~~Item1A.~~ Item 1A. Risk Factors

This Annual Report on Form 10-K includes forward-looking statements. These forward-looking statements generally are identified by words such as ~~“believe”~~"believe", ~~“expect”~~"expect", ~~“anticipate”~~"anticipate", ~~“estimate”~~"estimate", ~~“intend”~~"intend", ~~“strategy”~~"strategy", ~~“may”~~"may", ~~“will likely”~~"will likely" and similar words or phrases. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this Report. We are under no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements are all based on currently available market, operating, financial and competitive information and are subject to various risks and uncertainties, including but not limited to the ~~rapidly-changing~~rapidly- changing nature of technology; evolving industry standards; 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; fluctuations in the market price of critical components; and the political and regulatory environment in the PRC. Our actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below. The risks below are not the only ones we face. Additional risks and risks that management currently considers immaterial may also have an adverse effect on us.

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

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

•: 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 inability to develop new or enhanced products that achieve market acceptance in a timely manner;~~
·       ~~the timing of introductions of competing products or technologies;~~
·       ~~our ability to adequately support future growth;~~
·       ~~our ability to procure an adequate supply of key components;~~
·
•: changes in the prices of our products or in the cost of the materials that we use to build our ~~products;~~
·products, including fluctuations in the market price of DRAM ICs and NAND;
•: our inability to develop new or enhanced products that achieve customer or market acceptance in a timely manner;

•

the timing of introductions of competing products or technologies;

•

our ability to adequately finance future growth;

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

•

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

•

our ~~establishment and ongoing operation~~failure to produce products that meet the quality requirements of our customers;

•

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

•

the loss of any of our key personnel;

•

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

•

disputes regarding intellectual property rights;

•

litigation involving our products;

•

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

·and;

•

changes in accounting principles or policies.

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

~~Our two largest~~Sales to a limited number of customers ~~comprised approximately 71%~~represent a significant portion of our net sales ~~for 2006 and our three largest customers comprised approximately 68% of our net sales for 2005~~ 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 such as Dell, IBM and ~~IBM~~Hewlett Packard have historically represented ~~38% and 33%, respectively,~~a significant portion of our net ~~sales in 2006. Sales to Dell, IBM and Lenovo represented 35%, 20% and 13%, respectively, of our net sales in 2005.~~sales. We currently expect that sales to Dell and ~~IBM~~Hewlett Packard will continue to represent a significant percentage of our net sales for at least the next 12 months. We do not have long-term agreements with these customers, or with any other customer. Any one of these ~~two~~ customers could decide at any time to discontinue, decrease or delay their purchase of our products. In addition, the prices that these ~~two~~ customers pay for our products could change at any time. The loss of ~~either of~~ Dell or ~~IBM~~Hewlett Packard as a customer, or a significant reduction in sales to ~~either~~any of them, would significantly reduce our net sales and adversely affect our operating results.

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

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

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

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

these potential customers. Even if we establish these relationships, our financial results will be largely dependent on these ~~customers’~~customers' sales and business results.

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

~~The~~ Sales of our products are dependent upon demand in the computing, networking, communications, printer, storage and industrial markets. These markets ~~in which we compete and in which our customers operate~~ have been cyclical and are characterized by wide fluctuations in product supply and demand. These markets have experienced significant downturns, often connected with, or in anticipation of, maturing product cycles, reductions in technology spending and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity,, high inventory levels and the erosion of average selling prices.

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. During an industry downturn, there is also a higher risk that our trade receivables would be uncollectible. 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 ~~net~~ sales, our ~~results of operations~~gross margins, operating income and cash flow would be negatively impacted.

A decline in the worldwide semiconductor market or a future decline in economic conditions or consumer confidence in any significant geographic area would also likely decrease the overall demand for our products, which could have a material adverse effect on us. More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility to the United States economy and worldwide financial markets. Any of these occurrences could have a material adverse effect on our business, financial condition and results of operations.

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

In ~~2006~~2007 and ~~2005,~~2006, we derived ~~79%~~approximately 68% and ~~51%~~79%, respectively, 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 ~~most~~a significant portion of our net sales in the near term. Continued market acceptance of these products for use in servers is critical to our success. If the demand for servers deteriorates or if the demand for our products to be incorporated in servers declines, our operating results would be adversely affected, and we would be forced to diversify our product portfolio and our target markets. We may not be able to achieve this diversification, and our inability to do so may adversely affect our business.

Our investments in auction rate securities are subject to risks which may cause losses and affect the liquidity of these investments.

We hold certain investments in auction rate securities which have failed, or may in the future fail, their respective auctions. An auction failure means that the parties wishing to sell their securities could not do so. As a result of failed auctions, our ability to liquidate and fully recover the carrying value of our investments in the near term may be limited or not exist. If the issuers of these investments are unable to close future auctions and their credit ratings deteriorate, we may in the future be required to record an impairment charge on these investments. We may be required to wait until market stability is restored for these investments or until the final maturity of the underlying notes (up to 30 years) to realize our investments' recorded value.

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

We incurred net losses each year from the inception of our business through fiscal ~~2005.~~2005, as well as for the year ended December 29, 2007. Our cumulative net losses were ~~$16.3~~$23.9 million and ~~$21.4~~$16.3 million as of December ~~30, 2006~~29, 2007 and December ~~31, 2005,~~30, 2006, respectively. We may not be able to achieve or maintain profitability on a quarterly or annual basis in the future.

The prices of DRAM ICs and NAND is volatile, and changes in their prices could adversely affect our gross margin.

The prices of our products are adjusted periodically based in part on the market price of DRAM ICs and NAND, which have historically constituted approximately 70% - 90% of the total cost of our memory subsystems. 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 price for DRAM ICs and NAND increases, we generally cannot pass this price increase on to our customers for products purchased under an existing purchase order. As a result, our cost of sales could increase and our gross margins could decrease. Alternatively, if there is a decline 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.

Customer demand is difficult to accurately forecast 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. 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.

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 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, which could cause order cancellations, the loss of customers and a decrease in our net sales.

Conversely, 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 price of DRAM ICs and NAND, the value of our inventory will fall. As a result, we may need to write-down the value of our DRAM IC and 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.

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

Our ability to fulfill customer orders is dependent on a sufficient supply of DRAM ICs and NAND, which are an essential component of our memory subsystems. There is 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. Our dependence on a small number of

suppliers and the lack of any guaranteed sources of DRAM and NAND supply expose us to several risks, including the inability to obtain an adequate supply of DRAM ICs and NAND, price increases, delivery delays and poor quality.

The recent declines in customer demand and revenues has caused us to reduce our purchases of DRAM ICs and NAND. Should we not maintain sufficient purchase levels with some suppliers, our ability to obtain future 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.

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

Our customers qualify the DRAM ICs 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 customers. This would disrupt our supplies of DRAM ICs and NAND and reduce the number of suppliers available to us, and may require that we qualify a new supplier.

The ~~price~~flash memory market is constantly evolving and competitive, and we may not have rights to manufacture and sell certain types of ~~DRAM ICs~~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 ~~volatile,~~constantly undergoing rapid technological change and ~~excess inventory of DRAM ICs, other components,~~evolving industry standards. Many consumer devices, such as digital cameras, PDAs and ~~finished products~~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 ~~adversely affect our gross margin.~~

The prices of our products are adjusted periodically based largely on the market price of DRAM ICs, which constituted more than 77% and 82% of the total cost of our memory subsystems sold during 2006 and 2005, respectively. Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. Consequently, we are exposed to the risks associated with the volatility of the price of DRAM ICs during that period. If the market price for DRAM ICs increases, we generally cannot pass this price increase on to our customers for products purchased under an existing purchase order. As a result, our cost of sales could increase and our gross margins could decrease. Alternatively, if there is a decline in the price of DRAM ICs, we will need to reduce our selling prices for subsequent purchase orders, which may result in a decline in demand, on a relative basis, for other products that we manufacture such as CompactFlash 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 which 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 ~~expected~~ net ~~sales.~~

~~Customer demand for our products, and thus DRAM ICs, can~~sales could be ~~difficult to estimate because we do not have long-term commitments from our customers,~~adversely impacted and our customers ~~may~~would likely cancel orders or defer purchase orders for any reason. If we overestimate customer demand, we will have excess inventory of DRAM ICs. If there is a subsequent decline in the price of DRAM ICs, the value of our inventory will fall. As a result, we may needseek other suppliers to write-down the value of our DRAM IC inventory, which may result in a significant decrease in our gross margin and financial condition. If we underestimate customer demand, we will not have sufficient inventory of DRAM ICs to manufacture our products. This will lead to delays in the delivery of our products, which could cause order cancellations, the loss of customers and a decrease in our net sales.replace us.

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.

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

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

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

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

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

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

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

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develop and maintain effective marketing strategies.

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

products. Delays in product development and introduction could 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’~~customers' requirements or gain market acceptance. Accordingly, we cannot assure you that our future product development efforts will result in the development of new or enhanced products or that such products will achieve market acceptance.

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

Our prospective customers generally make a significant commitment of resources to test and evaluate our memory subsystems prior to purchasing our products and integrating them into their systems. This extensive qualification process involves rigorous reliability testing and evaluation of our products, which may continue for six months or longer and is often subject to delays. 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 requalify our products, or to qualify our new products, for use in new platforms or applications. For example, as our OEM customers transition from prior generation ~~DDR~~DDR1 DRAM architectures to current generation DDR2 DRAM architectures, we must design and qualify new products for use by those customers. In the past, this process of design and qualification has taken up to six months to complete, during which time our net sales to those customers declined significantly. After our products are qualified, it can take several months before the customer begins production and we begin to generate net sales. We must devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualify our products with prospective customers in anticipation of sales. If we delay or do not succeed in qualifying a product with a prospective customer, we will not be able to sell that product to that prospect, which would harm our operating results and business.

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

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

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

impacted and we could lose market share, any or all of which could harm our business and results of operations.

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.

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

The establishment and ongoing operation of our ~~planned~~ manufacturing facility in the ~~People’s~~People's Republic of China, or the PRC, could expose us to new and significant risks.

~~We are~~ During fiscal 2007 we invested significant time and effort in ~~the process of~~ establishing a new manufacturing facility in the ~~PRC. To prepare this~~PRC and preparing it for full-scale operations. Our new manufacturing facility ~~for operation, we will need to purchase new equipment, replicate our current manufacturing processes~~became operational in July 2007 and ~~hire additional technical personnel.~~was successfully qualified by certain key customers. The difficulties normally associated with this complicated process ~~will be~~are compounded by language and cultural

differences, as well as the geographic distance from our current ~~facility.~~domestic facility in Irvine. Our management has limited experience in creating or overseeing foreign operations, and this new facility may divert substantial amounts of their time. ~~Further, this new facility will be subject to factory audits by our customers.~~ We ~~may not be able to begin operations at this new facility on a timely basis, or at all. Even if this facility becomes operational and is qualified by our customers, we~~ cannot assure you that we will be able to maintain control over product quality, delivery schedules, manufacturing yields and costs as we increase our output. We ~~will~~ also have to manage a local workforce that may subject us to uncertainties or regulatory ~~policies. Any difficulties in operating this new facility could cause product delivery delays~~policies and ~~reduce~~we remain subject to risks related to managing the increased production capacity provided by the facility. Should anticipated demand not materialize, the costs related to having excess capacity would have an adverse impact on our gross margins and operating results.

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

The PRC currently provides for favorable tax rates for certain foreign-owned enterprises operating in specified locations in the PRC. We ~~are establishing~~have established our ~~China~~PRC facility in such a tax-favored location. Should the PRC government enact a revised ~~income~~ tax structure, it is possible that we would not realize the tax benefits that we currently anticipate and this could adversely impact our operating results.

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

~~Our success to~~ To date ~~has~~we have been highly dependent on the experience, relationships and technical knowledge of ~~Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board, Jayesh Bhakta, our Chief Technology Officer, and Christopher Lopes, our Vice President of Sales.~~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 ~~Mr. Hong.~~Chun K. Hong, our President, Chief Executive Officer and Chairman of the Board. We do not carry ~~“Key Man”~~"Key Man" life insurance on any of our key employees.

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

exceed our expectations and resources. These increased costs may make hiring new engineers difficult, or may reduce our margins.

As of ~~January 31,~~December 29, 2007, ~~20%~~approximately 36% of our workforce consisted of contract personnel. We invest considerable time and expense in training these contract employees. We may experience high turnover rates in our contract employee workforce, which may require us to expend additional resources in the future. If we convert any of these contract employees into permanent employees, we may have to pay ~~finder’s~~finder's fees to the contract agency.

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

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

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

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

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

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

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

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

We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in the remaining applications will be allowed. To date we have had only ~~four~~seven patents issued. We intend to continue

filing patent applications with respect to most of the new processes and technologies that we develop. However, patent protection may not be available for some of these processes or technologies.

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

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

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

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

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

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

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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 ~~are in the process of establishing~~have established a new manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.

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

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

Lawsuits claiming that we are infringing ~~others’~~others' intellectual property rights may be brought against us, and we may have to defend against claims of infringement or invalidity. We currently plan to explore new technologies ~~such as flash memory~~ and to develop new products for our existing markets, such as communications, and for new markets, such as networking. By making use of these new technologies and entering these 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 could subject us to significant liability for damages or invalidate our proprietary rights. An adverse outcome also could force us to take specific actions, including causing us to:

•

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

•

pay royalties on past or future sales;

•

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

•

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

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

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

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

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

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

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 product recalls or product liability claims.

If our products are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could be subject to product liability claims and product recalls, safety alerts or advisory notices. While we have product liability insurance coverage, it may not be adequate to satisfy claims made against us. We also may be unable to obtain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims or product recalls, regardless of their ultimate outcome, could have an adverse effect on our business, financial condition and reputation, and on our ability to attract and retain customers. In addition, 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 acquire other businesses or technologies in the future, these acquisitions could disrupt our business and harm our operating results and financial condition.

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

•

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

•

the diversion of ~~management’s~~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 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.

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

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

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

We plan to evaluate our internal controls over financial reporting to allow management to report on, and our registered public accounting firm to attest to, those internal controls as will be required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the Securities and Exchange Commission, which we collectively refer to as Section ~~404. This~~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 beginning in fiscal 2007. Section 404 will ~~involve system and process evaluations and testing to comply with the management assessment and~~also require our independent registered public accounting firm ~~attestation requirements~~to attest to the effectiveness of ~~Section 404, which will initially have to be made~~our internal controls over financial reporting in ~~our annual report on Form 10-K for our 2007 fiscal year.~~

future periods. 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 share price.

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

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

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 clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or personal injury, as a result of violations of, or noncompliance with, environmental laws and regulations. These laws and regulations also could require us to incur significant costs to remain in compliance.

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

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

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

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

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

~~Our~~ As of December 29, 2007, our executive officers, directors and 5% stockholders beneficially own, in total, approximately 50% of our outstanding common stock. As a result, these stockholders, acting together, have 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 our executive officers, directors and principal stockholders. For example, our executive officers, directors and principal stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders. In addition, this significant concentration of share ownership may adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in companies with stockholders that have the ability to exercise significant control.

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

Item 1B. Unresolved Staff Comments

Not Applicable.

Item 2. Properties
~~Properties~~

Our corporate headquarters and domestic manufacturing facility are located in approximately ~~7,000~~28,700 square feet of space in Irvine, California, under a lease that expires in June ~~2007.~~2011. We also continue to lease approximately 8,500 square feet of space ~~for~~in Irvine, California that previously housed our manufacturing facility, ~~located in Irvine, California.~~and which we are currently subleasing to another tenant. This lease expires in November 2010. We ~~are presently negotiating~~also currently lease approximately 43,600 square feet of space for ~~larger space,~~a manufacturing facility in ~~Irvine, to consolidate our headquarters and manufacturing buildings.~~the PRC. In addition, we lease offices on a monthly basis in corporate office centers located in Austin, Texas, Raleigh, North Carolina and Dublin, Ireland. We are in the process of establishing a manufacturing facility in the PRC. To date we have entered into a letter of intent to lease a facility and have commenced recruiting local personnel. We expect this facility to be operational in the second half of 2007. We believe that our current and planned facilities are adequate for our current and expected operations for the next twelve months and that additional space can be obtained if needed.

	High
Fourth Quarter	$	3.40	$	2.11
Third Quarter		3.60		1.67
Second Quarter		7.00		2.92
First Quarter		12.40		6.84

	Year Ended
	December 29, 2007		December 30, 2006		December 31, 2005	January 1, 2005		December 27, 2003
	(in thousands)
Cost of sales	$	171		$	104	$	56		$	29	$	69
Research and development		149			125		(52	)		80		9,733
Selling, general and administrative		861			363		(65	)		141		10,872

December 31,
2002

December 27,
2003

January 1,
2005

December 31,
2005

December 30,
2006

(in thousands)

Consolidated Balance Sheet Data:

Cash, cash equivalents and short term investments

$
91

$
1,907

$
759

$
953

$
36,242

Total assets

9,129

22,404

22,110

25,842

87,694

Total debt(1)

3,778

3,464

9,379

13,921

21,501

Stockholders’ equity

754

5,981

5,261

2,855

50,244

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

Effective January 1, 2003, we changed our fiscal year from a calendar year to a 52/53-week fiscal year ending on the Saturday closest to December 31.

Item 7. ~~Management’s~~ Management's Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

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

Due to their importance to overall system architecture and performance, our products must undergo lengthy qualification reviews by our OEM customers, which may last up to six months. In addition, in order to penetrate large OEMs, we have typically been required to demonstrate our ability to meet strict standards for quality, customer service and turnaround time by first supplying less complex products into a limited range of high volume applications. For example, the initial products we sold to IBM were used in mobile computing applications. The majority of our sales of subsequent products to IBM have been for high-end server applications, our primary market focus. Consistent with the concentrated nature of the OEM customer base in our target markets, a small number of large customers have historically accounted for a significant portion of our net sales. Dell, Hewlett Packard and IBM represented approximately 55%, 23% and ~~Lenovo represented 38%, 33% and 2%~~7%, respectively, of our net sales in fiscal ~~2006,~~2007, and ~~35%~~approximately 38%, ~~20%~~4% and ~~13%~~33%, respectively, of our net sales in fiscal ~~2005. The decline in~~2006. Net sales to ~~Lenovo was due to our sales emphasis on high-end server applications. We expect that Dell and IBM will continue to represent a significant percentage~~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, or EMSs, for incorporation into products manufactured exclusively for the OEM customer. These net sales to EMSs have historically fluctuated period by period as a portion of the total net sales to these OEM customers. Net sales to Hon Hai Precision Industry Co. Ltd., an EMS that purchases memory modules from us for ~~at least the next 12 months.~~

We commenced operations in September 2000 and initially focused on memory subsystems for the telecommunications markets. Beginning in the second quarter of 2001, we shifted our focus to the server and high performance computing markets, due in large part to the telecommunications market downturn.incorporation into

~~In 2002, we became a qualified supplier~~products manufactured exclusively for ~~RLX Technologies, Inc., a blade server manufacturer. One~~Dell, represented approximately 57% of ~~the products we initially developed for RLX, our proprietary 2-inch form factor, 1-gigabyte memory subsystem, led to the development of a range of additional memory subsystems.~~

~~We began qualifying our 2-inch form factor, 1-gigabyte memory subsystem with Dell in the second quarter of 2002 and started shipping it to Dell in the fourth quarter of 2002. Our~~net sales to Dell ~~continued to increase throughout~~for fiscal ~~2003~~2007 and ~~the first three quarters~~approximately 40% of fiscal 2004, as we began to ship more of our memory subsystems to a larger number of Dell facilities in the U.S., Europe and Asia. During this time, we also qualified new products with other leading server and high performance computing OEMs. Beginning in the fourth quarter of fiscal 2004, issues associated with the transition from DDR to DDR2 DRAM architectures, including the requirement for new IC packaging, assembly and handling techniques, resulted in a significant decrease in our sales to Dell. In response to this revenue decline, we carried out two workforce reductions in fiscal 2005 to reduce expenses and preserve cash. Ournet sales to Dell ~~began~~for fiscal 2006. Net sales to ~~recover in the fourth quarter~~Kingston Technology Company, Inc., and to International Systems Technology Co. Ltd., both EMSs that purchase memory modules from us for incorporation into products manufactured exclusively for IBM, represented approximately 43% and 21%, respectively, of ~~fiscal 2005. Also during fiscal 2005, our~~net sales to IBM for fiscal 2007 and ~~Lenovo began to increase significantly.~~

~~Our~~approximately 57% and 22%, respectively, of net sales to IBM ~~continued~~for fiscal 2006.

