 Technology Drive, Suite 150, Irvine, CA 92618.

 

R ECITALS

 

A. Bank and Borrower are parties to that certain Loan and Security Agreement with an Effective Date of October 31, 2009 (as amended, modified, supplemented or restated, the “Loan Agreement”) in effect between Bank and Borrower.

 

B. Bank has extended credit to Borrower for the purposes permitted in the Loan Agreement.

 

C. Bank has agreed to so amend the Loan Agreement, but only to the extent, in accordance with the terms, subject to the conditions and in reliance upon the representations and warranties set forth below.

 

AGREEMENT

 

Now, Therefore, in consideration of the foregoing recitals and other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, and intending to be legally bound, the parties hereto agree as follows:

 

1. Definitions.  Capitalized terms used but not defined in this Amendment shall have the meanings given to them in the Loan Agreement.

 

2. Amendments to Loan Documents.  The Loan Agreement is amended as follows, effective on the date hereof (except where a different effective date is specified below):

 

2.1 Modified Anniversary Fee.  Section 2.4(g) of the Loan Agreement is hereby amended in its entirety to read as follows

 

(g) Anniversary Fee .  [Omitted].

 

2.2 Modified Tangible Net Worth Financial Covenant.  Section 6.9(b) of the Loan Agreement is hereby amended in its entirety to read as follows:

 

(b) Tangible Net Worth .  A Tangible Net Worth of at least $ 3,000,000 (“Minimum Tangible Net Worth”) plus (i) 50% of all consideration received after the date hereof for equity securities and subordinated debt of the Borrower, plus (ii) 50% of the Borrower’s net income in each fiscal quarter ending after the date hereof.  Increases in the Minimum Tangible Net Worth based on consideration received for equity securities and subordinated debt of the Borrower shall be effective as of the end of the month in which such consideration is received, and shall continue effective thereafter. Increases in the Minimum Tangible Net Worth based on net income shall be effective on the last day of the fiscal quarter in which said net income is realized, and shall continue effective thereafter. In no event shall the Minimum Tangible Net Worth be decreased.

 

1


 

 

2.3 Modified Termination Fee. Section 12.1 of the Loan Agreement is hereby amended in its entirety to read as follows:

 

12.1 Termination Prior to Revolving Line Maturity Date .   On the Revolving Line Maturity Date or on any earlier effective date of termination, Borrower shall pay and perform in full all Obligations, whether evidenced by installment notes or otherwise, and whether or not all or any part of such Obligations are otherwise then due and payable.  This Agreement may be terminated prior to the Revolving Line Maturity Date by Borrower, effective three (3) Business Days after written notice of termination is given to Bank.  Notwithstanding any such termination, Bank’s lien and security interest in the Collateral and all of Bank’s rights and remedies under this A g reement shall continue until Borrower fully satisfies its Obligations . If such termination is at Borrower’s election, or at Bank’s election due to the occurrence and continuance of an Event of Default, Borrower shall pay to Bank, in addition to the payment of any other expenses or fees then-owing, a termination fee in an amount equal to 1.0% of the Maximum Revolver Amount; provided that no termination fee shall be charged if the credit facility hereunder is replaced with a new facility from another division of Silicon Valley Bank. 

 

2.4 Modified Definition of Revolving Line Maturity Date.  The definition of Revolving Line Maturity Date set forth in Section 13.1 of the Loan Agreement is hereby amended in its entirety to read as follows:

 

Revolving Line Maturity Date ” September 29, 2015.

 

2.5 Modified Exhibit B.  Exhibit B to the Loan Agreement is hereby amended in its entirety to read as set forth in Exhibit B attached hereto.

 

3. Limitation of Amendments.

 

3.1 The amendments set forth in Section 2 , above, are effective for the purposes set forth herein and shall be limited precisely as written and shall not be deemed to (a) be a consent to any amendment, waiver or modification of any other term or condition of any Loan Document, or (b) otherwise prejudice any right or remedy which Bank may now have or may have in the future under or in connection with any Loan Document.

 

3.2 This Amendment shall be construed in connection with and as part of the Loan Documents and all terms, conditions, representations, warranties, covenants and agreements set forth in the Loan Documents (as amended by this Amendment, as applicable) are hereby ratified and confirmed and shall remain in full force and effect.

 

4. Representations and Warranties.  To induce Bank to enter into this Amendment, Borrower hereby represents and warrants to Bank as follows:

 

4.1 Immediately after giving effect to this Amendment, (a) the representations and warranties contained in the Loan Documents are true, accurate and complete in all material respects as of the date hereof (except to the extent such representations and warranties relate to an earlier date, in which case they are true and correct as of such date, or except as otherwise previously disclosed in writing by Borrower to Bank), and (b) no Event of Default has occurred and is continuing;

 

4.2 Borrower has the power and authority to execute and deliver this Amendment and to perform its obligations under the Loan Documents, as amended by this Amendment;

2


 

 

4.3 The organizational documents of Borrower delivered to Bank on the Effective Date remain true, accurate and complete and have not been otherwise amended, supplemented or restated and are and continue to be in full force and effect;

 

4.4 The execution and delivery by Borrower of this Amendment and the performance by Borrower of its obligations under the Loan Documents, as amended by this Amendment, have been duly authorized;

 

4.5 The execution and delivery by Borrower of this Amendment and the performance by Borrower of its obligations under the Loan Documents, as amended by this Amendment, do not and will not contravene (a) any law or regulation binding on or affecting Borrower, (b) any contractual restriction with a Person binding on Borrower, (c) any order, judgment or decree of any court or other governmental or public body or authority, or subdivision thereof, binding on Borrower, or (d) the organizational documents of Borrower;

 

4.6 The execution and delivery by Borrower of this Amendment and the performance by Borrower of its obligations under the Loan Documents, as amended by this Amendment, do not require any order, consent, approval, license, authorization or validation of, or filing, recording or registration with, or exemption by any governmental or public body or authority, or subdivision thereof, binding on either Borrower, except as already has been obtained or made; and

 

4.7 This Amendment has been duly executed and delivered by Borrower and is the binding obligation of Borrower, enforceable against Borrower in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, liquidation, moratorium or other similar laws of general application and equitable principles relating to or affecting creditors’ rights.

 

5.

Release by Borrower .  Borrower hereby agree as follows:

 

5.1 FOR GOOD AND VALUABLE CONSIDERATION , Borrower hereby forever relieves, releases, and discharges Bank and its present or former employees, officers, directors, agents, representatives, attorneys, and each of them, from any and all claims, debts, liabilities, demands, obligations, promises, acts, agreements, costs and expenses, actions and causes of action, of every type, kind, nature, description or character whatsoever, whether known or unknown, suspected or unsuspected, absolute or contingent, arising out of or in any manner whatsoever connected with or related to facts, circumstances, issues, controversies or claims existing or arising from the beginning of time through and including the date of execution of this Amendment (collectively “ Released Claims ”).  Without limiting the foregoing, the Released Claims shall include any and all liabilities or claims arising out of or in any manner whatsoever connected with or related to the Loan Documents, the Recitals hereto, any instruments, agreements or documents executed in connection with any of the foregoing or the origination, negotiation, administration, servicing and/or enforcement of any of the foregoing.

 

5.2 In furtherance of this release, Borrower expressly acknowledges and waives any and all rights under Section 1542 of the California Civil Code, which provides as follows:

 

“A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR EXPECT TO EXIST IN HIS OR HER FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM OR HER MUST HAVE MATERIALLY AFFECTED HIS OR HER SETTLEMENT WITH THE DEBTOR.” (Emphasis added.)

 

5.3 By entering into this release, Borrower recognizes that no facts or representations are ever absolutely certain and it may hereafter discover facts in addition to or different from those which it presently knows or believes to be true, but that it is the intention of Borrower hereby to fully, finally and forever settle and release all matters, disputes and differences, known or unknown,

3


 

suspected or unsuspected; accordingly, if Borrower should subsequently discover that any fact that it relied upon in entering into this release was untrue, or that any understanding of the facts was incorrect, Borrower shall not be entitled to set aside this release by reason thereof, regardless of any claim of mistake of fact or law or any other circumstances whatsoever. Borrower acknowledges that it is not relying upon and has not relied upon any representation or statement made by Bank with respect to the facts underlying this release or with regard to any of such party’s rights or asserted rights.

 

5.4 This release may be pleaded as a full and complete defense and/or as a cross-complaint or counterclaim against any action, suit, or other proceeding that may be instituted, prosecuted or attempted in breach of this release. Borrower acknowledges that the release contained herein constitutes a material inducement to Bank to enter into this Amendment, and that Bank would not have done so but for Bank’s expectation that such release is valid and enforceable in all events.

 

5.5 Borrower hereby represents and warrants to Bank, and Bank is relying thereon, as follows:

 

(a) Except as expressly stated in this Amendment, neither Bank nor any agent, employee or representative of Bank has made any statement or representation to Borrower regarding any fact relied upon by Borrower in entering into this Amendment.