For the year ended December 29, 2007, the market price for mainstream DRAM ICs decreased by approximately 85%. This decline has adversely affected the selling prices of many of our products and generally contributed to ~~grow significantly~~lower revenues, lower gross margin and reduced inventory value during fiscal 2006, driven by high demand for IBM’s line of blade servers that incorporates our proprietary very low profile memory subsystem. Sales to Dell also grew significantly as our DDR2 products began to shipthis period. Should the decline in ~~volume. In addition, we began shipments to other leading OEMs, including Gateway~~the DRAM IC market continue, it would result in lower net sales, lower gross margin and ~~Hewlett-Packard. We have several new products~~reduced inventory value in ~~various stages of qualification that we anticipate will be incorporated into additional platforms currently in development at our customers.~~subsequent periods.

Key Business Metrics

The following describes certain line items in our statements of operations that are important to ~~management’s~~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 ~~purchase~~ orders with us approximately two weeks in advance of scheduled delivery. Selling prices are typically negotiated monthly, based on competitive market conditions and the current price of DRAM ICs. Purchase orders generally have no cancellation or rescheduling penalty provisions. We often ship our products to our ~~customers’~~customers' international manufacturing sites. All of our sales to date, however, are denominated in U.S. dollars. We also sell excess component inventory of DRAM ICs to distributors and other users of memory ICs. These sales accounted for 8%approximately 2% and ~~24%~~8% of our net sales infor fiscal ~~2006~~2007 and ~~2005,~~2006, respectively. We expect that component inventory sales will continue to decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.

Cost of Sales.Our cost of sales includes the cost of materials, manufacturing costs, depreciation and amortization of equipment, inventory valuation provisions, 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.~~ICs and NAND. We attempt to pass through such DRAM IC and NAND cost fluctuations to our customers by frequently renegotiating pricing prior to the placement of their purchase orders. To the extent we are successful, a large majority of our product cost is variable, and thus our cost of sales and gross margin percentages may not be significantly impacted by changes in sales volume. However, the sales prices of our memory subsystems can also fluctuate due to competitive situations unrelated to the pricing of DRAM ICs and NAND, which will affect gross margins. The gross margin on our sales of excess component DRAM IC and NAND inventory is much lower than the gross margin on our

sales of our memory subsystems. As a result, a decrease in DRAM IC and NAND inventory sales as a percentage of our overall sales would result in an improved overall gross margin. We assess the valuation of our inventories on a monthly basis and record a provision to cost of sales as necessary to reduce inventories to the lower of cost or ~~market~~net realizable value.

Research and Development.Research and development expense consists primarily of employee and independent contractor compensation and related costs, stock-based compensation, computer-aided design software licenses, reference design development costs, patent-related fees, depreciation or rental of evaluation equipment, and occupancy and other allocated overhead costs. Also included in research

and development expense are the costs of material and overhead related to the production of engineering samples of new products under development or products used solely in the research and development process. Our customers typically do not separately compensate us for design and engineering work involved in developing application-specific products for them. All research and development costs are expensed as incurred. AsTo the extent that we continue efforts to develop additional proprietary technologies, we anticipate that research and development expenditures will increase.

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

Provision (Benefit) for Income Taxes. Our income tax provision (benefit) is based on the statutory federal tax rate of 35% and is typically impacted by state taxes and permanent book-tax differences.

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 Securities and Exchange ~~Commission’s~~Commission's Staff Accounting Bulletin ~~(“SAB”)~~ No. 104,Revenue Recognition., or SAB No. 104. Under the provisions of SAB No. 104, we recognize revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed or determinable, and collectibility of the resulting receivable is reasonably assured.

~~For all sales, we~~ We generally use ~~a binding~~customer purchase ~~order~~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 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. ~~Returns from customers have not been material in any period as our principal customers have adopted build-to-order manufacturing models or just-in-time management processes.~~

We offer a standard product warranty to our customers and have no other post-shipment obligations. 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 assess collectibility based on the creditworthiness of the customer as determined by credit checks and evaluations, as well as the ~~customer’s~~customer's payment history. Most of our international shipments are made to ~~third- party~~third-party inventory warehouses, or hubs, and we recognize revenue when the inventory is pulled from the hub for use in production by the customer. We receive a report from the customer on a daily basis indicating the inventories pulled from a hub for use by the customer, and perform a daily reconciliation of inventories shipped to and pulled by the customer to those inventories reflected on the ~~customer’s~~customer's reports to ensure that sales are recognized in the appropriate periods.

Customers are generally allowed limited rights of return for up to 30 days. Estimated returns are provided for at the time of sale based on historical experience or specific identification of an event necessitating a reserve. While these returns We have historically ~~been~~had good visibility into our customers' requirements within each reporting period. However, if a customer does not pull our ~~expectations~~inventory from its hub in accordance with the schedule it originally provided to us, our predicted future revenues could vary from our forecasts and ~~the provisions established,~~our results of operations could be materially and adversely affected. Additionally, since we ~~cannot guarantee~~own inventories that ~~we will continue~~are physically located in hubs, our ability to ~~experience similar return rates in the future. Any significant~~effectively manage inventory levels may be impaired, causing our inventory turns to decrease, which would increase ~~in product failure rates~~expenses associated with excess and ~~the resulting product returns could have a material adverse effect on~~obsolete inventories and negatively impact our ~~operating results for the period or periods in which such returns materialize.~~cash flow.

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

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

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

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

Inventories. We value our inventories at the lower of the actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on an average cost basis which approximates actual cost on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. We regularly review inventory quantities on hand and on order and record a provision for excess and obsolete inventories based primarily on our estimated forecast of product demand and production requirements for the next three to six months. In addition, we consider changes in the market value of DRAM ICs and NAND in determining the realizable value of our raw

material inventory. Once established, any write-downs are considered permanent adjustments to the cost basis of ~~the excess or obsolete~~

our 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 and NAND decrease significantly, we may be required to lower our selling prices to reflect the lower cost of our raw materials. If such price decreases reduce the 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, or technological developments or the market value of DRAM ICs and NAND could have a material effect on the value of our inventories and our reported operating results.

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

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

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

On January 1, 2006, we adopted SFAS No. 123(R),Share-Based Payment, or SFAS No. 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors ~~related to our Amended and Restated 2000 Equity Incentive Plan~~ based on estimated fair values. We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our consolidated financial statements as of and for the year ended December 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, our consolidated

financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).

We currently use the Black-Scholes option pricing model to estimate the fair value of stock-based awards. While this model meets the requirements of SFAS No. 123(R), the estimated fair values generated by it may not be indicative of the actual fair values of our stock-based awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements as well as limited transferability. 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 stock-based awards. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The expected volatility is based on the historical volatilities of the common stock of comparable publicly traded companies based on our belief that we currently have limited historical data regarding the volatility of our stock price on which to base a meaningful estimate of expected volatility. 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 expectation of dividend payouts. We evaluate the assumptions used to value stock-based 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 the past.

The value of the portion of ~~the award~~stock-based awards that isare ultimately expected to vest is recognized as expense over the requisite service periods in our ~~consolidated statement of operations.~~financial statements in fiscal 2006 and thereafter. As stock-based compensation expense recognized in ~~the consolidated statement of operations for the year ended December 30, 2006~~our financial statements is based on awards ultimately expected to vest, it has been reduced

for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. ~~The estimated average forfeiture rate for~~If there are any modifications or cancellations of the ~~year ended December 30, 2006 of 8% was based on historical forfeiture experience and estimated future employee forfeitures. In our pro forma information~~underlying unvested stock-based awards, we may be required ~~under SFAS No. 123 for the periods prior~~ to ~~fiscal 2006, we accounted for forfeitures as they occurred.~~

~~Employee~~accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense ~~recognized under SFAS No. 123(R) for~~and unearned stock-based compensation will increase to the year ended December 30, 2006 was $592,000, determined by the Black-Scholes valuation model. As of December 30, 2006, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options was $3,687,000, which is expected to be recognized as an expense over a weighted-average period of approximately 4 years. See Note 2 to our consolidated financial statements forextent that we grant additional ~~information.~~stock-based awards.

Income Taxes.We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance, when determined necessary, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we operate at a loss for an extended period of time or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to record a valuation allowance against all or a significant portion of our deferred tax assets which could substantially increase our effective tax rate for such period. Any significant changes in statutory tax rates or the amount of our valuation allowance could have a material effect on the value of our deferred tax assets and liabilities, and our reported financial results.

~~Our current effective tax rate is approximately 36%. We expect this rate to decrease if~~ Additionally, we ~~generate profits from our planned manufacturing facility~~adopted Financial Accounting Standards Board, or FASB, Interpretation No. 48,Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109, or FIN 48, on December 31, 2006, the ~~PRC in~~first day of fiscal 2007. ~~This decrease~~FIN 48 seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 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 ~~attributable~~taken on a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under FIN 48 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 ~~favorable tax treatment available~~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 ~~region in which we intend~~need to ~~establish our operation. The magnitude of the decrease is not known, as we have not finalized our~~record additional tax ~~strategy as it relates to the planned PRC operation.~~liabilities or potentially reverse previously recorded tax liabilities.

Results of Operations

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

Year Ended

January 1,
2005

December 31,
2005

December 30,
2006

Consolidated Statement of Operations Data:

Net sales

$
143,659

$
79,856

$
151,448

Cost of sales(1)

133,503

73,892

129,181

Gross profit

10,156

5,964

22,267

Operating expenses:

Research and development(1)

3,770

2,961

3,315

Selling, general and administrative(1)

6,314

5,062

9,191

Total operating expenses

10,084

8,023

12,506

Operating income (loss)

72

(2,059
)

9,761

Other expense, net

(1,386
)

(1,200
)

(1,849
)

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

(1,314
)

(3,259
)

7,912

Provision (benefit) for income taxes

(340
)

(912
)

2,844

Net income (loss)

$
(974
)

$
(2,347
)

$
5,068

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

Year Ended

January 1,
2005

December 31,
2005

December 30,
2006

Cost of sales

$
29

$
56

$
104

Research and development

80

(52
)

125

Selling, general and administrative

141

(65
)

363

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

	Year Ended											Year Ended
	January 1, 2005			December 31, 2005			December 30, 2006					December 29, 2007		December 30, 2006		December 31, 2005
Consolidated Statement of Operations Data:
Net sales		100.0	%		100.0	%		100.0	%	Net sales		100	%	100	%	100	%
Cost of sales		92.9			92.5			85.3		Cost of sales		91		85		93

Gross profit		7.1			7.5			14.7		Gross profit		9		15		7

Operating expenses:										Operating expenses:
Research and development		2.6			3.7			2.2
Selling, general and administrative		4.4			6.4			6.1
Total operating expenses		7.0			10.1			8.3
										Research and development		5		2		4
										Selling, general and administrative		16		6		6

											Total operating expenses	21		8		10

Operating income (loss)		0.1			(2.6	)		6.4		Operating income (loss)		(12	)	6		(3	)
Other expense, net		(1.0	)		(1.5	)		(1.2	)

Other income (expense):										Other income (expense):
										Interest income (expense), net		—		(1	)	(2	)
										Other income (expense), net		—		—		—

											Total other income (expense), net	—		(1	)	(2	)
Income (loss) before provision (benefit) for income taxes		(0.9	)		(4.1	)		5.2		Income (loss) before provision (benefit) for income taxes		(11	)	5		(4	)
Provision (benefit) for income taxes		(0.2	)		(1.1	)		1.9		Provision (benefit) for income taxes		(4	)	2		(1	)

Net income (loss)		(0.7	)%		(3.0	)%		3.3	%	Net income (loss)		(7	)%	3	%	(3	)%

Year Ended December 29, 2007 Compared to the Year Ended December 30, 2006

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 29, 2007 and December 30, 2006 (in thousands, except percentages):

	Year Ended
	December 29, 2007			December 30, 2006			Decrease			% Change
Net sales	$	100,060		$	151,448		$	(51,388	)	(34	)%
Cost of sales		91,261			129,181			(37,920	)	(29	)%

Gross profit	$	8,799		$	22,267		$	(13,468	)	(60	)%

Gross margin		8.8	%		14.7	%		(5.9	)%

Net Sales. Net sales for the year ended December 29, 2007 were adversely impacted by two primary factors. First, the significant decreases in DRAM IC market prices during the period, which was primarily driven by continued oversupply in the DRAM market, forced us to significantly reduce

our selling prices on many of our products. Additionally, we experienced decreases in demand as falling market prices generally led to expectations of further price reductions, which caused certain customers to delay purchases from us.

The decrease in net sales for the year ended December 29, 2007 as compared to the year ended December 30, 2006 resulted primarily from decreases of (i) $42.1 million in sales of our very low profile memory subsystems, (ii) $21.6 million in sales of Double Data Rate, or DDR and DDR2 memory subsystems and (iii) $23.0 million in sales of other memory products, primarily with respect to certain of our upgrade and distribution business customers that were affected by the the overall downward market in 2007. These decreases were partially offset by increases in net sales for 2007 as compared to 2006 of (i) $27.2 million in sales of laptop personal computer memory subsystems and (ii) $9.6 million in sales of memory subsystems used to control Redundant Arrays of Independent Disks, or RAIDs. The overall decreases in net sales are primarily attributable to the market-driven reductions in selling prices of our products and lower customer demand as described above, particularly on our high volume products with lower average selling prices as well as overall lower than expected demand from OEM products in which our products are incorporated, such as blade servers that use our very low profile memory subsystems.

Should the market price declines for DRAM ICs continue, our overall revenues could be adversely impacted as we lower prices further on some products to meet market conditions.

Sales of our component inventory to distributors and other users of memory ICs represented approximately 2% and 8% of net sales for the years ended December 29, 2007 and December 30, 2006, respectively. We expect that component inventory sales will decrease as a percentage of net sales in future periods as we diversify our customer base and therefore are able to use components in a wider range of memory subsystems.

Gross Profit and Gross Margin. Gross profit for the year ended December 29, 2007 as compared to the year ended December 30, 2006 decreased primarily due to the 34% decrease in net sales between the two years. The decrease in gross profit and gross margin for 2007 is also attributable to the significant decrease in the market price of DRAM ICs during 2007. This market decline significantly impacted the valuation of our inventories, whereby we incurred a loss in the year ended December 29, 2007 of approximately $5.3 million as a result of slow moving and lower-of-cost-or-market value inventory adjustments. Additionally, as a result of the overall decrease in demand that we experienced in 2007, along with the start-up costs to establish our new manufacturing facility in the People's Republic of China, or PRC, we incurred excess manufacturing capacity costs in 2007 of approximately $4.7 million. The declines in both gross profit and gross margin in 2007 were partially offset by certain shifts in product mix that provide for higher margins. To the extent that DRAM IC market prices continue to decline, or should our product sales mix move toward lower margin products such as laptop memory, our gross profit, gross margin and overall operating results could be adversely affected in future periods.

Research and Development

The following table presents research and development expenses for the years ended December 29, 2007 and December 30, 2006 (in thousands, except percentages):

		Year Ended
		December 29, 2007			December 30, 2006			Increase			% Change
Research and development		$	4,748		$	3,315		$	1,433		43	%

The increase in research and development expense for the year ended December 29, 2007 as compared to the year ended December 30, 2006 resulted primarily from increases of (i) $0.5 million in

personnel-related expenses as a result of an increase in the number of employees engaged in research and development activities since December 30, 2006, along with increased expenses related to changes to our employee insurance plan coverage premiums and matching contributions to our employee 401(k) plan, (ii) $0.2 million for certain engineering and design tools, product qualification and other related expenses along with $0.1 million in legal and professional services fees as we increased activities related to new and emerging markets during 2007, (iii) $0.3 million for impairment write-downs of certain long-lived assets used in the product development process as further discussed in Note 11 of Notes to Consolidated Financial Statements and (iv) $0.3 million in various allocated overhead expenses.

Selling, General and Administrative

The following table presents selling, general and administrative expenses for the years ended December 29, 2007 and December 30, 2006 (in thousands, except percentages):

		Year Ended
		December 29, 2007			December 30, 2006			Increase			% Change
Selling, general and administrative		$	15,900		$	9,191		$	6,709		73	%

The increase in selling, general and administrative expenses for the year ended December 29, 2007 as compared to the year ended December 30, 2006 resulted primarily from increases of (i) $2.8 million in personnel-related expenses as a result of an increase in the number of employees engaged in selling, general and administrative activities since December 30, 2006, including recruitment and related expenses, along with increased expenses related to changes to our employee insurance plan coverage premiums and matching contributions to our employee 401(k) plan, (ii) $0.5 million in stock-based compensation expenses due to our increased headcount and additional stock-based awards granted during 2007, (iii) $1.2 million in various selling and promotion expenses primarily as a result of additional product qualification activities, travel and other costs incurred in connection with our efforts to begin operations at our facility in the PRC, (iv) $0.9 million in legal and professional services as a result of additional legal and other professional services primarily related to certain reporting and other obligations due to becoming a public company, along with costs for litigation-related matters as further discussed in Note 9 of Notes to Consolidated Financial Statements, (v) $0.4 million related primarily to certain facility lease relocation costs and a write-down of the carrying value of certain of our long-lived assets and (vi) $1.1 million in various allocated overhead expenses which include, but are not limited to, expenses for insurance, depreciation and rent. The increases in selling, general and administrative expenses are partially offset by decreases of (i) $0.3 million in bad debt expense and (ii) $0.1 million in commission-related expenses due to our lower overall net sales in 2007 as compared to 2006.

Other Income (Expense), Net

The following table presents other income (expense) for the years ended December 29, 2007 and December 30, 2006 (in thousands, except percentages):

	Year Ended
	December 29, 2007		December 30, 2006			Increase		% Change
Interest income (expense), net	$	395	$	(1,825	)	$	2,220	122	%
Other income (expense), net		16		(24	)		40	167	%

Total other income (expense), net	$	411	$	(1,849	)	$	2,260	122	%

Net interest income for the year ended December 29, 2007 was comprised of interest income of approximately $1.7 million, partially offset by interest expense of approximately $1.3 million. The increase in net interest income during 2007 as compared to 2006 resulted primarily from (i) interest

income earned on our cash equivalents and marketable securities balances, which is attributable to the proceeds from our IPO in December 2006 and (ii) a decrease in interest expense due to our lower outstanding line of credit and debt balances in 2007 as compared to 2006.

Other income (expense), net, primarily includes gains and losses on foreign currency transactions in 2007 and losses on dispositions of property and equipment.

Provision (Benefit) for Income Taxes

The following table presents the provision (benefit) for income taxes for the years ended December 29, 2007 and December 30, 2006 (in thousands, except percentages):

		Year Ended
		December 29, 2007			December 30, 2006			Decrease			% Change
Provision (benefit) for income taxes		$	(4,025	)	$	2,844		$	(6,869	)	(242	)%

The federal statutory rate was 35% for fiscal 2007 and 2006. We recorded a benefit for income taxes due to a pre-tax loss for the year ended December 29, 2007 as compared to a provision for income taxes for the year ended December 30, 2006. The differences between our effective tax rates and the federal statutory rate primarily relates to the benefit of lower federal tax brackets, state taxes and foreign losses recorded without tax benefits in fiscal 2007 and the benefit of lower federal tax brackets and state taxes in fiscal 2006.

We use the liability method of accounting for income taxes as set forth in SFAS No. 109,Accounting for Income Taxes. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future income, tax planning strategies, and recent financial performance including carryback opportunities to the extent available. As a result of recent cumulative taxable income, a federal carryback opportunity, and projections of income in the near future, we have concluded that no valuation allowance should be recorded as of the end of 2007.

As a result of our adoption of FIN 48 in fiscal 2007, we recorded an increase in the net liability for unrecognized tax positions of approximately $0.2 million, which was recorded as an adjustment to the beginning balance of accumulated deficit as of December 31, 2006.

Included in the unrecognized tax benefits at December 29, 2007 was approximately $0.6 million of tax positions that, if recognized, would affect our annual effective tax rate. Our continuing practice is to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. This policy did not change as a result of the adoption of FIN 48. At December 29, 2007, we had approximately $75,000 accrued for interest and $0 accrued for penalties. We do not expect our unrecognized tax benefits to change significantly over the next 12 months.

In future periods, we will begin to operate under tax holidays in the PRC, which are effective from January 2008 through December 2012.

Year Ended December 30, 2006 Compared to the Year Ended December 31, 2005

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 30, 2006 and December 31, 2005 (in thousands, except percentages):

	Year Ended
	December 30, 2006			December 31, 2005			Increase			% Change
Net sales	$	151,448		$	79,856		$	71,592		90	%
Cost of sales		129,181			73,892			55,289		75	%

Gross profit	$	22,267		$	5,964		$	16,303		273	%

Gross margin		14.7	%		7.5	%		7.2	%

Net Sales.~~Net~~ Approximately $32.7 million of the increase in net sales for the year ended December 30, 2006 ~~were $151.4 million, an increase of $71.5 million, or 90%, over~~as compared to the year ended December 31, ~~2005. Approximately $32.7 million of the increase~~2005 was attributable to higher unit sales of our very low profile memory subsystems. In addition, DDR2 server memory subsystem sales increased by $28.0 million and DDR subsystem sales decreased by $8.1 million due to customers transitioning to DDR2 architectures. Sales of memory subsystems used to control ~~redundant arrays of independent disks (RAIDs)~~RAIDs commenced late in the second quarter of fiscal 2006 and contributed $22.4 million to the increase in revenues. Finally, sales of laptop and desktop personal computer, or PC, memory subsystems decreased $3.5 million as we focused on sales of higher margin server memory subsystems.