 

(b) Borrower has made such investigation of the facts pertaining to this Amendment and all of the matters appertaining thereto, as it deems necessary.

 

(c) The terms of this Amendment are contractual and not a mere recital. 

 

(d) This Amendment has been carefully read by Borrower, the contents hereof are known and understood by Borrower, and this Amendment is signed freely, and without duress, by Borrower. 

 

(e) Borrower represents and warrants that it is the sole and lawful owner of all right, title and interest in and to every claim and every other matter which it releases herein, and that it has not heretofore assigned or transferred, or purported to assign or transfer, to any person, firm or entity any claims or other matters herein released. Borrower shall indemnify Bank, defend and hold it harmless from and against all claims based upon or arising in connection with prior assignments or purported assignments or transfers of any claims or matters released herein.

 

6. Bank Expenses.  Borrower shall pay to Bank, when due, all Bank Expenses (including reasonable attorneys’ fees and expenses), when due, incurred in connection with or pursuant to this Amendment .

 

7. Counterparts.  This Amendment may be executed in any number of counterparts and all of such counterparts taken together shall be deemed to constitute one and the same instrument.

 

8. Effectiveness .  This Amendment shall be deemed effective upon (a) the due execution and delivery to Bank of this Amendment by each party hereto and (b) Borrower’s payment of an amendment fee in an amount equal to $25,000.  The above-mentioned fee shall be fully earned and payable concurrently with the execution and delivery of this Amendment and shall be non-refundable and in addition to all interest and other fees payable to Bank under the Loan Documents.  Bank is authorized to charge such fees to Borrower’s loan account. 

 

[Remainder of page intentionally left blank; signature page immediately follows.]

 

4


 

In Witness Whereof,   the parties hereto have caused this Amendment to be duly executed and delivered as of the date first written above.

 

 

 

 

 

 

 

 

 

 

 

BANK

 

BORROWER

 

 

 

 

 

Silicon Valley Bank

 

Netlist, Inc.

 

 

 

 

 

 

 

 

 

 

By:

/s/ Brian Lowry

 

By:

/s/ Gail M. Sasaki

Name:

Brian Lowry

 

Name:

Gail Sasaki

Title:

Vice President

 

Title:

CFO, Vice President

 

 


 

EXHIBIT B

 

COMPLIANCE CERTIFICATE

 

 

 

 

 

TO:       SILICON VALLEY BANK

Date:                                               

FROM:       NETLIST, INC.

 

 

The undersigned authorized officer of NETLIST, INC. (“Borrower”) certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”), (1) Borrower is in complete compliance for the period ending _______________ with all required covenants except as noted below, (2) there are no Events of Default, (3) all representations and warranties in the Agreement are true and correct in all material respects on this date except as noted below; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date , (4) Borrower, and each of its Subsidiaries, has timely filed all required tax returns and reports, and Borrower has timely paid all foreign, federal, state and local taxes, assessments, deposits and contributions owed by Borrower except as otherwise permitted pursuant to the terms of Section 5.9 of the Agreement, and (5) no Liens have been levied or claims made against Borrower or any of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has not previously provided written notification to Bank.  Attached are the required documents supporting the certification.  The undersigned certifies that these are prepared in accordance with GAAP consistently applied from one period to the next except as explained in an accompanying letter or footnotes.  The undersigned acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and that compliance is determined not just at the date this certificate is delivered.  Capitalized terms used but not otherwise defined herein shall have the meanings given them in the Agreement.

 

Please indicate compliance status by circling Yes/No under “Complies” column.

 

 

 

 

 

 

 

Reporting Covenant

Required

Complies

 

 

 

Monthly financial statements with Compliance Certificate

Monthly within 30 days

Yes   No

Annual financial statement (CPA Audited)

Concurrently with Form 10-K

Yes   No

10 ‑Q, 10 ‑K and 8-K

Within 5 days after filing with SEC

Yes   No

Annual Projections

Within 30 days of start of FYE

Yes   No

A/R & A/P Agings; Deferred Revenue Report

Monthly within 20 days

Yes   No

Transaction Reports

(i) if no Credit Extensions outstanding, monthly ( within twenty (20) days after the end of each month ) and at the time of each request for an Advance; and (ii) if Credit Extensions outstanding, weekly and at the time of each request for an Advance

Yes   No

 

The following intellectual property was registered after the Effective Date (if no registrations, state “None”)

____________________________________________________________________________

 

 

 

 

 

 

 

 

 

 

 

Financial Covenant

Required

Actual

Complies

 

 

 

 

Maintain on a Monthly Basis:

 

 

 

Minimum Adjusted Quick Ratio

1.00 : 1.00

         : 1.00

Yes   No

Minimum Tangible Net Worth

$3,000,000 plus (i) 50% of new equity and sub debt plus (ii) 50% of quarterly net income.