Sales of our component inventory to distributors and other users of memory ICs represented 8% and 24% of net sales for the years ended December 30, 2006 and ~~December~~ December��31, 2005, respectively. ~~We expect that component inventory~~Such sales ~~will decrease~~decreased primarily as a ~~percentage~~result of ~~net sales in future periods as we~~our efforts to diversify our customer base ~~and therefore are able~~which has resulted in our ability to use components in a wider range of memory subsystems.

Gross Profit and Gross Margin.Gross profit for the year ended December 30, 2006 was $22.3 million, an increase of $16.3 million, or 273%, over the year ended December 31, 2005. Gross margin increased to 14.7% from 7.5% for the same period. The increase in both gross profit and gross margin for the year ended December 30, 2006 as compared to the year ended December 31, 2005 is primarily attributable to increased sales of our very low profile memory subsystems and memory subsystems to control RAIDs, which generate higher margins due to their innovative design, as well as lower margin products becoming a smaller portion of our overall product sales mix.

Research and ~~Development.~~Development~~Research~~

The following table presents research and development expenses for the years ended December 30, 2006 and December 31, 2005 (in thousands, except percentages):

		Year Ended
		December 30, 2006			December 31, 2005			Increase			% Change
Research and development		$	3,315		$	2,961		$	354		12	%

The increase in research and development expense for the year ended December 30, 2006 ~~were $3.3 million, an increase of $0.3 million~~as compared to the year ended December 31, ~~2005. The increase~~2005 is related primarily to increases of (i) $0.4 million in ~~part to increased~~personnel-related expenses as a result of an increase in personnel, salaries and bonuses in fiscal 2006 and (ii) $0.2 million in stock-based ~~compensation.~~compensation expense. These increases were partially offset by ~~a decrease~~decreases of (i) $0.1 million in depreciation expense and (ii) $0.1 million in outside services and professional fees.

Selling, General and ~~Administrative.~~Administrative~~Selling,~~

The following table presents selling, general and administrative expenses for the years ended December 30, 2006 and December 31, 2005 (in thousands, except percentages):

		Year Ended
		December 30, 2006			December 31, 2005			Increase			% Change
Selling, general and administrative		$	9,191		$	5,062		$	4,129		82	%

The increase in selling, general and administrative expense for the year ended December 30, 2006 ~~were $9.2 million, an increase of $4.1 million~~as compared to the year ended December 31, ~~2005. The increase~~2005 is primarily attributable to increases of (i) $2.8 million as a result of higher sales commissions related to increased net sales, increased salaries and bonuses and related costs due to an increase in personnel and higher costs related to qualification of new products at customers, (ii) $0.4 million due to increased stock-based compensation expense and (iii) $0.4 million for a provision for bad debt ~~of approximately $0.4 million~~ related to a single distribution customer.

Other Expense, ~~Net.~~Net

The following table presents other income (expense) for the years ended December 30, 2006 and December 31, 2005 (in thousands, except percentages):

	Year Ended
	December 30, 2006			December 31, 2005			Increase (Decrease)			% Change
Interest expense, net	$	(1,825	)	$	(1,221	)	$	604		49	%
Other income (expense), net	$	(24	)	$	21			(45	)	(214	)%

Total other expense, net	$	(1,849	)	$	(1,200	)	$	559		47	%

Other expense, net, increased for the year ended December 30, 2006 ~~was $1.8 million, an increase of $0.6 million~~as compared to the year ended December 31, 2005 primarily due to higher interest expense related to increased borrowings under our revolving line of credit and convertible notes payable.

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

The following table presents the provision (benefit) for income taxes for the years ended December 30, 2006 and December 31, 2005 (in thousands, except percentages):

		Year Ended
		December 30, 2006			December 31, 2005			Increase			% Change
Provision (benefit) for income taxes		$	2,844		$	(912	)	$	3,756		412	%

We recorded a provision for income taxes for the year ended December 30, 2006 ~~was $2.8 million~~as compared to an income tax benefit ~~of $0.9 million~~ in the year ended December 31, ~~2005. The change was~~2005 due to our attaining profitability in fiscal 2006.

~~Year Ended December 31, 2005 Compared to the Year Ended January 1, 2005~~

~~Net Sales.~~Net sales for the year ended December 31, 2005 were $79.9 million, a decrease of $63.8 million, or 44%, from the year ended January 1, 2005. This decrease was due to a $72.6 million decrease in net sales to one key customer, partially offset by the commencement of shipments of our very low profile subsystem during the year ended December 31, 2005. The decrease in net sales to the key customer was attributable to its shift in memory technology from DDR to DDR2. Our net sales decreased significantly as the key customer delayed qualifying new suppliers during this transition.

Sales of our component inventory to distributors and other users of memory ICs represented 24% and 20% of net sales for the years ended December 31, 2005 and January 1, 2005, respectively. The increase in the proportion of component sales was due to the overall decrease in net sales, as sales of component inventory decreased $8.9 million from the year ended January 1, 2005.

~~Gross Profit and Gross Margin.~~Gross profit for the year ended December 31, 2005 was $6.0 million, a decrease of $4.2 million, or 41%, from the year ended January 1, 2005. Gross margin increased to 7.5% for the year ended December 31, 2005 from 7.1% for the year ended January 1, 2005. The decrease in gross profit was attributable to the overall decrease in net sales. The increase in gross margin was attributable to the higher margins realized on sales of our very low profile memory subsystems compared to our other products.

~~Research and Development.~~Research and development expenses in the year ended December 31, 2005 were $3.0 million, a decrease of $0.8 million from the year ended January 1, 2005. This decrease was attributable to reductions in personnel, a decrease in stock-based compensation expense due to forfeitures of equity awards related to personnel reductions, as well as a recovery of costs through the liquidation of engineering samples.

~~Selling, General and Administrative.~~Selling, general and administrative costs in the year ended December 31, 2005 were $5.1 million, a decrease of $1.2 million compared to the year ended January 1, 2005. This decrease was primarily related to the absence in 2005 of costs incurred in 2004 related to our proposed equity financing through an initial public offering. These offering-related costs totaled $1.0 million during the year ended January 1, 2005.

~~Other Expense, Net.~~Other expense, net, during the year ended December 31, 2005 was $1.2 million, a decrease of $0.2 million compared to the year ended January 1, 2005. The decrease was related to a reduction in interest expense due to decreased usage of accounts receivable financing related to a key customer.

~~Provision (Benefit) for Income Taxes.~~The benefit for income taxes during the year ended December 31, 2005 increased $0.6 million compared to the year ended January 1, 2005 due to the increased pre-tax losses in the year ended December 31, 2005.

Selected Quarterly Financial Information

The following table presents our unaudited quarterly statements of operations for each of the eight quarters in the two-year period ended December ~~30, 2006.~~29, 2007. You should read the following table in conjunction with our audited consolidated financial statements and related notes contained elsewhere in this ~~report.~~Report. We have prepared the underlying unaudited financial statements on the same basis as our audited consolidated financial statements included in this ~~report,~~Report, which include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future periods.

	Three Months Ended																												Three Months Ended
	April 2, 2005			July 2, 2005			October 1, 2005				December 31, 2005				April 1, 2006				July 1, 2006		September 30, 2006			December 30, 2006					December 29, 2007			September 29, 2007			June 30, 2007			March 31, 2007			December 30, 2006			September 30, 2006			July 1, 2006			April 1, 2006
	(in thousands, except share and per share data)																												(in thousands, except shares and per share data)
Net sales	$	20,956		$	15,539			$	20,057			$	23,304			$	26,020		$	39,914		$	43,505		$	42,009	Net sales		$	22,517		$	27,194		$	12,811		$	37,538		$	42,009		$	43,505		$	39,914		$	26,020
Cost of sales	20,087			14,232				18,163				21,410				23,466			33,981			36,524			35,210		Cost of sales			17,411			23,027			18,734			32,089			35,210			36,524			33,981			23,466
Gross profit	869			1,307				1,894				1,894				2,554			5,933			6,981			6,799

Gross profit (loss)																											Gross profit (loss)			5,106			4,167			(5,923	)		5,449			6,799			6,981			5,933			2,554

Operating expenses:																											Operating expenses:
Research and development	916			960				617				468				666			848			874			927
Selling, general & administrative	1,194			1,106				1,394				1,368				1,803			2,108			2,583			2,697
Total operating expenses	2,110			2,066				2,011				1,836				2,469			2,956			3,457			3,624
																											Research and development			947			1,256			1,478			1,067			927			874			848			666
																											Selling, general and administrative			4,311			4,040			3,845			3,704			2,697			2,583			2,108			1,803

																												Total operating expenses		5,258			5,296			5,323			4,771			3,624			3,457			2,956			2,469

Operating income (loss)	(1,241		)	(759		)		(117		)		58				85			2,977			3,524			3,175		Operating income (loss)			(152	)		(1,129	)		(11,246	)		678			3,175			3,524			2,977			85
Other expense, net	248			235				254				463				410			534			652			253
Other income (expense), net:																											Other income (expense), net:			183			109			166			(47	)		(253	)		(652	)		(534	)		(410	)

Income (loss) before provision (benefit) for income taxes	(1,489		)	(994		)		(371		)		(405		)		(325		)	2,443			2,872			2,922		Income (loss) before provision (benefit) for income taxes			31			(1,020	)		(11,080	)		631			2,922			2,872			2,443			(325	)
Provision (benefit) for income taxes	(399		)	(296		)		(116		)		(101		)		(83		)	895			1,084			948		Provision (benefit) for income taxes			202			(363	)		(3,864	)		—			948			1,084			895			(83	)

Net income (loss)	$	(1,090	)	$	(698	)		$	(255	)		$	(304	)		$	(242	)	$	1,548		$	1,788		$	1,974	Net income (loss)		$	(171	)	$	(657	)	$	(7,216	)	$	631		$	1,974		$	1,788		$	1,548		$	(242	)

Net income (loss) per common share:																											Net income (loss) per common share:
Basic	$	(0.10	)	$	(0.07	)		$	(0.03	)		$	(0.02	)		$	(0.02	)	$	0.14		$	0.16		$	0.14
Diluted	$	(0.10	)	$	(0.07	)		$	(0.03	)		$	(0.02	)		$	(0.02	)	$	0.11		$	0.12		$	0.12
																											Basic		$	(0.01	)	$	(0.03	)	$	(0.37	)	$	0.03		$	0.14		$	0.16		$	0.14		$	(0.02	)
																											Diluted		$	(0.01	)	$	(0.03	)	$	(0.37	)	$	0.03		$	0.12		$	0.12		$	0.10		$	(0.02	)
Weighted-average common shares outstanding:																											Weighted-average common shares outstanding:
Basic	10,672			10,672				10,673				10,673				10,753			11,223			11,235			13,616
Diluted	10,672			10,672				10,673				10,673				10,753			15,681			15,401			16,793
																											Basic			19,730			19,689			19,653			19,624			13,616			11,235			11,223			10,753
																											Diluted			19,730			19,689			19,653			21,425			16,793			15,401			15,681			10,753

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

Liquidity and Capital Resources

~~Cash Flows~~

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

Year Ended

January 1,
2005

December 31,
2005

December 30,
2006

Net cash provided by (used in):

Operating activities

$
(6,567
)

$
(4,608
)

$
(9,785
)

Investing activities

(496
)

1,332

(9,028
)

Financing activities

5,915

3,470

48,835

Net increase (decrease) in cash and cash equivalents

$
(1,148
)

$
194

$
30,022

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

Working Capital and Cash and Marketable Securities

The following table presents working capital, cash and cash equivalents and investments in marketable securities (in thousands):

	December 29, 2007		December 30, 2006
Working Capital	$	27,387	$	45,584

Cash and cash equivalents(1)	$	7,182	$	30,975
Short-term marketable securities(1)		15,573		5,267
Long-term marketable securities		7,814		1,502

	$	30,569	$	37,744

(1): Included in working capital

Our working capital decreased ~~to $800,000 at~~in the ~~end of the second quarter of fiscal 2005 due to a reduction in our borrowing base caused by the decrease in revenue from Dell. Availability has increased to $4.9 million as of~~year ended December ~~30, 2006 due to an increase in our borrowing base~~29, 2007 primarily as a result of ~~revenue growth~~(i) additional net purchases of long-term investments in marketable securities of approximately $6.3 million, (ii) purchases of equipment and leasehold improvements of approximately $6.3 million and (iii) decreases in certain current operating assets and liabilities, primarily due to the overall decline in net sales during the year.

Cash Provided and Used in the Years Ended December 29, 2007 and December 30, 2006

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

	Year Ended
	December 29, 2007			December 30, 2006
Net cash provided by (used in):
Operating activities	$	14,076		$	(9,785	)
Investing activities		(22,922	)		(9,028	)
Financing activities		(14,947	)		48,835

Net increase (decrease) in cash and cash equivalents	$	(23,793	)	$	30,022

Operating Activities. Net cash provided by operating activities for the year ended December 29, 2007 was primarily the result of (i) approximately $5.7 million in net non-cash operating expenses, mainly comprised of inventory adjustments, depreciation and amortization, stock-based compensation, impairment of long-lived assets and deferred income taxes and (ii) approximately $15.8 million in net cash provided by changes in operating assets and liabilities, partially offset by a net loss of approximately $7.4 million.

Accounts receivable decreased approximately $11.7 million during fiscal ~~2006.~~

~~In December 2006,~~2007 primarily as a result of the ~~Company sold 6,250,000 shares~~overall decline in our net sales during the year. During 2007, we were successful in collecting cash from sales to our customers substantially in accordance with our standard payment terms to those customers.

Inventories decreased approximately $16.1 million during fiscal 2007 primarily as a result of ~~its common stock~~(i) the overall decline in ~~its initial public offering at an offering price~~our net sales during the year, (ii) sales of ~~$7.00 per share, resulting in total~~inventories on hand during the current year to our customers, which generated net cash proceeds of ~~$39.5~~approximately $10.8 million ~~net of underwriters’ discounts~~in 2007 and ~~offering expenses~~(iii) a loss of approximately ~~$4.2 million.~~$5.3 million due to slow moving and lower-of-cost-or-market value inventory adjustments. In the future, our inventory levels will continue to be determined based on, among other factors, the level of customer orders received and overall demand as well as the stage at which our products are in their respective life cycles and competitive situations in the marketplace. We make efforts to balance such considerations against the risk of obsolescence or potentially excess inventory levels.

~~Operating Activities.~~ Accounts payable decreased approximately $5.0 million during fiscal 2007 primarily as a result of an overall decline in materials purchasing levels during the year given our decline in net sales. Cash payments primarily for the purchase of manufacturing materials and related goods for resale to our customers used net operating cash of approximately $5.1 million during 2007.

Net cash used in operating activities for the year ended December 30, 2006 was ~~$9.8~~primarily the result of approximately $16.4 million in net cash used by changes in operating assets and liabilities, partially offset by net income of approximately $5.1 million and net non-cash operating expenses of approximately $1.6 million, primarily comprising depreciation and amortization and stock-based compensation. As compared to ~~$4.6 million for~~fiscal 2005, the ~~year ended December 31, 2005. This~~overall change in cash used in operating activities in 2006 was primarily due to an increase in cash flow related to net income of ~~$7.4~~$5.1 million offset by (i) a decrease in cash flow related to accounts receivable of ~~$6.3~~$6.2 million due to a higher proportion of net sales being generated by customers with longer payment ~~terms;~~terms, (ii) a decrease in cash flow related to net inventories of $13.2 million as we increased inventory levels to support higher sales volumes and (iii) an increase in cash flow related to accounts payable of $4.1 million as we trade financed our inventory increase and other operating expenses. In addition, cash flow related to income taxes payable increased $0.6 million as we attained profitability in the first half of 2006 and started to accumulate an income tax liability that was paid later in 2006.

~~Cash~~ Investing Activities. Net cash used in ~~operating~~investing activities for the year ended December ~~31, 2005~~29, 2007 was ~~$4.6~~primarily the result of purchases of additional investments in marketable securities of approximately $63.3 million, as compared to $6.6 million for the year ended January 1, 2005. This change was attributable to a decrease in cash flow related to net loss of $1.4 million, a decrease in cash flow related to accounts receivable of $0.8 million due to a higher proportion of sales being generated by customers with longer payment terms; and a decrease in cash flow related to inventories of $2.2 million. These declines werepartially offset by ~~an increase~~proceeds received from maturities and sales of certain investments in ~~cash flow related to accounts payable~~marketable securities of ~~$4.0 million and an increase in cash flow related to income taxes of $2.9 million as~~approximately $46.6 million. In 2007 we continued to ~~incur losses, did not have~~invest the majority of the proceeds from our initial public offering, or IPO, in various marketable securities investments in connection with our efforts to ~~pay income taxes~~both preserve capital as well as achieve competitive returns on our investments. We also used approximately $6.3 million in cash primarily to purchase equipment and ~~received a tax refund~~leasehold improvements related to our new facilities in ~~2005 as a result of carrying back net operating losses to prior years.~~the PRC and in Irvine, California.

~~Investing Activities.~~ Net cash used in investing activities for the year ended December 30, 2006 was ~~$9.0~~primarily the result of (i) purchases of investments in marketable securities of approximately $6.8 million as ~~compared to cash generated by~~a result of investing activities of $1.3 million for the year ended December 31, 2005. This change is attributable to a decrease in proceeds of $1.8 million received from the sale of the building housing our manufacturing operation in 2005 to raise capital to fund our operations; an increase in manufacturing equipment purchases of $2.0 million required to support increased sales

~~volumes and long term and short term investments of~~ a portion of the proceeds from ~~the~~our IPO and (ii) purchases of ~~$6.8 million.~~

~~Net cash provided from investing activities was $1.3 million~~manufacturing equipment of approximately $2.5 in ~~2005~~order to support increased sales in fiscal 2006 as compared to ~~net~~fiscal 2005.

Financing Activities. Net cash used in ~~investing~~financing activities for the year ended December 29, 2007 was primarily the result of ~~$0.5~~net repayments on our outstanding revolving line of credit of approximately $14.4 million, along with net repayments on our long term debt of approximately $1.0 million. These repayments were slightly offset by approximately $0.3 million in ~~2004. This change is attributable to~~cash provided through the ~~proceeds~~exercise of $1.8 million from the sale of the building housing our manufacturing operation in 2005 to raise capital to fund our operations. We currently lease back the building, and there was no disruption of manufacturing due to this transaction.stock options during 2007.

~~Financing Activities.~~ Net cash provided by financing activities for the year ended December 30, 2006 was ~~$48.8~~primarily the result of (i) approximately $39.5 million received as ~~compared to net cash provided by financing activities~~a result of ~~$3.5 million for~~ the ~~year ended December 31, 2005. This change was primarily due the Company’s~~ sale of ~~its~~ common stock in ~~its initial public offering resulting in total proceeds of $39.5 million,~~our IPO, net of ~~underwriters’~~underwriters' discounts and offering expenses of approximately $4.2 million and ~~increased usage~~

(ii) approximately $9.8 million in net borrowings of our revolving line of credit used to ~~finance~~assist in financing our working capital needs as a result of ~~our accelerating growth.~~

~~Net cash provided from financing activities~~significant growth in ~~2005 was $3.5 million~~2006 as compared to $5.9 million in 2004. This change is attributable to approximately $1.4 million less in net borrowings against our revolving line of credit and an increase in net payments on capital leases and other debt of $1.0 million.2005.

Capital Resources

In August 2006, we amended our credit agreement with our bank. The credit agreement, as amended, provides for a revolving line of credit with maximum borrowings of $25 million, a term loan of $2 million, and an equipment financing line of credit with maximum borrowings of $2 million. Prior to August 2006, the credit agreement provided for a revolving line of credit of $15 million and no term loan or equipment line of credit. In August 2006, we used approximately $1 million of the proceeds from the term loan to repay convertible debt of $950,000 plus accrued interest that had become ~~due and payable. The~~due.The interest rate under the term loan was less than that of the convertible debt repaid.