$             

Yes   No

 

 


 

 

The following financial covenant analysis and information set forth in Schedule 1 attached hereto are true and accurate as of the date of this Certificate.

 

The following are the exceptions with respect to the certification above:  (If no exceptions exist, state “No exceptions to note.”)

 

--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

 

 

 

 

 

 

 

 

 

 

 

 

 

NETLIST, INC.

 

BANK USE ONLY

 

 

 

 

 

 

 

Received by:

 

 

By:

 

 

authorized signer

 

Name:

 

 

Date:

 

 

Title:

 

 

 

 

 

 

 

Verified:

 

 

 

 

authorized signer

 

 

 

Date:

 

 

 

 

 

 

 

 

 

Compliance Status:                  Yes     No       

 

 

 


 

 

Schedule 1 to Compliance Certificate

 

Financial Covenants of Borrower

 

In the event of a conflict between this Schedule and the Loan Agreement, the terms of the Loan Agreement shall govern.

 

Dated:                       

 

I. Adjusted Quick Ratio (Section 6.9(a))

 

Required: 1.00 : 1.00

 

 

 

 

 

 

 

 

 

 

 

Actual:

    

 

 

 

 

 

 

A.

Borrower’s cash and Cash Equivalents that are unencumbered (except for Bank’s security interest) and unrestricted

 

             

 

 

 

 

B.

Aggregate net amount of Borrower’s Eligible Accounts

 

           

 

 

 

 

C.

Sum of line A plus line B

 

           

 

 

 

 

D.

Current Liabilities

 

           

 

 

 

 

E.

Adjusted Quick Ratio (line C divided by line D)

 

            : 1.00

 

 

 

 

Is line F equal to or greater than 1.00 : 1.00 ?

 

 

 

 

 

 

 

         No, not in compliance

          Yes, in compliance

    

 

 

[continued on next page]

 

 


 

 

II. Minimum Tangible Net Worth (Section 6.9(b))

 

Required Amount: $3,000,000 plus (i) 50% of consideration for equity securities and subordinated debt plus (ii) 50% of Borrower’s quarterly net income.

 

 

 

 

 

 

 

 

 

 

Actual:

 

 

 

 

 

 

 

A.

Aggregate value of total assets of Borrower and its Subsidiaries

 

           

 

 

 

 

B.

Aggregate value of goodwill of Borrower and its Subsidiaries

 

           

 

 

 

 

C.

Aggregate value of intangible assets of Borrower and its Subsidiaries

 

           

 

 

 

 

D.

Aggregate value of investments of Borrower and its Subsidiaries consisting of minority investments in companies which investments are not publicly-traded

 

           

 

 

 

 

E.

Aggregate value of any reserves not already deducted from assets

 

           

 

 

 

 

F.

Aggregate value of liabilities of Borrower and its Subsidiaries (including all Indebtedness) and current portion of Subordinated Debt permitted by Bank to be paid by Borrower (but no other Subordinated Debt)

 

           

 

 

 

 

G.

Aggregate value of Indebtedness of Borrower subordinated to Borrower’s Indebtedness to Bank

 

           

 

 

 

 

H.

Tangible Net Worth (line A minus line B minus line C minus line D minus line E minus line F plus line G)

 

           

 

 

 

 

Is line H equal to or greater than Required Amount?

 

 

          No, not in compliance

          Yes, in compliance

 

 

 

 


Exhibit 14.1

 

NETLIST’S CODE OF BUSINESS CONDUCT & ETHICS FOR EMPLOYEES, EXECUTIVE OFFICERS & DIRECTORS

 

Introduction

 

Netlist strives to apply high ethical, moral and legal principles in every aspect of its business conduct. This Code of Business Conduct and Ethics (the “Code”) is a guide for each of the Company’s employees, executive officers, and directors to follow in meeting these principles. Netlist is firmly committed to complying with its legal and ethical obligations under all state and federal laws. As a result, we expect all employees, at every level within the company, to comply strictly with all legal and ethical obligations. Our philosophy can be implemented only if our employees recognize their responsibility to treat everyone in an honest and fair manner. Accordingly, an employee who fails to fulfill his or her responsibilities under this Code, including by engaging in conduct that adversely affects or is otherwise detrimental to the interests of the Company, other employees, or customers, will be subject to disciplinary action, up to and including immediate termination of employment.