~~Under~~ In April 2007, we executed a seventh amendment to our credit agreement with our bank, which was effective March 21, 2007. This amendment allows us, at our election, to increase our maximum borrowings on the ~~revolving~~ line of credit ~~we may borrow~~from $25 million, in $2.5 million increments, up to a total of $40 million. In addition, among other terms, the ~~greater of 85% of eligible accounts receivable plus the least of~~amendment (i) a percentage of eligible inventory determined from time to time by the Company’s bank, (ii) 80% of the orderly liquidation value, as defined, of eligible inventories, and (iii) $7 million. Interest is payable monthly at the prime rate of 8.25% as of December 2006. Outstanding borrowings under the revolving line of credit were $19.2 million as of December 30, 2006 and $9.5 million as of December 31, 2005. Borrowing availability as of December 30, 2006 was $4.9 million.

Under the new equipment financing line of credit, we may borrow up to 80% of the cost of equipment purchases up to the maximum of $2 million. Interest on equipment line of credit advances was payable at the prime rate plus 0.5% prior to the Company’s initial public offering in December 2006 and was reduced to the prime rate thereafter. Principal is due monthly throughextends the maturity date of the ~~credit agreement in July 2008, when all unpaid principal and interest is due. Outstanding borrowings under the new equipment~~ line of credit ~~were $1.1~~to July 31, 2009, (ii) establishes an equipment advance line of $3 million, as(iii) increases the sublimit for letters of ~~December 30, 2006.~~credit to $5 million, (iv) sets an inventory sublimit of $7 million, subject to increase to $10 million if certain targets are met and (v) provides for the reduction in interest rates on borrowings if certain borrowing amounts and financial performance targets are met.

~~The $2 million term loan was fully repaid in December 2006 in connection with the closing of~~ In July 2007, we executed an eighth amendment to our ~~initial public offering.~~

~~Under the terms of the~~ credit agreement, ~~as amended,~~which was effective June 29, 2007, and which revised the various financial and other covenants of which we are required to ~~comply with certain financial and other covenants.~~comply. The ~~financial covenants require~~amendment requires us to (i) achieve minimum book net worth on a monthly basis, ~~minimum net income on a quarterly basis, and~~(ii) limit annual capital expenditures under a defined annual ~~cap. Also, we are required to~~cap, (iii) achieve certain minimum monthly profitability thresholds and (iv) maintain a minimum ~~debt service coverage ratio in relation to~~liquidity threshold as of the ~~term loan and equipment line~~end of ~~credit.~~each month. While we are currently in compliance with all financial covenants and expect to maintain compliance for the foreseeable future, we have in the past been in violation of one or more covenants. As of December 31, 2005, January 28, 2006 and February 25, 2006, we were not in compliance with covenants related to minimum book net worth, maximum year to date and monthly net loss as a result of the unanticipated decline in our revenues in fiscal 2005 and early fiscal 2006

as compared to the forecasts that were utilized to establish the covenants. A delay in the delivery of audited financial statements for fiscal 2004 and fiscal 2005 due to turnover in staffing within our finance department caused us to violate another covenant. Our finance staffing has been stabilized since the beginning of fiscal 2006. In April 2006, we received a waiver from our lender for all of these covenant violations. We cannot assure you that we will not violate one or more covenants in the future. If we were to be in violation of covenants under our credit agreement, our lender could choose to accelerate payment on all outstanding loan balances. There can be no assurance that we would be able to quickly obtain equivalent or suitable replacement financing in this event. If we were not able to secure alternative sources of funding, such acceleration would have a material adverse impact on our financial condition.

Under the revolving line of credit, we may borrow up to the greater of 85% of eligible accounts receivable plus the least of (i) a percentage of eligible inventory determined from time to time by our bank, (ii) 80% of the orderly liquidation value, as defined, of eligible inventories, and (iii) $7 million. Interest is payable monthly at the prime rate of 7.25% as of December 29, 2007. Outstanding borrowings under the revolving line of credit were approximately $4.9 million and $19.2 million as of December 29, 2007 and December 30, 2006, respectively. Borrowing availability as of December 29, 2007 was approximately $6.4 million.

Under the equipment financing line of credit, we may borrow up to 80% of the cost of equipment purchases up to a maximum of $3 million. Interest on equipment line of credit advances was payable at the prime rate plus 0.5% prior to our initial public offering in December 2006 and was reduced to the prime rate thereafter. Principal is due monthly through the maturity date of the credit agreement in July 2009, when all unpaid principal and interest is due. Outstanding borrowings under the equipment line of credit were approximately $0.9 million and $1.1 million at December 29, 2007 and December 30, 2006, respectively.

Any borrowings under the revolving and equipment lines of credit are collateralized by a general first priority lien against all of our assets, both tangible and intangible.

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

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

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.

Contractual Obligations

The following table ~~outlines~~summarizes our principal obligations and commitments, excluding periodic interest payments, as of December ~~30, 2006:~~29, 2007 (in thousands):

		Within One Year		1-3 Years		4-5 Years		After 5 Years		Total
Scheduled payments under contractual obligations:
Long-term debt		$	454		492		—		—	$	946
Capital lease obligations			287		145		—		—		432
Operating leases			743		1,949		20		—		2,712
Purchase commitments			524		354		—		—		878

	Total		2,008		2,940		20		—		4,968
Potential cash requirements under existing commitments:
Letters of credit			500		—		—		—		500

	Total	$	2,508	$	2,940	$	20	$	—	$	5,468

For purposes of the table above, obligations for purchase commitments are defined as agreements that represent a firm commitment and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on our current manufacturing needs and are typically fulfilled by our vendors within a relatively short time horizon. We have additional purchase orders (not included in the table above) that represent authorizations to purchase for which we generally have a contractual right to increase or decrease quantities as needed. We do not have significant agreements for the purchase of inventories or other goods specifying minimum quantities or set prices that exceed our expected requirements.

Within
One Year

1-3 Years

4-5 Years

After 5
Years

Total

(in thousands)

Scheduled payments under contractual obligations:

Long-term debt

$
595

$
687

$
179

$
—

$
1,461

Capital lease obligations

438

318

46

—

802

Operating leases

173

260

124

—

557

Purchase commitments

690

—

—

—

690

Total

1,896

1,265

349

—

3,510

Potential cash requirements under existing commitments:

Letters of credit

500

—

—

—

500

Total

$
2,396

$
1,265

$
349

$
—

$
4,010

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

New Accounting Pronouncements

In June ~~2006,~~2007 the FASB ~~issued Interpretation~~ratified EITF No. ~~48,~~ 07-3,Accounting for ~~Uncertainty~~Nonrefundable Advance Payments for Goods or Services to Be Used in ~~Income Taxes—an interpretation of FASB Statement~~Future Research and Development Activities, or EITF No. ~~109~~ ~~(“FIN 48”), which clarifies the accounting~~07-3. EITF No. 07-3 requires non-refundable advance payments for ~~uncertainty in income taxes. FIN 48 prescribes a recognition threshold~~goods and ~~measurement attribute for the financial statement recognition and measurement of a tax position taken or expected~~services to be ~~taken~~used in ~~a tax return. The Interpretation requires that~~future research and development activities to be recorded as an asset and the ~~Company recognize in~~payments to be expensed when the ~~financial statements the impact of tax position, if that position~~research and development activities are performed. EITF No. 07-3 is ~~more likely than not of being sustained on audit, based on the technical merits~~

~~of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are~~ effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The Company is currently in the process of assessing the impact the adoption of FIN 48 will have on its consolidated financial statements.

~~In September 2006, the FASB issued SFAS No. 157,~~ ~~Fair Value Measurements~~. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Specifically, SFAS No. 157 sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The provisions of SFAS No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under SFAS No. 133, ~~Accounting for Derivative Instruments and Hedging Activities~~, for which the provisions of SFAS No. 157 should be applied retrospectively. The Company will adopt SFAS No. 157 in the first quarter of 2008 and is still evaluating the effect, if any, on its financial position or results of operations.

~~In September 2006, the SEC staff issued SAB No. 108,~~ ~~Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements~~. SAB No. 108 was issued in order to eliminate the diversity in practice surrounding how public companies quantify financial statement misstatements. SAB No. 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of this statement2007. This standard is not expected to have a material impact on ~~the Company’s~~our future consolidated financial ~~condition or results of operations.~~statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our bank credit facility because borrowings under all lines under the facility are variable rate borrowings, generally at prime. Assuming that all lines under the facility are fully available and drawn and holding other variables constant, each 1.0% increase in interest rates on our variable rate borrowings will result in an increase in annual interest expense and a decrease in our cash flows and income before taxes of approximately ~~$0.2~~$0.4 million per year. ~~We do~~To date, we have not ~~use~~used derivative instruments to hedge the interest rate risk related to our credit facility.

We have invested most of the proceeds of our initial public offering in securities which may be subject to market risk for changes in interest rates. To mitigate this risk, we maintain a portfolio of cash equivalents and ~~short-term~~ investments in a variety of marketable securities, which meet high quality credit standards, as specified in our investment policy, and include commercial paper, money market funds, government and non-government debt securities and auction rate securities. ~~Currently, we are exposed~~Our investment policy guidelines generally limit the amount of credit exposure to ~~minimal market risks.~~

~~Off-Balance Sheet Arrangements~~

any one issue, issuer or type of instrument. We currently do not ~~have any relationships~~use derivative financial instruments.

Our cash equivalents and investments in marketable securities are classified as available-for-sale in accordance with ~~unconsolidated entities~~SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, or ~~financial partnerships, such~~SFAS No. 115, and are therefore stated at fair value. Differences between fair value and amortized cost are recorded as ~~entities often referred to~~unrealized gains and losses and are reported, net of taxes, as ~~structured finance or special purpose entities, which would have been established for~~a component of accumulated other comprehensive income (loss). The fair value of our investments in marketable securities fluctuates based on changes in market conditions and interest rates; however, given the ~~purpose~~general short-term maturities of ~~facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition,~~our investments, we do not believe these instruments are subject to significant market or interest rate risk.

Due to disruptions of, and the resulting reduced liquidity in certain financial markets in 2007, two of our AAA rated auction rate securities with a total purchased cost of approximately $2.0 million experienced failed auctions during the fourth quarter of 2007. Due to the failed auctions, we were unable to sell the securities at their respective costs, resulting in a decrease in fair value which has been recorded as a component of accumulated other comprehensive loss in accordance with SFAS No. 115. These investments have been classified as long-term investments in marketable securities in our consolidated balance sheet as of December 29, 2007. As of February 23, 2008, the unrealized loss on these two investments was approximately $141,000. We have concluded that the unrealized losses on these two investments are temporary because (i) we believe that the decline in market value that has occurred is due to general market conditions, (ii) the auction rate securities continue to be of a high credit quality and interest is paid as due and (iii) we have the intent and ability to hold these

investments until a recovery in market value occurs. The fair value of these securities could change significantly in the future and we may be required to record other-than-temporay impairment charges or additional unrealized losses in future periods.

Unrealized losses on certain of our other investments as of the end of 2007 were due primarily to changes in interest rates. We have determined that the unrealized losses on all of our investments in marketable securities at December 29, 2007 are temporary in nature. We review our investments to evaluate indications of possible impairment. Factors considered in determining whether impairments are other than temporary include the length of time and extent to which fair value has been less than the amortized cost basis, the financial condition and near-term prospects of the investee and our intent and ability to hold an investment for a period of time sufficient to allow for any ~~undisclosed borrowings or debt,~~anticipated recovery in market value.

Fixed rate securities may have their market value adversely impacted due to rising interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates.

The carrying value, maturity and estimated fair value of our cash equivalents and investments in marketable securities as of December 29, 2007 were as follows (in thousands, except interest rates):

					Maturity
		Carrying Value December 29, 2007			Within One Year after December 29, 2007			Greater Than One Year After December 29, 2007			Fair Value December 29, 2007
Investments
Cash equivalents		$	6,895		$	6,895		$	—		$	6,895
	Weighted average interest rate		4.91	%		4.91	%		—	%
Marketable securities		$	23,387		$	15,573		$	7,814		$	23,387
	Weighted average interest rate		5.68	%		5.88	%		5.13	%

Exchange Rate Risk

We consider our direct exposure to foreign exchange rate fluctuations to be minimal. Currently, sales to our customers provide for pricing and payment in U.S. dollars, and, therefore, are not subject to exchange rate fluctuations. Increases in the value of the U.S. dollar relative to other currencies could make our products more expensive, which could negatively impact our ability to compete. As a result of our foreign operations, we have certain costs, assets and liabilities that are denominated in foreign currencies, and therefore, decreases in the value of the U.S. dollar could result in increases in our manufacturing costs that could have a material adverse effect on our business, financial condition and results of operations. To date, we have not ~~entered into any synthetic leases. We are, therefore, not materially exposed~~used derivative instruments to ~~any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.~~manage risks related to foreign currency exchange rate fluctuations.

Item 8. Financial Statements and Supplementary Data

~~See Index to Consolidated Financial Statements.~~ The financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Report.

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

~~Not Applicable.~~ In 2006 we appointed KMJ Corbin & Company LLP as our new independent registered public accounting firm to conduct the audit of our financial statements beginning as of and for the year ended December 31, 2005, with quarterly reviews of our financial statements beginning as of and for the quarter ended April 1, 2006. The decision to engage KMJ Corbin & Company LLP was recommended by management and approved by the Audit Committee of the Board of Directors.

Item 9A. Controls and Procedures

Conclusion Regarding the Effectiveness of 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 Securities Exchange Act of 1934, as amended (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 ~~of December 30, 2006.~~appropriate to allow timely decisions regarding required disclosures.

~~Management’s~~Management's Report on Internal Control Over Financial Reporting

~~This annual report does not include a report of management’s assessment regarding~~ Our management is responsible for establishing and maintaining adequate internal control over financial reporting, oras 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 29, 2007 based on the criteria set forth inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the criteria set forth inInternal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 29, 2007.

This Annual Report does not include an attestation report of our independent registered public accounting firm ~~due~~regarding internal control over financial reporting. We were not required to ~~a transition period established by~~have, nor have we engaged our independent registered public accounting firm to perform, an audit on our internal control over financial reporting pursuant to the rules of the Securities and Exchange Commission ~~for newly public companies.~~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 fiscal ~~2006~~2007 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.

Item 9B. Other Information

None.

~~Not Applicable.~~

PART III

Certain information required by this Part III is omitted from this Annual Report as we will 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 Governance

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

We have adopted a ~~“Code~~"Code of Business Conduct and ~~Ethics”~~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.~~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 Securities and Exchange Act rules, we intend to disclose such amendment or waiver and the reasons therefor on our Internet site.

Item 11. Executive Compensation

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

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

The information required by this Item is incorporated herein by reference to the section entitled ~~“Security~~"Security Ownership of Certain Beneficial Owners and ~~Management”~~Management" and ~~“Equity~~"Equity Compensation Plan ~~Information”~~Information" in our Proxy Statement.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this Item is incorporated herein by reference to the section entitled ~~“Certain~~"Certain Relationships and Related ~~Transactions”~~ Transactions" in our Proxy Statement.

Item 14. Principal Accounting Fees and Services

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

PART IV

Item 15. Exhibits, Financial Statement Schedules

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

~~Reports~~(a)(1)	All financial statements filed as part of this report.
	Report of Independent Registered Public Accounting ~~Firms~~ Firm	F-2
	Consolidated Balance Sheets	~~F-4~~ F-3
	Consolidated Statements of Operations	~~F-5~~ F-4
	Consolidated Statements of ~~Stockholders’~~Stockholders' Equity	~~F-6~~ F-5
	Consolidated Statements of Cash Flows	~~F-7~~ F-6

~~(a)(2) All financial statement schedules filed as part of this report.~~

~~Reports~~ (a)(2)	All financial statement schedules filed as part of this report.
	Report of Independent Registered Public Accounting ~~Firms~~Firm on Financial Statement Schedule	~~F-29~~ S-1
	Schedule II—Consolidated Valuation and Qualifying Accounts	~~F-30~~ S-2
All other schedules for which provision is made in the applicable accounting regulations of the Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the consolidated financial statements, and therefore have been omitted.
(a)(3)	Exhibits

All other schedules for which provision is made in the applicable accounting regulations of the Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the consolidated financial statements, and therefore have been omitted.

~~(a)(3) Exhibits~~

3.1(1)		Restated Certificate of Incorporation of Netlist, Inc.
3.2(1)		Amended and Restated Bylaws of Netlist, Inc.

10.1(2)		Amended and Restated Credit and Security Agreement, dated as of December 27, 2003, among Netlist, Inc., Netlist Technology Texas, L.P. (“("Netlist ~~Texas”~~Texas"), and Wells Fargo Business Credit, Inc. (“("Wells ~~Fargo”~~Fargo").
~~10.2(2)~~ 10.2(2)		First Amendment to Amended and Restated Credit and Security Agreement, dated as of June 30, 2004, among Netlist, Inc., Netlist Texas and Wells Fargo.
~~10.3(2)~~ 10.3(2)		Second Amendment to Credit and Security Agreement and Waiver of Defaults, dated as of December 20, 2005, among Netlist, Inc., Netlist Texas and Wells Fargo.
~~10.4(2)~~ 10.4(2)		Third Amendment to Amended and Restated Credit and Security Agreement, dated as of February 14, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
~~10.5(2)~~ 10.5(2)		Fourth Amendment to Amended and Restated Credit and Security Agreement and Waiver of Defaults, dated as of April 18, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
~~10.6(2)~~ 10.6(2)		Fifth Amendment to Amended and Restated Credit and Security Agreement, dated as of July 28, 2006, among Netlist, Inc., Netlist Texas and Wells Fargo.
10.7(1)#		Amended and Restated 2000 Equity Incentive Plan of Netlist, Inc.
10.8(2)#		Letter agreement regarding employment, dated January 11, 2006, between Netlist, Inc. and Lee Kim.
~~10.9(2)~~ 10.9(2)		Full-time Permanent Engagement Resources Agreement, dated as of January 10, 2006, between Netlist, Inc. and Tatum, LLC.

~~10.10(3)~~ 10.10(3)		Master Sales and Supply Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.
~~10.11(2)~~ 10.11(2)		Management Fee Agreement, dated as of January 1, 2004, between Netlist, Inc. and Netlist Texas.
~~10.12(2)~~ 10.12(2)		Form of Indemnity Agreement for officers and directors.
~~10.13(3)~~ 10.13(3)#		Employment Agreement, dated September 5, 2006, between Netlist, Inc. and Chun K. Hong.
~~10.14(3)~~ 10.14(3)#		Form of Performance Incentive Agreement entered into by Netlist, Inc. with each of Christopher Lopes, Jayesh Bhakta and Paik Ki Hong in August 2006.
~~10.15(3)~~ 10.15(3)#		Form of Amendment to Performance Incentive Agreement entered into by Netlist, Inc. with each of Christopher Lopes, Jayesh Bhakta and Paik Ki Hong in September 2006.
~~10.16(1)~~ 10.16(1)#		2006 Equity Incentive Plan of Netlist, Inc.
~~10.17(1)~~ 10.17(1)		Note Purchase Agreement, dated October 3, 2005, between Netlist, Inc. and Serim Paper Manufacturing Co., Ltd. (“("Serim ~~Paper”~~Paper").
~~10.18(1)~~ 10.18(1)		7.5% Promissory Note, dated October 3, 2005, issued by Netlist, Inc. to Serim Paper.
~~10.19(1)~~ 10.19(1)		Note Purchase Agreement, dated February 12, 2006, between Netlist, Inc. and Serim Paper.
~~10.20(1)~~ 10.20(1)		6.5% Promissory Note, dated February 12, 2006, issued by Netlist, Inc. to Serim Paper.
~~10.21~~ 10.21(4)		Sixth Amendment to Amended and Restated Credit and Security Agreement, dated as of December 29, 2006.
~~14.1(1)~~ 10.22(5)		Lease (Multi-Tenant; Net), dated April 2, 2007, by and between The Irvine Company LLC, a Delaware limited liability company, and Netlist, Inc., a Delaware corporation.
10.23(5)		Seventh Amendment to Amended and Restated Credit and Security Agreement, dated effective as of March 21, 2007, by and among Netlist, Inc., a Delaware corporation, Netlist Technology Texas, L.P., a Texas limited partnership, and Wells Fargo Bank, National Association.
10.24(6)		Eighth Amendment to Amended and Restated Credit and Security Agreement, dated effective as of June 29, 2007, by and among Netlist, Inc., a Delaware corporation, Netlist Technology Texas, L.P., a Texas limited partnership, and Wells Fargo Bank, National Association.
10.25(7)		Offer Letter to Nita Moritz dated August 16, 2007
10.26(8)#		Stock Option Agreement dated September 17, 2007 for options to purchase 200,000 shares of the Registrant's common stock awarded to Nita J. Moritz
14.1(1)		Code of Business Conduct and Ethics.
~~21.1(2)~~ 21.1(9)		Subsidiaries of Netlist, Inc.
~~23.1~~ 23.1(9)		Consent of KMJ Corbin & Company LLP.
24.1

~~23.2~~		~~Consent of Deloitte & Touche LLP.~~
~~24.1~~		Power of Attorney (included on the signature page in this Part IV of this report).
~~31.1~~ 31.1(9)		Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a-15(e) or Rule 15d-15(e).

~~31.2~~ 31.2(9)		Certification of Chief Financial Officer of Periodic Report Pursuant to Rule 13a-15(e) or Rule 15d-15(e).
32 32(9)		Certification by Chief Executive Officer and Chief Financial Officer of Periodic Report Pursuant to 18 U.S.C. Section 1350.

(1)

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

(2)

(3)

(4)

Incorporated by reference to the corresponding exhibit number of the annual report on Form 10-K of the registrant filed with the Securities and Exchange Commission on February 28, 2007.

(5)

Incorporated by reference to exhibit numbers 10.1 and 10.2 of the current report on Form 8-K of the registrant filed with the Securities and Exchange Commission on April 6, 2007.

(6)

Incorporated by reference to exhibit numbers 10.1 of the quarterly report on Form 10-Q of the registrant filed with the Securities and Exchange Commission on August 14, 2007.

(7)

Incorporated by reference to the corresponding exhibit number of the current report on Form 8-K of the registrant filed with the Securities and Exchange Commission on September 18, 2007.

(8)

Incorporated by reference to exhibit number 4.3 of the registration statement on Form S-8 of the registrant (No. 333-146192) filed with the Securities and Exchange Commission on September 20, 2007.

(9)

Filed herewith

#

Management contract or compensatory plan or arrangement.

~~(b)~~

(b)		Exhibits
See subsection (a)(3) above.
(c)		Financial Statement Schedules
See subsections (a)(1) and (2) above.

SIGNATURES

~~See~~ ~~subsection~~ ~~(a)(3) above.~~

~~(c)~~~~Financial Statement Schedules~~

~~See~~ ~~subsections~~ ~~(a)(1) and (2) above.~~

~~SIGNATURES~~

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, in the City of Irvine, State of California, on this 2729^th day of February, ~~2007.~~2008.

	NETLIST, INC.
~~By:~~	By:	/s/ Chun K. Hong
	Chun K. Hong
	President, Chief Executive Officer and
	Chairman of the Board

POWER OF ATTORNEY

Each person whose signature appears below constitutes and appoints Chun K. Hong and ~~Lee Kim,~~Gail Itow, jointly and severally, each in his or her own capacity, ~~his~~his/her true and lawful attorneys-in-fact, with full power of substitution, for ~~him~~him/her and ~~his~~his/her name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such said attorneys-in-fact and agents with full power and authority to do so and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:

	Signature			Title	Date

/s/ Chun K. Hong Chun K. Hong	President, Chief Executive Officer and
~~Chun K. Hong~~		Chairman of the Board		~~February 27, 2007~~
		(Principal Executive Officer)		February 29, 2008
/s/ ~~Lee Kim~~ Gail Itow Gail Itow	Vice President and Chief Financial Officer	~~February 27, 2007~~
~~Lee Kim~~		(Principal Financial Officer and Principal Accounting Officer)		February 29, 2008
	~~Accounting Officer)~~
/s/ Nam Ki Hong		~~Director~~		~~February 27, 2007~~
Nam Ki Hong		Director	February 29, 2008
	~~Director~~
/s/ Thomas F. Lagatta Thomas F. Lagatta		Director	February 29, 2008
/s/ Alan H. Portnoy	~~Director~~		~~February 27, 2007~~
Alan H. Portnoy		Director	February 29, 2008
/s/ David M. Rickey	~~Director~~		~~February 27, 2007~~
David M. Rickey		Director	February 29, 2008
/s/ Preston Romm	~~Director~~		~~February 27, 2007~~
Preston Romm		Director	February 29, 2008

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

			Page
~~Reports~~Report of Independent Registered Public Accounting ~~Firms~~ Firm	F-2
Consolidated Balance Sheets	~~F-4~~	F-3
Consolidated Statements of Operations	~~F-5~~	F-4
Consolidated Statements of ~~Stockholders’~~Stockholders' Equity	~~F-6~~	F-5
Consolidated Statements of Cash Flows	~~F-7~~	F-6
Notes to Consolidated Financial Statements	F-8
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule	S-1
Schedule II: Consolidated Valuation and Qualifying Accounts	~~F-30~~	S-2

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Netlist, Inc.

We have audited the accompanying consolidated balance sheets of Netlist, Inc. and subsidiaries (the ~~“Company”~~"Company") as of December ~~30, 2006~~29, 2007 and December ~~31, 2005,~~30, 2006, and the related consolidated statements of operations, ~~stockholders’~~stockholders' equity and cash flows for each of the ~~two~~three years in the period ended December ~~30, 2006.~~29, 2007. These consolidated financial statements are the responsibility of the ~~Company’s~~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~~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 for 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 ~~30, 2006~~29, 2007 and December ~~31, 2005,~~30, 2006, and the consolidated results of their operations and their cash flows for each of the ~~two~~three years in the period ended December ~~30, 2006~~29, 2007 in conformity with accounting principles generally accepted in the United States of America.

As described in Note 2 to the consolidated financial statements, on December 31, 2006, the Company changed its method of accounting for income tax uncertainties in accordance with guidance provided in FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109, and effective January 1, 2006, the Company changed its method of accounting for share-based compensation to adopt Statement of Financial Accounting Standards No. 123(R),Share-Based Payment.

/s/ KMJ CORBIN & COMPANY LLP
Irvine, California
February 27, ~~2007~~2008

F-
2

~~REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM~~

~~Board of Directors and Stockholders~~
~~Netlist, Inc.~~

We have audited the consolidated statements of operations, stockholders’ equity and cash flows of Netlist, Inc. and subsidiaries (the “Company’’) for the year ended January 1, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of the Company’s operations and its cash flows for the year ended January 1, 2005, in conformity with accounting principles generally accepted in the United States of America.

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

F-3

NETLIST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except ~~per share amounts)~~par value)

December 31,
2005

December 30,
2006

ASSETS

Current assets:

Cash and cash equivalents

$
953

$
30,975

Investments in marketable securities

—

5,267

Accounts receivable, net of allowance for sales returns and doubtful accounts of $109 (2005) and $88 (2006), respectively

13,140

23,703

Inventories

6,816

19,473

Income taxes receivable

259

—

Deferred taxes

902

1,054

Prepaid expenses and other current assets

434

988

Total current assets

22,504

81,460

Property and equipment, net

2,437

3,830

Deferred taxes

759

576

Long-term investments in marketable securities

—

1,502

Other assets

142

326

Total assets

$
25,842

$
87,694

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable

$
6,645

$
11,680

Revolving line of credit

9,463

19,238

Current portion of long-term debt

720

1,033

Current portion of deferred gain on sale and leaseback transaction

116

118

Current portion of convertible notes payable

1,000

—

Income taxes payable

—

552

Accrued expenses and other current liabilities

1,841

3,255

Total current liabilities

19,785

35,876

Long-term debt, net of current portion

988

1,230

Deferred gain on sale and leaseback transaction, net of current portion

464

344

Convertible notes payable, net of current portion

1,750

—

Total liabilities

22,987

37,450

Commitments and contingencies (Note 10)

—

—

Stockholders’ equity:

Series A convertible preferred stock, $2.00 par value—1,000 shares authorized; 1,000 shares issued and outstanding (liquidation preference of $2,000) (2005); no shares issued and outstanding (2006)

2,000

—

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; 10,673 (2005) and 19,544 (2006) shares issued and outstanding

11

20

Additional paid-in capital

22,604

66,557

Note receivable from stockholder

(23
)

(1
)

Deferred stock-based compensation

(337
)

—

Accumulated deficit

(21,400
)

(16,332
)

Total stockholders’ equity

2,855

50,244

Total liabilities and stockholders’ equity

$
25,842

$
87,694

			December 29, 2007			December 30, 2006
ASSETS
Current assets:
	Cash and cash equivalents		$	7,182		$	30,975
	Investments in marketable securities			15,573			5,267
	Accounts receivable, net of allowance for doubtful accounts of $89 (2007) and $62 (2006)			12,034			23,703
	Inventories			3,333			19,473
	Income taxes receivable			708			—
	Deferred taxes			3,464			1,054
	Prepaid expenses and other current assets			392			988

		Total current assets		42,686			81,460
Property and equipment, net				8,191			3,830
Deferred taxes				1,065			576
Long-term investments in marketable securities				7,814			1,502
Other assets				600			326

		Total assets	$	60,356		$	87,694

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	6,697		$	11,680
	Revolving line of credit			4,872			19,238
	Current portion of long-term debt			740			1,033
	Current portion of deferred gain on sale and leaseback transaction			118			118
	Income taxes payable			—			552
	Accrued expenses and other current liabilities			2,872			3,255

		Total current liabilities		15,299			35,876
Long-term debt, net of current portion				638			1,230
Deferred gain on sale and leaseback transaction, net of current portion				226			344

		Total liabilities		16,163			37,450
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; 19,758 (2007) and 19,544 (2006) shares issued and outstanding			20			20
	Additional paid-in capital			68,109			66,557
	Note receivable from stockholder			—			(1	)
	Accumulated deficit			(23,899	)		(16,332	)
	Accumulated other comprehensive income (loss)			(37	)		—

		Total stockholders' equity		44,193			50,244

		Total liabilities and stockholders' equity	$	60,356		$	87,694

See accompanying notes to consolidated financial statements.

F-4

NETLIST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except par value)

NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(in thousands, except per share amounts)

	Year Ended														Year Ended
	January 1, 2005				December 31, 2005				December 30, 2006						December 29, 2007			December 30, 2006			December 31, 2005
Net sales		$	143,659			$	79,856			$	151,448		Net sales		$	100,060		$	151,448		$	79,856
Cost of sales(1)		133,503				73,892				129,181			Cost of sales(1)			91,261			129,181			73,892

Gross profit		10,156				5,964				22,267			Gross profit			8,799			22,267			5,964

Operating expenses:													Operating expenses:
Research and development(1)		3,770				2,961				3,315
Selling, general and administrative(1)		6,314				5,062				9,191
Total operating expenses		10,084				8,023				12,506
													Research and development(1)			4,748			3,315			2,961
													Selling, general and administrative(1)			15,900			9,191			5,062

														Total operating expenses		20,648			12,506			8,023

Operating income (loss)		72				(2,059		)		9,761			Operating income (loss)			(11,849	)		9,761			(2,059	)

Other income (expense):													Other income (expense):
Interest expense, net of interest income		(1,071		)		(1,221		)		(1,825		)
Other income (expense), net		(315		)		21				(24		)
Total other expense, net		(1,386		)		(1,200		)		(1,849		)
													Interest income (expense), net			395			(1,825	)		(1,221	)
													Other income (expense), net			16			(24	)		21

														Total other income (expense), net		411			(1,849	)		(1,200	)

Income (loss) before provision (benefit) for income taxes		(1,314		)		(3,259		)		7,912			Income (loss) before provision (benefit) for income taxes			(11,438	)		7,912			(3,259	)
Provision (benefit) for income taxes		(340		)		(912		)		2,844			Provision (benefit) for income taxes			(4,025	)		2,844			(912	)

Net income (loss)		$	(974	)		$	(2,347	)		$	5,068		Net income (loss)		$	(7,413	)	$	5,068		$	(2,347	)

Net income (loss) per common share:													Net income (loss) per common share:
Basic		$	(0.09	)		$	(0.22	)		$	0.43
Diluted		$	(0.09	)		$	(0.22	)		$	0.34
													Basic		$	(0.38	)	$	0.43		$	(0.22	)
													Diluted			(0.38	)		0.34			(0.22	)
Weighted-average common shares outstanding:													Weighted-average common shares outstanding:
Basic		10,671				10,673				11,705
Diluted		10,671				10,673				15,331
													Basic			19,674			11,705			10,673
													Diluted			19,674			15,331			10,673

(1)

Amounts include stock-based compensation expense as follows:

Cost of sales

$
29

$
56

$
104

Research and development

80

(52
)

125

Selling, general and administrative

141

(65
)

363

Cost of sales	$	171	$	104	$	56
Research and development		149		125		(52	)
Selling, general and administrative		861		363		(65	)

See accompanying notes to consolidated financial statements.

F-

NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of ~~Stockholders’~~Stockholders' Equity

(in thousands)

Series A
Preferred
Stock

Common Stock

Additional
Paid-in

Notes
Receivable
From

Deferred
Stock-Based

Accumulated

Net
Stockholders’

Shares

Amount

Shares

Amount

Capital

Stockholders

Compensation

Deficit

Equity

Balance, December 27, 2003

1,000

$
2,000

10,650

$
11

$
24,656

$
(22
)

$
(2,585
)

$
(18,079
)

$
5,981

Forfeiture of stock options and warrants

—

—

—

—

(1,335
)

—

943

—

(392
)

Amortization of deferred stock-based compensation

—

—

—

—

—

—

642

—

642

Exercise of stock options

—

—

22

—

4

—

—

—

4

Interest from stockholder notes receivable

—

—

—

—

—

(1
)

—

—

(1
)

Payment of interest on stockholder note receivable

—

—

—

—

—

1

—

—

1

Net loss

—

—

—

—

—

—

—

(974
)

(974
)

Balance, January 1, 2005

1,000

2,000

10,672

11

23,325

(22
)

(1,000
)

(19,053
)

5,261

Issuance of stock options to nonemployees

—

—

—

—

6

—

(6
)

—

—

Forfeiture of stock options and warrants

—

—

—

—

(730
)

—

454

—

(276
)

Amortization of deferred stock-based compensation

—

—

—

—

—

—

215

—

215

Exercise of stock options

—

—

1

—

3

—

—

—

3

Interest from stockholder note receivable

—

—

—

—

—

(1
)

—

—

(1
)

Net loss

—

—

—

—

—

—

—

(2,347
)

(2,347
)

Balance, December 31, 2005

1,000

2,000

10,673

11

22,604

(23
)

(337
)

(21,400
)

2,855

Reclassification of deferred stock-based compensation upon adoption of SFAS No. 123(R)

—

—

—

—

(337
)

—

337

—

—

Estimated relative fair value of beneficial conversion feature on convertible note payable

—

—

—

—

50

—

—

—

50

Stock-based compensation

—

—

—

—

592

—

—

—

592

Interest from stockholder notes receivable

—

—

—

—

—

(1
)

—

—

(1
)

Payment on stockholders notes receivable

23

23

Exercise of warrants

—

—

550

—

110

—

—

—

110

Issuance of common stock in connection with conversion of note payable and accrued interest

—

—

21

—

53

—

—

—

53

Tax benefit from exercise of warrants

—

—

—

—

203

—

—

—

203

Issuance of common stock in an initial public offering (net of underwriters’ discounts and offering expenses)

—

—

6,250

6

39,535

—

—

—

39,541

Conversion of preferred stock

(1,000
)

(2,000
)

1,000

1

1,999

—

—

—

—

Conversion of debt at initial public offering

1,050

2

1,748

—

—

—

1,750

Net income

—

—

—

—

—

—

—

5,068

5,068

Balance, December 30, 2006

–—

$
—

19,544

$
20

$
66,557

$
(1
)

$
—

($16,332
)

$
50,244

				Series A Preferred Stock
									Common Stock						Notes Receivable From Stockholders									Accumulated Other Comprehensive Income (Loss)
									Common Stock			Additional Paid-in Capital						Deferred Stock-Based Compensation			Accumulated Deficit						Total Stockholders' Equity
				Shares		Amount			Shares	Amount		Additional Paid-in Capital						Deferred Stock-Based Compensation			Accumulated Deficit						Total Stockholders' Equity
Balance, January 1, 2005				1,000		$	2,000		10,672	$	11	$	23,325		$	(22	)	$	(1,000	)	$	(19,053	)	$	—		$	5,261
	Issuance of stock options to nonemployees			—			—		—		—		6			—			(6	)		—			—			—
		Forfeiture of stock options and warrants		—			—		—		—		(730	)		—			454			—			—			(276	)
		Amortization of deferred stock-based compensation		—			—		—		—		—			—			215			—			—			215
	Exercise of stock options			—			—		1		—		3			—			—			—			—			3
	Interest from stockholder note receivable			—			—		—		—		—			(1	)		—			—			—			(1	)
	Net loss and comprehensive loss			—			—		—		—		—			—			—			(2,347	)		—			(2,347	)

Balance, December 31, 2005				1,000			2,000		10,673		11		22,604			(23	)		(337	)		(21,400	)		—			2,855
	Reclassification of deferred stock-based compensation upon adoption of SFAS No. 123R			—			—		—		—		(337	)		—			337			—			—			—
	Estimated relative fair value of beneficial conversion feature on convertible note payable			—			—		—		—		50			—			—			—			—			50
	Stock-based compensation			—			—		—		—		592			—			—			—			—			592
	Interest from stockholder notes receivable			—			—		—		—		—			(1	)		—			—			—			(1	)
	Payment on stockholder notes receivable			—			—		—		—		—			23			—			—			—			23
	Exercise of warrants			—			—		550		—		110			—			—			—			—			110
	Issuance of common stock in connection with conversion of note payable and accrued interest			—			—		21		—		53			—			—			—			—			53
	Tax benefit from exercise of warrants			—			—		—		—		203			—			—			—			—			203
	Issuance of common stock in an intial public offering (net of underwirters' discounts and offering expenses)			—			—		6,250		6		39,535			—			—			—			—			39,541
	Coversion of preferred stock			(1,000	)		(2,000	)	1,000		1		1,999			—			—			—			—			—
	Coversion of debt at intial public offering			—			—		1,050		2		1,748			—			—			—			—			1,750
	Net income and comprenhensive income			—			—		—		—		—			—			—			5,068			—			5,068

Balance, December 30, 2006				—			—		19,544		20		66,557			(1	)		—			(16,332	)		—			50,244
	Cumulative effect to prior year accumulated deficit related to the adoption of FIN 48			—			—		—		—		—			—			—			(154	)		—			(154	)
	Stock-based compensation			—			—		—		—		1,181			—			—			—			—			1,181
	Payment on stockholder notes receivable			—			—		—		—		—			1			—			—			—			1
	Exercise of stock options			—			—		191		—		310			—			—			—			—			310
	Exercise of warrants			—			—		23		—		—			—			—			—			—			—
	Tax benefit from stock option exercises			—			—		—		—		61			—			—			—			—			61
	Components of comprehensive loss:
			Change in net unrealized loss on investments	—			—		—		—		—			—			—			—			(37	)		(37	)
	Net loss			—			—		—		—		—			—			—			(7,413	)		—			(7,413	)

	Comprehensive loss			—			—		—		—		—			—			—			—			—			(7,450	)

Balance, December 29, 2007				—		$	—		19,758	$	20	$	68,109		$	—		$	—		$	(23,899	)	$	(37	)	$	44,193

See accompanying notes to consolidated financial statements.