 

This Code describes certain ethical principles that Netlist has established for the conduct of its business and outlines certain key legal requirements of which all employees must be generally aware and with which all employees must comply. While this Code does not cover every issue that may arise, it sets out basic principles to guide employees in the course of performing their duties and responsibilities to Netlist.

 

This Code is effective immediately and shall remain in effect unless and until further amended, modified and/or restated .

 

This Code is designed to deter wrongdoing and promote the following:

 

·

Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

 

·

Complete, fair, accurate, timely and understandable disclosure in reports and documents that Netlist files with, or submits to, the Securities and Exchange Commission and in other public communications made by Netlist;

 

·

Compliance with applicable governmental laws, rules and regulations;

 

·

Prompt internal reporting to an appropriate person or persons identified herein of violations of this Code; and

 

·

Accountability for adherence to this Code.

 

If an employee is concerned about a possible ethical or illegal situation or any violation of this Code or is not sure whether specific conduct meets applicable Netlist standards, he or she should discuss the situation with an immediate supervisor or contact Netlist’s Chief Executive Officer. Employees who are executive officers or members of Netlist’s board of directors (the “Board”) should discuss the situation with the Board or a committee of the Board. Any employee who violates the standards contained in this


 

Code will be subject to disciplinary action, which may include termination. Netlist will treat as confidential, to the extent possible, all information received from an employee with respect to a possible ethical or illegal situation and will not take any retributive or retaliatory action by reason of such disclosure against any employee who discloses such information in good faith.

 

1. Conflicts of Interest

 

A “conflict of interest” exists when an employee’s private interest interferes in any way or appears to interfere with the interests of Netlist. A conflict of interest can arise when an employee acts in a matter, or has interests, that may make it difficult for him or her to objectively and effectively perform his or her work for Netlist. Conflicts of interest also can arise when an employee, or members of his or her family, receives improper personal benefits because of his or her position in Netlist.

 

Unless approved by the Board or an appropriate committee of the Board, no employee or any member of his or her immediate family can acquire a financial interest in, or accept employment with, any entity doing business with Netlist if the interest or employment could conflict with his or her duties to Netlist and the performance of such duties. It is usually a conflict of interest for an employee to work simultaneously, even on a part-time or temporary basis, for a competitor, customer or supplier of Netlist. An employee cannot work for a competitor as an employee, consultant, contractor or board member. In addition, an employee and his or her immediate family members cannot accept material gifts or favors that could create the appearance that such employee’s business judgment could be affected by the receipt of such gifts or favors. An employee and members of his or her immediate family can accept gifts of nominal value from existing sources, prospective sources and persons, firms or companies with whom Netlist does or might do business. The purpose of business entertainment and gifts in a commercial setting is to create good will and sound working relationships, not to gain unfair advantage with customers. Employees cannot offer gifts or favors to any employee of a competitor, supplier or customer of Netlist, or a member of such employee’s immediate family, if the gifts or favors might place the recipient under any obligation to a Netlist employee or to Netlist.

 

Conflicts of interest are prohibited as a matter of company policy. Conflicts of interest may not always be apparent, so if an employee has a question regarding whether a particular situation is a conflict of interest, he or she should consult with his or her immediate supervisor or contact Netlist’s Chief Executive Officer. Executive officers or members of the Board should consult with the Board or a committee of the Board. An employee must bring any conflict of interest or potential conflict of interest to the attention of his or her immediate supervisor or the Company’s Chief Executive Officer, or follow the procedures described in Section 14 herein.

 

2. Corporate Opportunities

 

An employee cannot personally take for himself or herself business opportunities discovered using Netlist property, information or position for personal gain. It is the duty and responsibility of each employee to advance Netlist’s legitimate interests when the opportunity to do so arises.

 

3 . Confidentiality

 

An employee must maintain the confidentiality of all confidential and non-public information entrusted to him or her by Netlist and its customers and suppliers, except when disclosure is authorized by an executive officer of Netlist or required by applicable laws or regulations. Confidential information includes all information that, if disclosed, might be of use to competitors of Netlist or harmful to Netlist or its customers or suppliers. It also includes information that Netlist's customers and suppliers have entrusted to Netlist. For example, confidential information includes customer lists, financial documents, pricing, manufacturer and vendor information, corporate development materials, the cost of goods, personnel files, manuals and procedures, proprietary information (as discussed below), computer software, design documents, videos and internal reports and memoranda. Information that Netlist has made public, such as information presented in press releases, advertisements or documents filed with governmental regulatory authorities, is not confidential information. The obligation to preserve confidential information extends beyond the term of employment with, or service to, Netlist.