F-
6

NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)

				Year Ended
				December 29, 2007			December 30, 2006			December 31, 2005
Cash flows from operating activities:
	Net income (loss)			$	(7,413	)	$	5,068		$	(2,347	)
	Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
		Depreciation and amortization			1,510			972			1,031
		Amortization of deferred gain on sale and leaseback transaction			(118	)		(118	)		—
		Deferred income taxes			(2,899	)		31			(682	)
		Impairment of long-lived assets			502			—			—
		Loss (gain) on disposal of assets			68			30			(11	)
		Loss on inventory adjustments			5,328			—			—
		Facility relocation charge			134			—			—
		Stock-based compensation			1,181			592			(61	)
		Interest on notes receivable from stockholders			—			(1	)		(1	)
		Amortization of debt discount			—			50			—
		Changes in operating assets and liabilities:
			Accounts receivable		11,669			(10,563	)		(4,327	)
			Inventories		10,812			(12,657	)		526
			Income taxes receivable		(708	)		259			234
			Prepaid expenses and other current assets		596			(268	)		99
			Other assets		(274	)		(184	)		(85	)
			Accounts payable		(5,089	)		5,035			921
			Income taxes payable		(706	)		552			—
			Accrued expenses and other current liabilities		(517	)		1,417			95

		Net cash provided by (used in) operating activities			14,076			(9,785	)		(4,608	)

Cash flows from investing activities:
		Acquisition of property and equipment			(6,268	)		(2,500	)		(484	)
		Proceeds from sale of equipment			—			218			19
		Repayment of note receivable from stockholder			1			23			—
		Purchase of investments in marketable securities			(63,253	)		(6,769	)		—
		Proceeds from maturities of marketable securities			44,299			—			—
		Proceeds from sales of marketable securities			2,299			—			—
		Proceeds from sale and leaseback of facility			—			—			1,797

		Net cash provided by (used in) investing activities			(22,922	)		(9,028	)		1,332

Cash flows from financing activities:
		Borrowings on lines of credit			114,195			159,680			82,015
		Payments on lines of credit			(128,561	)		(149,905	)		(77,995	)
		Borrowings from debt			290			3,073			—
		Payments on debt			(1,242	)		(2,917	)		(1,553	)
		Proceeds from convertible notes payable			—			—			1,000
		Repayment of convertible notes payable			—			(950	)		—
		Proceeds from exercise of stock options and warrants			310			110			3
		Excess tax benefit from exercise of stock options and warrants			61			203			—
		Proceeds from initial public offering, net of offering costs			—			39,541			—

		Net cash provided by (used in) financing activities			(14,947	)		48,835			3,470

Net increase (decrease) in cash and cash equivalents					(23,793	)		30,022			194
Cash and cash equivalents, beginning of year					30,975			953			759

Cash and cash equivalents, end of year				$	7,182		$	30,975		$	953

Supplemental disclosure of cash flow information:
		Cash paid during the year for:
			Interest	$	1,359		$	2,010		$	1,169

			Income taxes	$	227		$	1,804		$	2

Year Ended

January 1,
2005

December 31,
2005

December 30,
2006

Cash flows from operating activities:

Net income (loss)

$
(974
)

$
(2,347
)

$
5,068

Adjustments to reconcile net income (loss) to net cash used in operating activities:

Depreciation and amortization

867

1,031

972

Amortization of deferred gain on sale and leaseback transaction

—

—

(118
)

Deferred income taxes

218

(682
)

31

Loss (gain) on disposal of assets

43

(11
)

30

Stock-based compensation

250

(61
)

592

Interest on notes receivable from stockholders

—

(1
)

(1
)

Amortization of debt discount

—

—

50

Changes in operating assets and liabilities:

Accounts receivable

(3,570
)

(4,327
)

(10,563
)

Inventories

2,704

526

(12,657
)

Income taxes receivable

(493
)

234

259

Prepaid expenses and other current assets

(116
)

99

(268
)

Other assets

(7
)

(85
)

(184
)

Accounts payable

(3,032
)

921

5,035

Income taxes payable

(2,634
)

—

552

Accrued expenses and other current liabilities

177

95

1,417

Net cash used in operating activities

(6,567
)

(4,608
)

(9,785
)

Cash flows from investing activities:

Acquisition of property and equipment

(557
)

(484
)

(2,500
)

Proceeds from sale of equipment

61

19

218

Repayment of note receivable shareholder

—

—

23

Purchase of investments in marketable securities

—

—

(5,267
)

Purchase of investments in long term marketable securities

—

—

(1,502
)

Proceeds from sale and leaseback of facility

—

1,797

—

Net cash provided by (used in) investing activities

(496
)

1,332

(9,028
)

Cash flows from financing activities:

Borrowings on lines of credit

146,488

82,015

159,680

Payments on lines of credit

(141,045
)

(77,995
)

(149,905
)

Borrowings from debt

820

—

3,073

Payments on debt

(348
)

(1,553
)

(2,917
)

Proceeds from convertible notes payable

—

1,000

—

Repayment of convertible notes payable

—

—

(950
)

Proceeds from exercise of stock options and warrants

—

3

110

Tax benefit from exercise of warrants

—

—

203

Proceeds from initial public offering, net of offering costs

—

—

39,541

Net cash provided by financing activities

5,915

3,470

48,835

Net increase (decrease) in cash and cash equivalents

(1,148
)

194

30,022

Cash and cash equivalents, beginning of period

1,907

759

953

Cash and cash equivalents, end of period

$
759

$
953

$
30,975

Supplemental disclosure of cash flow information:

Cash paid during the period for:

Interest

$
1,061

$
1,169

$
2,010

Income taxes

$
3,400

$
2

$
1,804

Supplemental disclosure of non-cash investing and financing activities:

Purchase of equipment through capitalized lease obligations

$
184

$
837

$
113

Purchase of insurance policies through notes payable

$
—

$
238

$
286

Deferred gain on sale and leaseback of facility

$
—

$
580

$
—

Estimated relative fair value of beneficial conversion feature on convertible note payable

$
—

$
—

$
50

Issuance of common stock in connection with conversion of note payable and accrued interest

$
—

$
—

$
53

Preferred stock conversion

$
—

$
—

$
2,000

Conversion of notes payable into common stock

$
—

$
—

$
1,750

NETLIST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)

(in thousands)

Supplemental disclosure of non-cash investing and financing activities:
	Purchase of equipment through capitalized lease obligations	$	67	$	113	$	837

	Purchase of equipment not paid for at the end of the year	$	123	$	—	$	—

	Cumulative effect to prior year accumulated deficit related to the adoption of FIN 48	$	154	$	—	$	—

	Purchase of insurance policies through notes payable	$	—	$	286	$	238

	Deferred gain on sale and leaseback of facility	$	—	$	—	$	580

	Estimated relative fair value of beneficial conversion feature on convertible note payable	$	—	$	50	$	—

	Issuance of common stock in connection with conversion of note payable and accrued interest	$	—	$	53	$	—

	Preferred stock conversion	$	—	$	2,000	$	—

	Conversion of notes payable into common stock	$	—	$	1,750	$	—

See accompanying notes to consolidated financial statements.

F-7

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 29, 2007

NOTE 1—DESCRIPTION OF BUSINESS

~~Description of Business~~

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

In December 2006, the Company sold 6,250,000 of its common shares in its initial public offering ("IPO") at an offering price of $7.00 per share, resulting in proceeds of $39.5 million, net of ~~underwriters’~~underwriters' discounts and offering expenses of approximately $4.2 million.

In 2007, the Company established a new manufacturing facility in the People's Republic of China ("PRC"). This facility became operational in July 2007 upon the successful qualification of certain key customers.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

Principles of Consolidation

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

Fiscal Year

~~Effective January 1, 2003, the~~ The Company ~~changed its fiscal year from~~has a ~~calendar year to a 52/53-week~~⁵²/53-week fiscal year ending on the Saturday closest to December 31. The ~~2004,~~2007, 2006 and 2005 ~~and 2006~~ fiscal years ended on ~~January 1, 2005,~~December 29, 2007, December 30, 2006 and December 31, 2005, ~~and December 30, 2006,~~ respectively, and consisted of 52 weeks.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management include, among others, provisions for uncollectible receivables and sales returns, warranty liabilities, valuation of inventories, recoverability of long-lived assets, stock-based compensation expense and realization of deferred tax assets. ~~Actual results could differ from these estimates.~~

~~Cash and Cash Equivalents and Investments in Marketable Securities~~

The Company ~~invests~~bases its ~~excess cash in money market funds~~estimates and ~~in highly liquid debt instruments~~assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of ~~U.S. municipalities, corporations~~which form the basis for making judgments about the carrying values of assets and liabilities and the ~~U.S. government~~accrual of costs and ~~its agencies. All highly liquid investments with stated maturities of three months or less~~expenses that are not readily apparent from ~~date of purchase are classified as cash equivalents; all highly liquid investments with stated maturities of greater than three months are classified as investments in marketable securities.~~

other sources. The ~~Company determines that appropriate classification of its investments in marketable debt securities at the time of purchase and reevaluates such designation at each balance sheet date. The~~

F-8

Company’s marketable debt securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities. Available-for-sale securities are stated at market value based on market quotes. Unrealized gains and losses, net of deferred taxes, have not been significant and will be recorded as a component of other comprehensive income.

~~Fair Value of Financial Instruments~~

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

~~Concentration of Credit Risk~~

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

The Company invests primarily in money market funds and high quality commercial paper and other debt instruments. Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. Investments in marketable securities are in high-credit quality debt instruments with an active resale market. Such investments are made only in instruments issued or enhanced by high-quality institutions. The Company has not incurred any credit risk losses related to these investments.

The Company’s trade accounts receivable are primarily derived from sales to original equipment manufacturers (“OEMs”) in the computer industry. The Company performs credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary but generally requires no collateral. The Company believes that the concentration of credit risk in its trade receivables is moderated by the Company’s credit evaluation process, relatively short collection terms and the high level of credit worthiness of its customers.

~~Inventories~~

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

~~Property and Equipment~~

Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which generally range from three to 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.

F-9

~~Impairment of Long-Lived Assets~~

~~The Company evaluates long-lived assets held and used~~actual results experienced by the Company ~~for impairment on an annual basis or whenever events or changes in circumstances indicate that their net book value~~ may ~~not~~differ materially and adversely from the Company's estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. At affected.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2005 and December 30, 2006, the Company’s management believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company’s products will continue, which could result in future impairment of long-lived assets.29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition

The ~~Company’s~~Company's revenues primarily consist of product sales of high performance memory subsystems to ~~OEMs.~~original equipment manufacturers ("OEMs"). Revenues also include sales of excess inventories to distributors and other users of memory ~~ICs~~integrated circuits ("ICs") totaling approximately ~~$28,016,000, $19,127,000, $11,424,000~~$1.9 million, $11.4 million and $19.1 million during the years ended ~~January 1, 2005,~~December 29, 2007, December 30, 2006 and December 31, 2005, ~~and December 30, 2006,~~ respectively.

The Company recognizes revenues in accordance with the Securities and Exchange ~~Commission’s~~Commission's Staff Accounting Bulletin ~~(“SAB”~~("SAB") No. 104,Revenue Recognition ("SAB No. 104"). Under the provisions of SAB No. 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed or determinable, and collectibility of the resulting receivable is reasonably assured.

~~For all sales, the~~ The Company generally uses ~~a binding~~customer purchase ~~order~~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. 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 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. ~~Returns from customers have not been material in any period as the Company’s principal customers have adopted build-to-order manufacturing models or just-in-time management processes.~~ The Company offers a standard product warranty to its customers and has no other post-shipment obligations. The Company assesses collectibility based on the creditworthiness of the customer as determined by credit checks and evaluations, as well as the ~~customer’s~~customer's payment history.

~~Most~~ A portion of the ~~Company’s~~Company's international shipments are made to third-party inventory warehouses, or hubs, and the Company recognizes revenue when the inventory is pulled from the hub for use in production by the customer. The Company receives a report from the customer on a daily basis indicating the inventories pulled from a hub for use by the customer, and performs a daily reconciliation of inventories shipped to and pulled by the customer to those inventories reflected on the ~~customer’s~~customer's reports to ensure that sales are recognized in the appropriate periods.

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.

F-Cash and Cash Equivalents

Cash and cash equivalents consist of cash and short-term investments with original maturities of 90 days or less.

Investments in Marketable Securities

In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,10Accounting for Certain Investments in Debt and Equity Securities ("SFAS No. 115"), the Company determines the appropriate classification of its investments in marketable debt securities at the time of purchase and

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

reevaluates such designation at each balance sheet date. The Company's investments in marketable securities have been classified and accounted for as available-for-sale based on management's investment intentions relating to these securities. Available-for-sale securities are stated at market value based on market quotes. Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss).

The Company generally invests its excess cash in money market funds and in highly liquid debt instruments of United States ("U.S.") municipalities, corporations, the U.S. government and its agencies and auction rate securities. All highly liquid investments with stated maturities of three months or less from the date of purchase are classified as cash equivalents; all investments with stated maturities of greater than three months are classified as investments in marketable securities.

Fair Value of Financial Instruments

The fair values of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate carrying values due to their short maturities. Investments in marketable securities are comprised of available-for-sale securities that are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders' equity, net of tax. The fair value of marketable securities is determined based on quoted market prices. The fair value of the Company's debt instruments approximates their carrying values based on rates currently available to the Company.

Allowance for Doubtful Accounts

The Company evaluates the collectibility 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 recognizes allowances for doubtful accounts based primarily on the length of time the receivables are past due, the current business environment and the Company's historical experience.

Concentration of Credit Risk

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

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Company believes that the concentration of credit risk in its trade receivables is moderated by the Company's credit evaluation process, relatively short collection terms and the high level of credit worthiness of its customers. 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 cost or net realizable value. 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 inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product type. Among other factors, the Company considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.

Property and Equipment

Impairment of Long-Lived Assets

The Company evaluates long-lived assets held and used by the Company for impairment on an annual basis or whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. Other than those matters discussed at Note 11, the Company's management believes there is no further impairment of its long-lived assets recorded on the accompanying consolidated balance sheets as of December 29, 2007 and December 30, 2006. 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.

Warranties

The Company offers warranties generally ranging from one to three years to its customers, other than on sales of excess inventory, depending on the product and negotiated terms of purchase agreements. Such warranties require the Company to repair or replace defective product returned to the Company during such warranty period at no cost to the customer. An estimate by the Company for ~~warranty related~~warranty-related costs is recorded by the Company at the time of sale based on its historical and

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

estimated product return rates and expected repair or replacement costs. Such costs have historically been consistent between periods and in-line with management's expectations. The Company's warranty liability is included as a component of accrued expenses and other current liabilities in the accompanying consolidated balance sheets.

The following table summarizes the activity related to the warranty liability for the year ended December 29, 2007 (in thousands):

Beginning balance, December 30, 2006	$	298
Charged to costs and expenses		256
Usage		(201	)

Ending balance, December 29, 2007	$	353

Prior to fiscal 2007, activity related to warranty costs was insignificant.

Beneficial Conversion Feature

The convertible feature of one of the ~~Company’s~~Company's convertible notes provided for a rate of conversion that was below market value (see Note 8)7). Such feature is normally characterized as a ~~“beneficial~~"beneficial conversion ~~feature” (“BCF”~~feature" ("BCF"). Pursuant to Emerging Issues Task Force ~~(“EITF”~~("EITF") Issue No. 98-5,Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratio and EITF No. 00-27,Application of EITF Issue No. 98-5 to Certain Convertible Instruments, the estimated relative fair value of the BCF was recorded as a discount from the face amount of the convertible note. The Company amortized the discount using the effective interest method through the conversion of such instrument.

Stock-Based Compensation

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

Prior to January 1, 2006, the Company accounted for stock-based compensation issued to employees and directors using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion ~~(“APB”~~("APB") No. 25,Accounting for Stock Issued to Employees ("APB No. 25"), and related ~~pronouncements (see Note 13).~~pronouncements. Under this method, compensation expense was recognized over the respective vesting period based on the excess, on the date of grant, of the estimated fair value of the ~~Company’s~~Company's common stock over the grant price, net of forfeitures. Deferred stock-based compensation expense was amortized on a straight-line basis over the vesting period of each grant. ~~During the years ended January 1, 2005 and December 31, 2005, stock-based compensation expense, net of forfeitures, was approximately $250,000 and $(61,000), respectively.~~

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

Had compensation cost for the ~~Company’s~~Company's stock-based awards to employees been determined based on the estimated fair value at the grant dates consistent with the fair value method of SFAS No. 123, the

F-11

~~Company’s~~ Company's net loss and loss per share for the ~~years~~year ended ~~January 1, 2005 and~~ December 31, 2005 would have approximated the pro forma amounts indicated below (in thousands, except per share amounts):

	Year Ended
	January 1, 2005				December 31, 2005					Year Ended December 31, 2005
Net loss, as reported		$	(974	)		$	(2,347	)	Net loss, as reported	$	(2,347	)
Plus: stock-based employee compensation expense included in reported net loss, net of tax		185				(44		)	Plus: stock-based employee compensation expense included in reported net loss, net of tax		(44	)
Less: stock-based employee compensation expense determined under fair value based method, net of tax		(470		)		354			Less: stock-based employee compensation expense determined under fair value based method, net of tax		354

Pro forma net loss		$	(1,259	)		$	(2,037	)	Pro forma net loss	$	(2,037	)

Net loss per common share as reported:									Net loss per common share as reported:
Basic		$	(0.09	)		$	(0.22	)
Diluted		$	(0.09	)		$	(0.22	)
									Basic	$	(0.22	)

									Diluted	$	(0.22	)

Pro forma:									Pro forma:
Basic		$	(0.12	)		$	(0.19	)
Diluted		$	(0.12	)		$	(0.19	)
									Basic	$	(0.19	)

									Diluted	$	(0.19	)

The fair value of options granted under the ~~Company’s~~Company's equity incentive plan during the ~~years~~year ended ~~January 1, 2005 and~~ December 31, 2005 was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the single option approach using the following weighted-average assumptions:

			~~January 1,~~Year Ended ~~2005~~			December 31, 2005
Risk-free interest rate	4.13	%
~~Weighted-average risk-free rate~~ Expected term (in years)	10	~~n/a~~		~~4.13~~	%
Expected ~~term~~ volatility	24	~~n/a~~		~~10 years~~		%
Expected ~~stock volatility~~ dividends	—	~~n/a~~		24	%
~~Dividend yield~~		~~n/a~~		—

~~There were no options granted during fiscal 2004.~~

Effective January 1, 2006, the Company adopted SFAS No. 123(R),Share-Based Payment ("SFAS No. 123(R)"), which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires ~~a public~~an entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. SFAS No. 123(R) supersedes the ~~Company’s~~Company's previous accounting under APB No. 25 for periods beginning in fiscal 2006. SFAS No. 123(R) also amends SFAS No. 95,Statement of Cash Flows, and requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under previous literature. In March 2005, the Securities and Exchange Commission issued SAB No. 107,Share-Based Payment ("SAB No. 107"), relating to SFAS No. 123(R). The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).

The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the ~~Company’s~~Company's fiscal year 2006. The ~~Company’s~~Company's consolidated financial statements as of and for the ~~year~~years ended December 29, 2007 and December 30, 2006 reflect the impact of adopting SFAS No. 123(R). In accordance with the modified prospective transition method, the ~~Company’s~~Company's consolidated financial statements for periods prior ~~periods~~to fiscal 2006 have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).

F-12

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

~~Stock-based~~ In accordance with SFAS No. 123(R), employee and director stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the ~~Company’s~~Company's consolidated ~~statement~~statements of operations for the ~~year~~years ended Decebmer 29, 2007 and December 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). AsGiven that stock-based compensation expense recognized in the consolidated ~~statement~~statements of operations for the ~~year~~years ended December 29, 2007 and December 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture ~~rate for~~rates used by the ~~year ended December 30, 2006 of approximately 8% was~~Company are based on historical forfeiture experience and estimated future

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

employee forfeitures. ~~The estimated term of option grants for the year ended December 30, 2006 was six years.~~ In the ~~Company’s~~Company's pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

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

The fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model. The Black-Scholes model requires subjective assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The expected volatility for the years ended December 29, 2007 and December 30, 2006 is based on the historical volatilities of the common stock of comparable publicly traded companies based on the the Company's belief that it currently has limited historical data regarding the volatility of its stock price on which to base a meaningful estimate of expected volatility. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the ~~pricing~~expected term of the grant effective as of the date of the grant. The expected ~~volatility for the year ended December 30, 2006~~dividends assumption is based on the ~~historical volatilities~~Company's history and expectation of ~~the common stock of comparable publicly traded companies.~~dividend payouts. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.

		~~Year~~ ~~December 30,~~ ~~2006~~
~~Expected term~~		~~6 years~~
~~Expected volatility~~		~~43%~~
~~Risk-free interest rate~~		~~4.55%-4.97%~~
~~Expected dividends~~		—

F-13

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

Shares

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Term
(Years)

Aggregate
Intrinsic
Value

Options outstanding at January 1, 2006

2,190

$1.26

Options granted

1,478

$ 6.16

Options exercised

—

$ —

Options forfeited

(350
)

$ 2.18

Options outstanding at December 30, 2006

3,318

$ 3.34

7.62

$ 15,458

Options exercisable at December 30, 2006

1,424

$0.74

5.48

$10,338

Options vested and expected to vest at December 30, 2006

3,167

$3.25

7.67

$15,052

The weighted-average grant date fair value of options granted during the year ended December 30, 2006 was $2.98 per option. The total intrinsic value of options exercised during the year ended December 30, 2006 was zero as no options were exercised during the period. Upon the exercise of options, the Company issues new shares from its authorized shares.

As of December 30, 2006, there was approximately $3,687,000 of total unrecognized compensation cost, net of estimated expected forfeitures, related to employee and director stock option compensation arrangements. That cost is expected to be recognized on a straight-line basis over the next 4 years. The total fair value of shares vested less estimated forfeitures during the year ended December 30, 2006 was approximately $592,000.

As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company’s income before provision for income taxes and net income for the year ended December 30, 2006 were approximately $481,000 and $308,000 lower, respectively, than if it had continued to account for share-based compensation under APB No. 25. Basic net income per share for the year ended December 30, 2006 was approximately $0.03 lower than if the Company had continued to account for share-based compensation under APB No. 25. Diluted net income per share for the year ended December 30, 2006 was approximately $0.02 lower due to the adoption of SFAS No. 123(R).

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

	~~Year Ended~~ ~~December 30,~~ ~~2006~~
~~Stock-based compensation expense included in:~~
~~Cost of sales~~		~~$ 104~~
~~Research and development~~		~~125~~
~~Selling, general and administrative~~		~~363~~

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes ("SFAS No. 109"). Under SFAS No. 109, deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at currently effective tax rates, of future deductible or taxable amounts

F-14

attributable to events that have been recognized on a cumulative basis in the consolidated financial statements. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized.

In July 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 and seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 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 FIN 48 the Company may only recognize or continue to recognize tax positions that meet a "more likely than not" threshold. The Company adopted FIN 48 on December 31, 2006, the first day of fiscal 2007.

Research and Development Expense

Research and development expenditures are expensed in the period incurred.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Advertising Expense

Advertising costs are expensed in the period incurred. Advertising expenses for fiscal years 2007, 2006 and 2005 were not significant.

Comprehensive Income (Loss)

SFAS No. 130,Reporting Comprehensive Income

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

Risks and Uncertainties

The Company's operations in the PRC are subject to various political, geographical and economic risks and uncertainties inherent to conducting business in China. These include, but are not limited to, (i) potential changes in ~~stockholders’ equity during~~economic conditions in the region, (ii) managing a local workforce that may subject the Company to uncertainties or certain regulatory policies and (iii) changes in other policies of the Chinese governmental and regulatory agencies. Additionally, the Chinese government controls the procedures by which its local currency, the Chinese Renminbi ("RMB"), is converted into other currencies. If changes or restrictions in the conversion of RMB are instituted, the Company's operations and operarting results may be negatively impacted.

Foreign Currency Remeasurement

The functional currency of the Company's foreign subsidiary in the PRC is the U.S. dollar. The local currency financial statements of this subsidiary are remeasured into U.S. dollars using the current exchange rate 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, ~~from non-owner sources. For the years January 1, 2005, December 30, 2005~~except items related to nonmonetary assets and ~~December 30, 2006 there were no differences between the Company’s~~liabilities, which are remeasured using historical exchange rates. All remeasurement gains and losses are included in determining net income (loss) ~~and its comprehensive income (loss)~~.

Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average shares outstanding during the ~~period.~~year. Diluted net income (loss) per share is calculated by dividing the net income (loss) by the weighted-average shares and dilutive potential common shares outstanding during the ~~period.~~year. Dilutive potential shares consist of dilutive shares issuable upon the exercise of outstanding stock options and warrants computed using the treasury stock ~~method~~method. Prior to fiscal 2007, in addition to outstanding stock options and warrants, dilituive potential common shares also consisted of shares issuable upon the conversion of convertible notes payable and convertible preferred stock using the ~~“if converted”~~"if converted" method. ~~All potentially dilutive shares of approximately 4,001,000~~

New Accounting Pronouncements

In June 2007, the FASB ratified EITF No. 07-3,Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and ~~3,632,000 during~~Development Activities ("EITF No. 07-3"). EITF No. 07-3 requires non-refundable advance payments for goods and services to be used in future

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

research and development activities to be recorded as an asset and the payments to be expensed when the research and development activities are performed. EITF No. 07-3 is effective for fiscal years ~~ended January 1,~~beginning after December 15, 2007. This standard is not expected to have a material impact on the Company's future consolidated financial statements.

Reclassifications

Certain amounts in the 2006 and 2005 ~~and December 30, 2005, respectively,~~consolidated financial statements have been ~~excluded from diluted loss per share as their effect would be anti-dilutive for~~reclassified to conform with the ~~periods then ended. Potentially dilutive shares~~current year presentation.

NOTE 3—SUPPLEMENTAL FINANCIAL INFORMATION

Inventories

Inventories consist of ~~approximately 3,626,000 for~~the following (in thousands):

	December 29, 2007		December 30, 2006
Raw materials	$	1,878	$	10,513
Work in process		425		3,343
Finished goods		1,030		5,617

	$	3,333	$	19,473

During the year ended December 29, 2007, the Company incurred a loss of approximately $5.3 million due to slow moving and lower-of-cost-or-market value inventory adjustments, which is included as a component of cost of sales in the accompanying consolidated statement of operations.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 3—SUPPLEMENTAL FINANCIAL INFORMATION (Continued)

Property and Equipment

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

	Estimated Useful Lives	December 29, 2007			December 30, 2006
Machinery and equipment	3-7 yrs.	$	8,055		$	5,153
Leasehold improvements	*		1,484			44
Furniture and fixtures	5 yrs.		457			205
Computer equipment and software	3-7 yrs.		2,278			1,731

			12,274			7,133
Less accumulated depreciation and amortization			(4,083	)		(3,303	)

		$	8,191		$	3,830

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

Included in property and equipment are assets under capital leases with a cost of approximately $1.9 million and $2.3 million and accumulated amortization of approximately $1.2 million and $1.2 million at December 29, 2007 and December 30, 2006, ~~have been included~~respectively.

Comprehensive Income (Loss)

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

		Year Ended
		December 29, 2007			December 30, 2006		December 31, 2005
Net income (loss)		$	(7,413	)	$	5,068	$	(2,347	)
Other comprehensive loss:
	Change in net unrealized loss on investments		(37	)		—		—

Total comprehensive income (loss)		$	(7,450	)	$	5,068	$	(2,347	)

Accumulated other comprehensive loss reflected on the consolidated balance sheet at December 29, 2007 represents accumulated net unrealized losses on investments in ~~the diluted net income per share computation for the period then ended.~~marketable securites.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 3—SUPPLEMENTAL FINANCIAL INFORMATION (Continued)

Computation of Net Income (Loss) Per Share

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

Year Ended

January 1,
2005

December 31,
2005

December 30,
2006

Basic income (loss) per share:

Net income (loss)

$  (974
)

$ (2,347
)

$ 5,068

Weighted-average common shares outstanding, basic

10,671

10,673

11,705

Basic income (loss) per share

$ (0.09
)

$ (0.22
)

$   0.43

Diluted income (loss) per share:

Net income (loss)

$  (974
)

$ (2,347
)

$ 5,068

Convertible notes interest expense (net of tax)

—

—

74

Adjusted net income (loss) available to common stockholders

$  (974
)

$ (2,347
)

$ 5,142

Weighted-average common shares outstanding, basic

10,671

10,673

11,705

Effect of dilutive securities:

Stock options and warrants

—

—

1,722

Convertible preferred stock

—

—

929

Convertible notes payable

—

—

975

Weighted-average common shares outstanding, diluted

10,671

10,673

15,331

Diluted net income (loss) per share

$ (0.09
)

$ (0.22
)

$   0.34

			Year Ended
			December 29, 2007			December 30, 2006		December 31, 2005
Basic net income (loss) per share:
	Numerator: Net income (loss)		$	(7,413	)	$	5,068	$	(2,347	)

	Denominator: Weighted-average common shares outstanding, basic			19,674			11,705		10,673

	Basic net income (loss) per share		$	(0.38	)	$	0.43	$	(0.22	)

Diltued net income (loss) per share:
	Net income (loss)		$	(7,413	)	$	5,068	$	(2,347	)
	Convertible notes interest expense (net of tax)			—			74		—

	Numerator: Adjusted net income (loss) available to common stockholders		$	(7,413	)	$	5,142	$	(2,347	)
	Weighted-average common shares outstanding, basic			19,674			11,705		10,673
	Effect of dilutive securities:
		Stock options and warrants		—			1,722		—
		Convertible preferred stock		—			929		—
		Convertible notes payable		—			975		—

	Denominator: Weighted-average common shares outstanding, diluted			19,674			15,331		10,673

	Diluted net income (loss) per share		$	(0.38	)	$	0.34	$	(0.22	)

All potentially dilutive common share equivalents of approximately 1.5 million and 3.6 million shares have been excluded from the diluted net loss per share calculations for the years ended December 29, 2007 and December 31, 2005 as their effect would be anti-dilutive for the years then ended.

~~New Accounting Pronouncements~~

~~In June 2006, the FASB issued Interpretation No. 48,~~ ~~Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109~~ ~~(“FIN 48”), which clarifies the accounting for uncertainty in~~NETLIST, INC. AND SUBSIDIARIES

F-15

income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that the Company recognize in the financial statements the impact of tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. The Company is currently in the process of assessing the impact the adoption of FIN 48 will have on its consolidated financial statements.

~~In September 2006, the SEC staff issued SAB No. 108,~~ ~~Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements~~. SAB No. 108 was issued in order to eliminate the diversity in practice surrounding how public companies quantify financial statement misstatements. SAB No. 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.December 29, 2007

NOTE 3—4—INVESTMENTS IN MARKETABLE SECURITIES

Investments in marketable securities consist of the following at December 29, 2007 and December 30, 2006 (in thousands):

	December 29, 2007
	Amortized Cost		Net Unrealized Gain (Loss)			Fair Value
Cash and money markets	$	6,148	$	—		$	6,148
Commercial paper		1,734		—			1,734
Corporate notes and bonds		11,892		(9	)		11,883
Federal agency notes and bonds		4,382		13			4,395
Auction and variable floating rate notes		6,163		(41	)		6,122

	$	30,319	$	(37	)	$	30,282

Classified as:
Cash equivalents						$	6,895
Marketable securities							23,387

						$	30,282

~~U.S. corporate bonds~~		~~$ 6,275~~
~~U.S. treasury/agency debt securities~~		~~494~~
		~~$ 6,769~~

	December 30, 2006
	Amortized Cost		Net Unrealized Gain (Loss)		Fair Value
Cash and money markets	$	29,952	$	—	$	29,952
Corporate notes and bonds		6,275		—		6,275
Federal agency notes and bonds		494		—		494

	$	36,721	$	—	$	36,721

Classified as:
Cash equivalents					$	29,952
Marketable securities						6,769

					$	36,721

Realized gains and losses on the sale of investments in marketable securities are determined using the specific identification method. Net realized gains recorded during the year ended December 29, 2007 were not significant.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 4—INVESTMENTS IN MARKETABLE SECURITIES (Continued)

The ~~contractual maturities~~following table provides the breakdown of ~~debt~~investments in marketable securities with unrealized losses at December 29, 2007 (in thousands):

	Continuous Unrealized Loss
	Less than 12 months					12 months or greater
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Corporate notes and bonds	$	6,830	$	(12	)	$	—	$	—
Federal agency notes and bonds		998		(3	)		—		—
Auction and variable floating rate notes		1,965		(41	)		—		—

	$	9,793	$	(56	)	$	—	$	—

As of December 29, 2007, the Company held 11 investments that were in an unrealized loss position.

Due to disruptions of, and the resulting reduced liquidity in certain financial markets in 2007, two of the Company's AAA rated auction rate securities with a total purchased cost of approximately $2.0 million experienced failed auctions during the fourth quarter of 2007. Due to the failed auctions, the Company was unable to sell the securities at their respective costs, resulting in a decrease in fair value, which has been recorded as a component of accumulated other comprehensive loss in accordance with SFAS No. 115. These investments have been classified as long-term investments in marketable securities in the Company's consolidated balance sheet as of December 29, 2007. As of February 23, 2008, the unrealized loss on these two investments was approximately $141,000. The Company has concluded that the unrealized losses on these investments are temporary because (i) the Company believes that the decline in market value that has occurred is due to general market conditions, (ii) the auction rate securities continue to be of a high credit quality and interest is paid as due and (iii) the Company has the intent and ability to hold these investments until a recovery in market value occurs. The fair value of these securities could change significantly in the future and the Company may be required to record other-than-temporay impairment charges or additional unrealized losses in future periods.

The unrealized losses on the Company's other investments were due primarily to changes in interest rates. The Company has determined that the unrealized losses on all of its investments in marketable securities at December 29, 2007 are temporary in nature. The Company reviews its investments to evaluate indications of possible impairment. Factors considered in determining whether impairments are other than temporary include the length of time and extent to which fair value has been less than the amortized cost basis, the financial condition and near-term prospects of the investee and the Company's intent and ability to hold an investment for a period of time sufficient to allow for any anticipated recovery in market value. The Company maintains an investment portfolio of various holdings, types and maturities. The Company invests in instruments that meet high quality credit standards, as specified in its investment policy guidelines. These guidelines generally limit the amount of credit exposure to any one issue, issuer or type of instrument.

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 4—INVESTMENTS IN MARKETABLE SECURITIES (Continued)

The following table presents the amortized cost and fair value of the Company's cash equivalents and investments in marketable securities classified as ~~held to maturity~~available-for-sale at December ~~30, 2006 is as follows (in thousands): $5,267 due in one year or less and $1,502 due in one year through two years. Unrealized gains and losses, net of deferred taxes, have not been significant.~~

F-16

~~NOTE 4—INVENTORIES~~

~~Inventories consist of the following~~29, 2007 by contractual maturity (in thousands):

December 31,
2005

December 30,
2006

Raw materials

$ 2,551

$ 10,513

Work in process

1,027

3,343

Finished goods

3,238

5,617

$ 6,816

$ 19,473

	Amortized Cost		Fair Value
Maturity
Less than one year	$	18,306	$	18,305
One to two years		5,850		5,855
Greater than two years*		6,163		6,122

	$	30,319	$	30,282

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

NOTE 5—~~PROPERTY AND EQUIPMENT~~

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

Estimated
Useful
Lives

December 31,
2005

December 30,
2006

Machinery and equipment

3-7 yrs.

$ 3,595

$ 5,153

Leasehold improvements

3 yrs.

—

44

Furniture and fixtures

5 yrs.

205

205

Computer equipment and software

3-7 yrs.

1,241

1,731

5,041

7,133

Less accumulated depreciation and amortization

(2,604
)

(3,303
)

$ 2,437

$ 3,830

Included in property and equipment are assets under capital leases with a cost of $2,618,000 and $2,326,000 and accumulated amortization of $896,000 and $1,176,000 at December 31, 2005 and December 30, 2006, respectively.

~~NOTE 6—~~CREDIT AGREEMENT

The Company has entered into an agreement ~~(the “Credit Agreement”)~~ with a bank which, as amended through November 2006, provides for a line of credit facility ~~up to $25 million ($3 million of which may be in the form of letters of credit),~~for borrowings limited to 85% of eligible accounts receivable, plus the least of (i) a percentage of eligible inventory determined from time to time by the ~~Company’s~~Company's bank, (ii) 80% of the orderly liquidation value, as defined, of eligible inventories, and (iii) $7 million. Interest is payable monthly, at the ~~Company’s~~Company's option, either at prime rate plus 0.50% or LIBOR plus 3%. The interest rate was reduced to the prime rate or LIBOR plus 2.50% in December 2006 concurrent with the ~~Company’s~~Company's raise of capital through an initial public ~~offering (see Note 1)~~offering.

In April 2007, the Company executed the Seventh Amendment to the Amended and Restated Credit and Security Agreement (the "Seventh Amendment"). The Seventh Amendment, which was effective as of March 21, 2007, allows the Company to, at its election, increase its line of credit ~~facility, as amended, matures on July 31, 2008.~~

~~The Credit Agreement also provided for~~from $25 million, in $2.5 million increments, up to a $2total of $40 million term loan to be funded in two advances. The first advance of $1 million was made in August 2006, and the second advance of $1 million was made in September 2006. The term loan principal was payable in equal monthly installments of $83,350 commencing on September 1, 2006. Interest was payable monthly, at the Company’s option, either at the prime rate ~~plus 0.50% or LIBOR plus 3%. The term loan, including all accrued~~of interest, which was 7.25% at December 29, 2007 and ~~unpaid interest was repaid in~~8.25% at December ~~2006 concurrent~~30, 2006. In addition, the Seventh Amendment (i) extends the maturity date of the line of credit to July 31, 2009, (ii) establishes an equipment advance line of $3 million, (iii) increases the sublimit for letters of credit to $5 million, (iv) sets an inventory sublimit of $7 million, with the ~~Company’s raise of capital through an initial public offering (see Note 1).~~

~~The Credit Agreement also~~ability to increase to $10 million if certain financial targets are met, (v) provides for ~~equipment advances up~~the reduction in interest rates on borrowings if certain borrowing amounts and financial performance targets are met and (vi) revised certain financial covenants.

In July 2007, the Company executed the Eighth Amendment to ~~$2 million.~~the Amended and Restated Credit and Security Agreement (the "Eighth Amendment"), which was effective as of June 29, 2007. Among other things, the Eighth Amendment added certain minimum profitability financial covenant requirements. As of December 29, 2007, the Company was in compliance with all financial covenants.

Interest on the equipment advances is payable monthly, at the ~~Company’s~~Company's option, either at the prime rate ~~plus 0.50% or LIBOR plus 3%. The interest rate was reduced to the prime rate~~ or LIBOR plus 2.50% ~~in December 2006 concurrent with the Company’s initial public offering.~~. Interest only payments were required on the

F-17

equipment advances through January 31, 2007. Commencing February 1, 2007, the Company is required to repay the

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 5—CREDIT AGREEMENT (Continued)

equipment advances in 42 equal monthly installments. The outstanding balance on this loan was ~~$1,072,000~~approximately $0.9 million and $1.1 million at December 29, 2007 and December 30, 2006, respectively (see Note 7) 6). ~~The~~

Any borrowings under the revolving and equipment ~~advances, including all accrued and unpaid interest, are due on July 31, 2008.~~

~~Any borrowings~~lines of credit, are collateralized by a general first priority lien against all ~~Company~~of the Company's assets, both tangible and intangible.

~~Prior~~ The following table presents details of interest expense related to ~~July 2006, the credit agreement provided for a revolving line of credit of $15 million and no term loan or equipment line of credit.~~

Interest was payable monthly at the prime rate plus 0.50% in fiscal 2004 (5.75% at January 1, 2005) and in fiscal 2005 at the prime rate plus 4.75% for eligible foreign accounts (12.00% at December 31, 2005) and at December 30, 2006 at the prime rate (8.25%) and for all other advances at the prime rate plus 3.50% and prime rate plus 0.50% (10.75% at December 31, 2005 and 8.25% at December 30, 2006, respectively). Outstanding borrowings on ~~this line of credit at December 31, 2005 and December 30, 2006 were $9,463,000 and $19,238,000, respectively. Borrowing availability under~~ the line of credit, ~~was approximately $2,400,000 and $4,872,000 at December 31, 2005 and December 30, 2006, respectively.~~

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

	Year Ended
	December 29, 2007		December 30, 2006		December 31, 2005
Interest expense	$	862	$	1,195	$	553

	December 29, 2007		December 30, 2006
Outstanding borrowings on the line of credit	$	4,872	$	19,238

Borrowing availability under the line of credit	$	6,366	$	4,872

Effective July 28, 2006, the Company executed the Fifth Amendment to Amended and Restated Credit and Security Agreement (the “Fifth Amendment”). The Fifth Amendment eliminated the prior covenant that required the Company to raise a minimum of $4 million in a private equity offering prior to March 31, 2007.

Effective December 29, 2006, the Company executed the Sixth Amendment to the Amended and Restated Credit and Security Agreement (the “Sixth Amendment”). The Sixth Amendment increased the allowable capital expenditures to $2,500,000 for the six-month period ended December 30, 2006 and any fiscal year thereafter. As of December 30, 2006, the Company was in compliance with all covenants.

NOTE 7—6—LONG-TERM DEBT

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

	December 31, 2005			December 30, 2006			December 29, 2007			December 30, 2006
Obligations under capital leases (see Note 10)		$ 1,285			$ 802
Term note payable to bank (see Note 6)		—			1,072
Obligations under capital leases							$	432		$	802
Equipment note payable to bank (see Note 5)								872			1,072
Notes payable to others		423			389			74			389

		1,708			2,263			1,378			2,263
Less current portion		(720	)		(1,033	)		(740	)		(1,033	)
		$ 988			$ 1,230
							$	638		$	1,230

F-18

Mortgage Note Payable

In November 2000, the Company obtained an SBA-backed 25-year mortgage note payable collateralized by its manufacturing facility in Irvine, California. This note bore interest at the prime rate plus 1.0% (6.25% at January 1, 2005), with principal and interest payments due monthly through 2025. In December 2005, the mortgage was paid in full in connection with the sale and leaseback transaction of the manufacturing facility (see Note ~~10)~~9).

Notes Payable to Others

In November 2002, the Company entered into a $100,000 unsecured loan agreement with an individual, bearing interest at 7% payable annually, principal due, as amended, in June 2006. In

NETLIST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 29, 2007

NOTE 6—LONG-TERM DEBT (Continued)

January 2004, $4,000 of the principal amount was used to exercise certain stock options. The balance of this note was $96,000 at ~~January 1, 2005, December 31, 2005 and~~ December 30, 2006. ~~The note is currently due on demand.~~ The balance of this note and accrued interest was repaid in full in January 2007.

In January 2003, the Company entered into a $300,000 loan agreement with a financing company, collateralized by assets owned by an employee related to the majority stockholder. This note bears interest at 14% per annum and matures in January 2009. Principal and interest payments of approximately $6,000 are due and payable monthly. The balance of this note was ~~$185,000~~approximately $74,000 and $133,000 at December ~~31, 2005~~29, 2007 and December 30, 2006, respectively.