 

4 . Fair Dealing

 

Netlist seeks to outperform its competition fairly and honestly through superior performance and not through unethical or illegal business practices. Employees must endeavor to deal fairly with their colleagues and customers, suppliers and competitors of Netlist. Employees cannot steal proprietary information, possess trade secret information obtained without the owner’s consent or induce such disclosures by past or present employees of other companies. No employee may take unfair advantage of anyone through manipulation, concealment, abuse of confidential information, misrepresentation of material facts or any other unfair-dealing practice. The knowing or deliberate falsification of any documents or data by an employee may be the basis for immediate discharge and may subject the employee to civil and/or criminal penalties.

 

Fair competition laws, including the U.S. antitrust rules, limit what Netlist can do with another company and what Netlist can do on its own.  Generally, such laws are designed to prohibit agreements or actions that reduce competition and harm consumers.  You may not enter into agreements or discussions with competitors that have the effect of fixing or controlling prices, dividing and allocating markets or territories, or boycotting suppliers or customers.  U.S. and foreign antitrust laws also apply to imports and exports. 

 

5. Privacy and Data Protection Compliance

 

Several countries (including Canada, Argentina, Japan, Hong Kong and Australia) and the European Union have strict rules with respect to collection of Personal Information about individuals, which apply to companies that collect information about their employees.  Personal Information may include information that would be routinely gathered in the U.S. such as home address, contact information, and personnel information.  Many of these rules prohibit transmission of Personal Information about individuals from outside the U.S. into the U.S., unless certain safeguards are provided with respect to the Personal Information transmitted into the U.S.  All employees outside the U.S. should use care with respect to collection, storage and transmission of any Personal Information to ensure compliance with applicable privacy and data protection laws and regulations.  All employees inside the U.S. should use care with respect to receiving or obtaining any Personal Information from locations outside the U.S.  All employees in any location should raise any questions about appropriate treatment of Personal Information with the Chief Executive Officer.

 

6. Protection and Proper Use of Company Assets

 

Employees must endeavor to protect Netlist’s assets and property and ensure their efficient use. Theft, carelessness and waste have a direct impact on Netlist’s profitability. Employees must report any suspected incident of fraud or theft immediately for investigation to their immediate supervisor or Netlist’s Chief Executive Officer. Executive officers or members of the Board must report such fraud or theft to the Board or a committee of the Board. Employees must use all assets and property of Netlist for legitimate business purposes only.

 

The obligation of an employee to protect Netlist’s assets includes protecting its proprietary information. Proprietary information includes intellectual property such as trade secrets, patents, patent applications, trademarks and copyrights, as well as business, marketing and service plans, engineering and manufacturing ideas, designs, databases, customer information, records, personnel or salary information and any unpublished financial data and reports. Unauthorized use or distribution of this information violates company policy and may subject employees to civil and/or criminal penalties.

 

7. Compliance with Laws, Rules and Regulations

 

All employees must respect and obey the laws, rules and regulations of the cities, states and countries in which Netlist operates. Employees must contact Netlist’s Chief Executive Officer with any questions as to the applicability of any law, rule or regulation or the appropriate manner of compliance therewith.


 

 

8. Insider Trading

 

Employees who have access to confidential information cannot use or share such information for stock trading purposes or for any other purpose except the proper conduct of Netlist’s business. All employees are subject to Netlist's policy on insider trading then in effect Netlist will deal firmly with all instances of insider trading. If an employee has any questions regarding non-public information and the use of such information or Netlist’s policy on insider trading then in effect, he or she should contact Netlist’s Chief Executive Officer.

 

9. Discrimination and Harassment

 

Netlist requires strict adherence to its policies and applicable laws regarding equal employment opportunities and discrimination in the workplace. Netlist will not tolerate any illegal discrimination or harassment of any kind. Relationships with colleagues and business relationships with competitors, suppliers and customers always must be conducted free of any discrimination, based on race, color, creed, religion, age, sex, sexual preference, national origin, marital status, veteran status, handicap, disability, or any other characteristic protected by law. Examples of illegal discrimination or harassment include derogatory comments based on any of the preceding characteristics and unwelcome sexual advances. Please refer to the company’s policy against harassment contained in this Employee Guidelines.

 

10. Health and Safety

 

Netlist strives to provide each employee with a safe and healthful work environment. Each employee is responsible for maintaining a safe and healthy workplace for their colleagues by following safety and health rules and practices and reporting accidents, injuries and unsafe equipment, practices or conditions. Netlist will not tolerate violence or threatening behavior in the workplace. Employees are required to report to work in condition to perform their duties, free from the influence of illegal drugs or alcohol. Netlist will not tolerate the use of alcohol or illegal drugs in the workplace or on any company property.

 

10. Record-Keeping

 

Netlist requires honest and accurate recording and reporting of information in order to make responsible business decisions. Employees must document and record accurately all business expense accounts they use. If an employee is unsure whether a certain expense is legitimate, the employee should ask his or her immediate supervisor or Netlist’s Chief Executive Officer. Executive officers or members of the Board should confer with the Board or a committee of the Board. Rules and guidelines regarding business expenses are available from Netlist’s accounting department.

 

All of Netlist’s books, records, accounts and financial statements must be maintained in reasonable detail, must appropriately reflect Netlist’s transactions and must conform both to applicable legal requirements and to Netlist’s system of internal controls. Unrecorded or “off the books” funds or assets cannot be maintained unless permitted by applicable laws or regulations. All employees are subject to Netlist’s document retention policy – add this policy to the Employee Guidelines. Please refer to Netlist’s Record Retention Policy (Ref. QF0015 - Record Retention Table in Netlist’s on-line Document Library. Any questions concerning Netlist’s document retention policy should be directed to the company’s Chief Executive Officer.

 

Employees must avoid exaggeration, derogatory remarks, guesswork or inappropriate characterizations of people and companies in business records and communications. This prohibition applies equally to e-mail, internal memos and formal reports.

 

11. Payments to Government Personnel or Candidates for Office

 

All employees must comply with the Foreign Corrupt Practices Act, which prohibits giving anything of value, directly or indirectly, to officials of foreign governments or foreign political parties or candidates to obtain or retain business and prohibits making payments to government officials of any country. No employee may give to, or receive from,       any government official kickbacks, bribes, rebates or other illegal consideration. All employees dealing with government agencies must be aware of, and comply with, any agency rules limiting or prohibiting gifts or other favors. In some countries, a very limited category of small payments to facilitate or expedite routine nondiscretionary governmental actions may be permitted


 

as exceptions to antibribery laws, including the U.S. Foreign Corrupt Practices Act (“FCPA”).  The requirements pertaining to such payments are complex.  Netlist employees engaged in international business activities must obtain prior approval of the Chief Executive Officer before making any such payment.  These “facilitating payments” to non-U.S. governmental officials are distinguished from payments made to influence a discretionary decision or to cause violation of, or an act in conflict with, the interests of an individual’s employer, which are strictly prohibited. 

 

Netlist cannot contribute, directly or indirectly, to any political campaign or party. Employees cannot use expense accounts to pay for any personal political contributions or seek any other form of reimbursement from Netlist for such contributions. Employees can engage in political activity using their own resources on their own time and not on company premises.

 

12. Waivers of the Code of Business Conduct and Ethics

 

Any waiver of this Code for executive officers or directors requires the approval of the Board and must be disclosed promptly as required by applicable law, rules or regulations.

 

13. Reporting any Illegal or Unethical Behavior

 

Employees are encouraged to talk to Human Resources, his/her immediate supervisor or Netlist’s Chief Executive Officer about observed illegal or unethical behavior when unsure about the best course of action to take in a particular situation. Executive officers or members of the Board should discuss such behavior with the Board or a committee of the Board. In addition, employees must report violations of laws, rules, regulations or this Code to immediate supervisors or Netlist’s Chief Executive Officer. Executive officers or members of the Board must report such matters to the Board or a committee of the Board. Netlist prohibits retaliation for reports of ethical misconduct made by employees in good faith. If a situation requires the identity of an employee reporting any such misconduct not be disclosed, Netlist will protect the anonymity of such employee to the extent legally possible. Netlist will not permit retaliation of any kind against any reporting employee for reporting, in good faith, any ethical violations.

 

14. Compliance Procedures

 

This Code broadly describes the ethical standards by which Netlist conducts its business. If an employee is uncertain as to the applicability of any of these standards to a particular situation or the propriety of any contemplated course of action, Netlist encourages such employee to discuss the potential situation with his or her immediate supervisor or Netlist’s Chief Executive Officer. Executive officers or members of the Board should discuss the potential situation with the Board or a committee of the Board. In any case where an employee feels that it is not appropriate to discuss an issue with an immediate supervisor, or where he or she does not feel comfortable approaching an immediate supervisor with a question, the employee is encouraged to discuss the question with Netlist’s Chief Executive Officer or report the matter directly to the Board or a committee of the Board.