In August 2005, the Company entered into an agreement with a financing company in connection with financing certain insurance policies. The financing agreement required monthly principal and interest payments of approximately $25,000 through maturity on June 30, 2006. Interest was payable at 8.55% per annum. The outstanding principal balance on this financing was $142,000 at December 31, 2005. During the year ended December 30, 2006, the balance was repaid in full. In August 2006, the Company entered into a new agreement with the financing company to finance its insurance policies. The financing agreement ~~requires~~required monthly principal and interest payments of approximately $32,000 through maturity on June 30, 2007. Interest iswas payable at 9.45% per annum. The outstanding principal balance on this financing was $160,000 at December 30, 2006. The balance of this note and accrued interest was repaid in June 2007.

Capital Leases

The Company has purchased manufacturing and computer equipment through the use of various capital leases. ~~These~~As of December 29, 2007, these leases require aggregate monthly payments of ~~$44,450~~approximately $44,000 and mature at various dates through May 2011. The interest rates on these leases vary between 4.3% and 10.4% (see Note ~~10)~~9).

As of December ~~30, 2006,~~29, 2007, maturities of long-term debt were as follows (in thousands):

Fiscal Year
2007		$ 1,033
2008	2008	633	$	740
2009	2009	373		474
2010	2010	214		149
2011	2011	10		15
		$ 2,263
			$	1,378

Interest expense related to long-term debt ~~was $177,000, $250,000 and $238,000 for~~is presented in the ~~years ended January 1, 2005 and December 31, 2005 and December 30, 2006, respectively.~~following table (in thousands):

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 29, 2007
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

Delaware		~~95-4812784~~
State or other jurisdiction of		~~(I.R.S. employer~~
incorporation or organization		95-4812784 (I.R.S. employer Identification No.)
51 Discovery, Irvine, CA 92618 (Address of principal executive offices) (Zip Code)
(949) 435-0025 (Registrant's telephone number, including area code)

	Title of each class				Name of each exchange on which registered
Common Stock, par value $0.001 per share		The NASDAQ Global Market

~~Density~~	~~Height~~		~~Speed (MHz)~~		~~Applications~~
~~256MB~~		~~30mm~~		~~400/533~~	~~RAID Memory~~
~~512MB~~		~~30mm~~		~~400/533/667~~	~~Blade Servers~~
~~512MB~~		~~18.3mm~~		~~400/533/667~~	~~Blade Servers~~
~~1GB~~		~~18.3mm~~		~~400/533/667~~	~~Blade Servers~~
~~1GB~~		~~30mm~~		~~400/533/667~~	~~1U, 2U+ Servers, Networking~~
~~2GB~~		~~30mm~~		~~400/533/667~~	~~1U, 2U+ Servers, Networking~~
~~2GB~~		~~18.3mm~~		~~400/533/667~~	~~Blade Servers, Networking~~
~~4GB~~		~~30mm~~		~~400/533/667~~	~~1U, 2U+ Servers, Workstations~~
~~4GB~~		~~18.3mm~~		~~400/533~~	~~Blade Servers~~

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

			Page
PART I
~~PART I~~
Item 1	Business of Netlist, Inc.	1
Item 1A	Risk Factors	9 8
Item 1B	Unresolved Staff Comments	21 22
Item 2	Properties	21 22
Item 3	Legal Proceedings	22
Item 4	Submission of Matters to a Vote of Security Holders	22 23
PART II
Item 5	Market for ~~Registrant’s~~Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	23 24
Item 6	Selected Consolidated Financial Data	26
Item 7	~~Management’s~~Management's Discussion and Analysis of Financial Condition and Results of Operations	27
Item 7A	Quantitative and Qualitative Disclosures About Market Risk	40 44
Item 8	Financial Statements and Supplementary Data	40 45
Item 9	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	41 46
Item 9A	Controls and Procedures	41 46
Item 9B	Other Information	41 47
PART III
Item 10	Directors, Executive Officers and Corporate Governance	41 47
Item 11	Executive Compensation	42 47
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	42 47
Item 13	Certain Relationships and Related Transactions, and Director Independence	42 47
Item 14	Principal Accounting Fees and Services	42 47
PART IV
Item 15	Exhibits, Financial Statement Schedules	42 48
SIGNATURES		45 51
INDEX TO EXHIBITS
Exhibit ~~10.21~~ 21.1
Exhibit 23.1
Exhibit 23.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32

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

~~High Performance Computing~~		~~Networking/Telecom~~
~~PSSC Labs, Verari,~~ ~~Western Scientific~~		~~Force10, Foundry Networks,~~ ~~Stoke, Tekelec~~

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights			Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))			Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(a)			(b)			(c)			(a)		(b)		(c)
Equity compensation plans approved by security holders	Equity compensation plans approved by security holders		3,318,250			$	3.34		985,000	(1)	3,546,500		$	3.14	124,500	(1)
Equity compensation plans not approved by security holders	Equity compensation plans not approved by security holders		397,500	(2)		$	1.35		—		518,000	(2)	$	1.27	—

Total	Total		3,715,750			$	3.13		985,000		4,064,500		$	2.90	124,500

	November 30, 2006			December 30, 2006
Netlist, Inc.		$	100.00		$	120.00
S&P Semiconductors Index		$	100.00		$	95.83
NASDAQ Stock Market (U.S.) Index		$	100.00		$	99.77

	Aggregate Offering Price of the Offering Amount Registered			Aggregate Offering Price of Amount Sold			Underwriting Discount			Fees and Expenses Incurred for Netlist’s Account			Net Offering Proceeds
Netlist, Inc.		$	43,750,000		$	43,750,000		$	3,062,000		$	1,147,000	$	39,541,000
Selling Stockholders		$	6,562,500		$	6,562,500		$	459,375		—		$	6,103,125
Total		$	50,312,500		$	50,312,500		$	3,521,375		$	1,147,000

Use of Net Proceeds:
Repayment of indebtedness and accrued interest	$	1,809
Reduce outstanding borrowings under our revolving line of credit	5,500
Payment to directors, officers or to persons owning ten (10) percent or more of our capital stock	500
Purchase of leaseholds and equipment for manufacturing facility in the People’s Republic of China	293
Investments in marketable securities	5,267
Long term investments in marketable securities	1,502
Temporary investments(1)	24,670
Total	$	39,541

	Year Ended
	December 31, 2002				December 27, 2003				January 1, 2005			December 31, 2005				December 30, 2006
	(in thousands, except per share data)
Consolidated Statement of Operations Data:
Net sales		$	13,994			$	100,375		$	143,659			$	79,856			$	151,448
Cost of sales(1)		12,147				86,107			133,503				73,892				129,181
Gross profit		1,847				14,268			10,156				5,964				22,267
Operating expenses:
Research and development(1)		491				11,759			3,770				2,961				3,315
Selling, general and administrative(1)		1,652				15,218			6,314				5,062				9,191
Total operating expenses		2,143				26,977			10,084				8,023				12,506
Operating income (loss)		(296		)		(12,709		)	72				(2,059		)		9,761
Other expense, net		(290		)		(879		)	(1,386		)		(1,200		)		(1,849		)
Income (loss) before provision (benefit) for income taxes		(586		)		(13,588		)	(1,314		)		(3,259		)		7,912
Provision (benefit) for income taxes		46				2,317			(340		)		(912		)		2,844
Net income (loss)		$	(632	)		$	(15,905	)	$	(974	)		$	(2,347	)		$	5,068
Net income (loss) per common share:
Basic		$	(0.07	)		$	(1.62	)	$	(0.09	)		$	(0.22	)		$	0.43
Diluted		$	(0.07	)		$	(1.62	)	$	(0.09	)		$	(0.22	)		$	0.34
Weighted-average common shares outstanding:
Basic		9,200				9,831			10,671				10,673				11,705
Diluted		9,200				9,831			10,671				10,673				15,331

		December 29, 2007		December 30, 2006		December 31, 2005		January 1, 2005		December 27, 2003
		(in thousands)
Consolidated Balance Sheet Data:
	Cash and cash equivalents	$	7,182	$	30,975	$	953	$	759	$	1,907
	Investments in marketable securities		23,387		6,769		—		—		—
	Total assets		60,356		87,694		25,842		22,110		22,404
	Total debt(1)		6,250		21,501		13,921		9,379		3,464
	Stockholders' equity		44,193		50,244		2,855		5,261		5,981

	Within One Year			1-3 Years			4-5 Years			After 5 Years			Total
	(in thousands)
Scheduled payments under contractual obligations:
Long-term debt		$	595		$	687		$	179		$	—	$	1,461
Capital lease obligations		438			318			46			—		802
Operating leases		173			260			124			—		557
Purchase commitments		690			—			—			—		690
Total		1,896			1,265			349			—		3,510
Potential cash requirements under existing commitments:
Letters of credit		500			—			—			—		500
Total		$	2,396		$	1,265		$	349		$	—	$	4,010

	December 31, 2005				December 30, 2006
ASSETS
Current assets:
Cash and cash equivalents		$	953			$	30,975
Investments in marketable securities		—				5,267
Accounts receivable, net of allowance for sales returns and doubtful accounts of $109 (2005) and $88 (2006), respectively		13,140				23,703
Inventories		6,816				19,473
Income taxes receivable		259				—
Deferred taxes		902				1,054
Prepaid expenses and other current assets		434				988
Total current assets		22,504				81,460
Property and equipment, net		2,437				3,830
Deferred taxes		759				576
Long-term investments in marketable securities		—				1,502
Other assets		142				326
Total assets		$	25,842			$	87,694
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	6,645			$	11,680
Revolving line of credit		9,463				19,238
Current portion of long-term debt		720				1,033
Current portion of deferred gain on sale and leaseback transaction		116				118
Current portion of convertible notes payable		1,000				—
Income taxes payable		—				552
Accrued expenses and other current liabilities		1,841				3,255
Total current liabilities		19,785				35,876
Long-term debt, net of current portion		988				1,230
Deferred gain on sale and leaseback transaction, net of current portion		464				344
Convertible notes payable, net of current portion		1,750				—
Total liabilities		22,987				37,450
Commitments and contingencies (Note 10)		—				—
Stockholders’ equity:
Series A convertible preferred stock, $2.00 par value—1,000 shares authorized; 1,000 shares issued and outstanding (liquidation preference of $2,000) (2005); no shares issued and outstanding (2006)		2,000				—
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; 10,673 (2005) and 19,544 (2006) shares issued and outstanding		11				20
Additional paid-in capital		22,604				66,557
Note receivable from stockholder		(23		)		(1		)
Deferred stock-based compensation		(337		)		—
Accumulated deficit		(21,400		)		(16,332		)
Total stockholders’ equity		2,855				50,244
Total liabilities and stockholders’ equity		$	25,842			$	87,694

	Series A Preferred Stock							Common Stock					Additional Paid-in				Notes Receivable From				Deferred Stock-Based				Accumulated				Net Stockholders’
	Shares			Amount				Shares		Amount			Capital				Stockholders				Compensation				Deficit				Equity
Balance, December 27, 2003		1,000			$	2,000			10,650		$	11		$	24,656			$	(22	)		$	(2,585	)		$	(18,079	)		$	5,981
Forfeiture of stock options and warrants		—			—				—		—			(1,335		)		—				943				—				(392		)
Amortization of deferred stock-based compensation		—			—				—		—			—				—				642				—				642
Exercise of stock options		—			—				22		—			4				—				—				—				4
Interest from stockholder notes receivable		—			—				—		—			—				(1		)		—				—				(1		)
Payment of interest on stockholder note receivable		—			—				—		—			—				1				—				—				1
Net loss		—			—				—		—			—				—				—				(974		)		(974		)
Balance, January 1, 2005		1,000			2,000				10,672		11			23,325				(22		)		(1,000		)		(19,053		)		5,261
Issuance of stock options to nonemployees		—			—				—		—			6				—				(6		)		—				—
Forfeiture of stock options and warrants		—			—				—		—			(730		)		—				454				—				(276		)
Amortization of deferred stock-based compensation		—			—				—		—			—				—				215				—				215
Exercise of stock options		—			—				1		—			3				—				—				—				3
Interest from stockholder note receivable		—			—				—		—			—				(1		)		—				—				(1		)
Net loss		—			—				—		—			—				—				—				(2,347		)		(2,347		)
Balance, December 31, 2005		1,000			2,000				10,673		11			22,604				(23		)		(337		)		(21,400		)		2,855
Reclassification of deferred stock-based compensation upon adoption of SFAS No. 123(R)		—			—				—		—			(337		)		—				337				—				—
Estimated relative fair value of beneficial conversion feature on convertible note payable		—			—				—		—			50				—				—				—				50
Stock-based compensation		—			—				—		—			592				—				—				—				592
Interest from stockholder notes receivable		—			—				—		—			—				(1		)		—				—				(1		)
Payment on stockholders notes receivable																		23												23
Exercise of warrants		—			—				550		—			110				—				—				—				110
Issuance of common stock in connection with conversion of note payable and accrued interest		—			—				21		—			53				—				—				—				53
Tax benefit from exercise of warrants		—			—				—		—			203				—				—				—				203
Issuance of common stock in an initial public offering (net of underwriters’ discounts and offering expenses)		—			—				6,250		6			39,535				—				—				—				39,541
Conversion of preferred stock		(1,000	)		(2,000		)		1,000		1			1,999				—				—				—				—
Conversion of debt at initial public offering									1,050		2			1,748				—				—				—				1,750
Net income		—			—				—		—			—				—				—				5,068				5,068
Balance, December 30, 2006		–—			$	—			19,544		$	20		$	66,557			$	(1	)		$	—			($16,332		)		$	50,244

	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Options outstanding at January 1, 2006		2,190			$1.26
Options granted		1,478			$ 6.16
Options exercised		—			$ —
Options forfeited		(350	)		$ 2.18
Options outstanding at December 30, 2006		3,318			$ 3.34		7.62		$ 15,458
Options exercisable at December 30, 2006		1,424			$0.74		5.48		$10,338
Options vested and expected to vest at December 30, 2006		3,167			$3.25		7.67		$15,052

	December 31, 2005			December 30, 2006
Deferred tax assets:
Reserves and allowances		$ 1,046			$ 914
Other accruals		73			357
Compensatory stock options and rights		503			546
Tax credit carryforwards		249			193
Deferred gain		241			194
NOL carryforward		289			—
Total deferred tax assets		2,401			2,204
Deferred tax liabilities:
State taxes, net of federal income tax benefit		(278	)		(176	)
Depreciation and amortization		(304	)		(254	)
Prepaid expenses		(158	)		(144	)
Total deferred tax liabilities		(740	)		(574	)
		$ 1,661			$ 1,630

			December 29, 2007			December 30, 2006
Deferred tax assets:
	Reserves and allowances		$	3,384		$	914
	Others accruals			347			357
	Compensatory stock options and rights			905			546
	Tax credit carryforwards			241			193
	Deferred gain			144			194
	Contribution carryforwards			2			—
	NOL carryforward			125			—

		Total deferred tax assets		5,148			2,204

Deferred tax liabilities:
	State taxes, net of federal income tax benefit			(422	)		(176	)
	Depreciation and amortization			(167	)		(254	)
	Prepaid expenses			(30	)		(144	)

		Total deferred tax liabilities		(619	)		(574	)

			$	4,529		$	1,630

Balance at December 31, 2006	$	515
Accrual of potential interest related to unrecognized tax benefits		45

Balance at December 29, 2007	$	560

Fiscal Year		Capital Leases				Operating Leases			Capital Leases			Operating Leases
2007			$	507			$	173
2008	2008		282				128		$	312		$	743
2009	2009		70				132			94			769
2010	2010		39				124			63			741
2011	2011		10				—			14			439
2012										—			20

Total minimum lease payments	Total minimum lease payments		908				$	557		483		$	2,712

Less amount representing interest	Less amount representing interest		(106		)					(51	)
Present value of future minimum lease payments (see Note 7)			$	802

Present value of future minimum lease payments (see Note 6)									$	432

Beginning balance, December 30, 2006	$	—
Charged to costs and expenses		134
Payments		(31	)

Ending balance, December 29, 2007	$	103

	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Life	Aggregate Intrinsic Value
	(in thousands)				(in years)	(in thousands)
Options outstanding—January 1, 2005	1,539		$	0.61
Options granted	866			2.55
Options exercised	(2	)		1.95
Options cancelled	(213	)		1.98

Options outstanding—December 31, 2005	2,190			1.25
Options granted	1,478			6.16
Options exercised	—			—
Options cancelled	(350	)		2.18

Options outstanding—December 30, 2006	3,318			3.34
Options granted	1,163			3.15
Options exercised	(191	)		1.62
Options cancelled	(544	)		5.44

Options outstanding—December 29, 2007	3,746			3.06	7.4	$	2,343

Options exercisable—December 29, 2007	1,641		$	1.58	5.4	$	2,078

Options expected to vest—December 29, 2007	1,895		$	4.69	8.9	$	239

Options available for grant under the 2006 Plan at December 29, 2007	125

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number of shares	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number of shares	Weighted Average Exercise Price
	(in thousands)	(in years)			(in thousands)
$0.20 - $ 0.30	1,011	4.1	$	0.02	1,011	$	0.02
$1.25 - $ 1.88	406	9.1	$	1.61	52	$	1.25
$1.93 - $ 2.90	1,029	8.2	$	2.35	383	$	2.51
$3.00 - $ 4.50	265	9.5	$	3.32	—	$	—
$6.94 - $10.41	1,035	8.7	$	7.07	195	$	7.00

	3,746	7.4	$	3.06	1,641	$	1.58

	Year Ended
	December 29, 2007			December 30, 2006
Expected term (in years)		5.4			6
Expected volatility		80	%		43	%
Risk-free interest rate		4.43	%		4.91	%
Expected dividends		—			—

Weighted-average grant date fair value per share	$	2.18		$	2.98

Intrinsic value of options exercised (in thousands)	$	813		$	—

Fair value of options vested (in thousands)	$	1,181		$	592

	Total Shares			Weighted- Average Exercise Price
Outstanding—December 28, 2003		2,750			$	0.70
Granted		—			—
Exercised		(22	)		$	0.20
Canceled		(279	)		$	1.72
Outstanding—January 1, 2005		2,449			$	0.58
Granted		866			$	2.55
Exercised		(2	)		$	1.95
Canceled		(213	)		$	1.98
Outstanding—December 31, 2005		3,100			$	1.04
Granted		1,515			$	3.01
Exercised		(550	)		$	0.20
Canceled		(350	)		$	2.18
Outstanding—December 30, 2006		3,715			$	1.86

	Options/Warrants Outstanding							Options/Warrants Exercisable
Exercise Price	Number of Shares		Weighted- Average Remaining Life (Years)		Weighted- Average Price			Number of Shares		Weighted- Average Price
$0.20		1,045		5		$	0.20		1,043		$	0.20
$1.00		300		1		$	1.00		300		$	1.00
$1.25		189		6		$	1.25		179		$	1.25
$1.95		33		7		$	1.95		28		$	1.95
$2.55		953		9		$	2.55		224		$	2.55
$7.00		1,180		10		$	7.00		10		$	7.00
$8.00		15		10		$	8.00		—		$	8.00
		3,715							1,784

	Year Ended
	January 1,			December 31,			December 30,
	2005			2005			2006
Customer:
A		71	%		35	%		38	%
B		—			13	%		2	%
C		2	%		20	%		33	%

~~/s/ CORBIN & COMPANY, LLP~~
~~Irvine, California~~
~~February 27, 2007~~

			Balance at Beginning of Year		Charged to Costs and Expenses		(Deductions)			Balance at End of Year
Year Ended December 29, 2007:
	Allowance for doubtful accounts		$	62		51	$	(24	)	$	89
	Allowance for sales returns			26		1,614		(1,212	)		428

		Total	$	88	$	1,665	$	(1,236	)	$	517

Year Ended December 30, 2006:
	Allowance for doubtful accounts		$	88	$	371	$	(397	)	$	62
	Allowance for sales returns			21		149		(144	)		26

		Total	$	109	$	520	$	(541	)	$	88

Year Ended December 31, 2005:
	Allowance for doubtful accounts		$	100	$	—	$	(12	)	$	88
	Allowance for sales returns			132		19		(130	)		21

		Total	$	232	$	19	$	(142	)	$	109

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

	Balance At Beginning of Period			Charged to Cost and Expenses			(Deductions)				Balance at End of Period
Allowance for sales returns and doubtful accounts:
Year Ended January 1, 2005		$	136		$	200		$	(104	)		$	232
Year Ended December 31, 2005		$	232		$	19		$	(142	)		$	109
Year Ended December 30, 2006		$	109		$	520		$	(541	)		$	88