 

15. Amendments

 

This Code may be amended by the Board. Netlist must report promptly any amendments pertaining to executive officers or senior financial officers as required by applicable laws, rules or regulations.


EXHIBIT 21.1

 

SUBSIDIARIES

 

Each of the following is a wholly owned direct subsidiary of Netlist, Inc.:

 

Entity
Name

    

Jurisdiction   of   Organization

Netlist Electronics (Suzhou) Co., Ltd

 

People s Republic of China

Netlist HK Limited

 

Hong Kong

 

 


EXHIBIT 23

 

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

We consent to the incorporation by reference in Registration Statements Nos.  333-139435, 333-146141, 333-151644, 333-161832, 333-161 834, 333-164261, 333-165916, 333-168330, 333-173646, 333-179776, and 333-193862 on Form S-8 and 333-164290 and 333-177118 on Form S-3 of our report dated March 27 ,   201 5 , relating to the consolidated financial statements of Netlist, Inc. and subsidiaries, appearing in this Annual Report on Form 10-K of Netlist, Inc. for the year ended December 27, 2014 .

 

/s/ KMJ CORBIN & COMPANY LLP

 

Costa Mesa, California

March 27 , 201 5

 

 


EXHIBIT 31.1

 

CERTIFICATION PURSUANT TO RULE 13A - 14 OF THE SECURITIES EXCHANGE ACT OF 1934

AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES ‑OXLEY ACT OF 2002

 

I, Chun K. Hong, certify that:

 

1. I have reviewed this Annual Report on Form 10 - K for the   fiscal year ended December 27, 2014 of Netlist, Inc., a Delaware corporation (the Registrant );

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

 

4. The Registrant s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d - 15(f)) for the Registrant and have:

 

a) D esigned such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) D esigned such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) E valuated the effectiveness of the Registrant s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) D isclosed in this report any change in the Registrant s internal control over financial reporting that occurred during the Registrant s most recent quarter (the Registrant s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant s internal control over financial reporting .

 

5. The Registrant s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant s auditors and the audit committee of the Registrant s board of directors (or persons performing the equivalent functions):

 

a) A ll significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant s ability to record, process, summarize and report financial information; and

 

b) A ny fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant s internal control over financial reporting.

 

March 27, 2015

/s/ Chun K. Hong

 

Chun K. Hong

 

President, Chief Executive Officer and Chairman of

 

the Board (Principal Executive Officer)

 

 


EXHIBIT 31.2

 

CERTIFICATION PURSUANT TO RULE 13A - 14 OF THE SECURITIES EXCHANGE ACT OF 1934

AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES ‑OXLEY ACT OF 2002

 

I, Gail Sasaki , certify that:

 

1. I have reviewed this Annual Report on Form 10 - K for the fiscal year ended December 27, 2014 of Netlist, Inc., a Delaware corporation (the Registrant );

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

 

4. The Registrant s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d - 15(f)) for the Registrant and have:

 

a) D esigned such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) D esigned such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) E valuated the effectiveness of the Registrant s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) D isclosed in this report any change in the Registrant s internal control over financial reporting that occurred during the Registrant s most recent quarter (the Registrant s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant s internal control over financial reporting .  

 

5. The Registrant s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant s auditors and the audit committee of the Registrant s board of directors (or persons performing the equivalent functions):

 

a) A ll significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant s ability to record, process, summarize and report financial information; a nd

 

b) A ny fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant s internal control over financial reporting.

 

March 27, 2015

/s/ Gail Sasaki

 

Gail Sasaki

 

Vice President and Chief Financial Officer

 

(Principal Financial Officer)

 

 


Exhibit 32

 

CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES ‑OXLEY ACT OF 2002

 

In connection with the Annual Report on Form 10 - K of Netlist, Inc., a Delaware corporation ( Netlist ) for the   fiscal year ended December 27, 2014 , as filed with the Securities and Exchange Commission on March 27 , 201 5 (the Report ), Chun K. Hong, president, chief executive officer and chairman of the board of Netlist, and Gail Sasaki , vice president and chief financial officer of Netlist, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes ‑Oxley Act of 2002, that, to his or her knowledge:

 

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Netlist.

 

March 27, 2015

/s/ Chun K. Hong

 

Chun K. Hong

 

President, Chief Executive Officer and Chairman of

 

the Board (Principal Executive Officer)

 

 

 

 

March 27, 2015

/s/ Gail Sasaki

 

Gail Sasaki

 

Vice President and Chief Financial Officer

 

(Principal Financial Officer)