This quarterly report on Form 10-Q, particularly in the sections entitled "Risk Factors," and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (Securities Act), and
Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act), that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this document, including statements regarding our future financial position, business strategy, plans and objectives of management for future operations, forecasts regarding the broadband market, market trends, our competitive status, our product development, our product marketing and inventory, technological developments, the features, benefits and performance of our current and future products, our compliance with governmental rules, our ability to adapt to industry standards, future price reductions, our future liquidity and cash needs, management of our expenses, anticipated demand for our products, customer relationships, the integration of our senior management, our dependence on our senior management and our ability to attract and retain key personnel and maintain a consistent senior management team, our ability to integrate current and future senior management, our ability to use of third party intellectual property, the effect of one large stockholder group on our common stock, qualification of foundries and our foundries' capacities, our ability to deliver quality products with acceptable manufacturing yields, current and potential litigation, the expected benefits of our intellectual property and the potential outcomes of intellectual property disputes, our ability to protect our intellectual property, our expected future operating costs and expenses, our internal controls, exchange rates, investment and foreign currency exposure, potential new competitors, sources of revenue, our continued growth, dependency and concentration of customer base, use of proceeds, the expected impact of various accounting policies and rules adopted by the Financial Accounting Standards Board and our accounting policy estimates, our future office space needs, expected benefits and completion of our corporate restructuring, our ability to operate internationally and fluctuations in our stock price are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "believe," "may," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "potential," or the negative of these terms or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions described under the caption "Risk Factors" and elsewhere in this document, regarding, among other things:

• our history of losses;

• our ability to integrate the technologies and employees from acquisitions into our existing business;

• cyclical and unpredictable decreases in demand for our semiconductors;

• our ability to adequately forecast demand for our products;

• our ability to develop and achieve market acceptance of new products and technologies;

• our sales cycle;

• selling prices of products being subject to declines;

• our dependence on a few customers;

• our reliance on subcontractors to manufacture, test and assemble our products;

• our dependence on and qualification of foundries to manufacture our products;

• production capacity;

• our customer relationships;

• the development and future growth of the broadband digital subscriber line (DSL) and communications processing markets;

• protection of our intellectual property;

• currency fluctuations;

• competition and competitive factors of the markets in which we compete; and

• future costs and expenses and financing requirements.

These risks are not exhaustive. Other sections of this quarterly report on Form 10-Q include additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 above and with our financial statements and notes thereto for the fiscal year ended January 1, 2012, contained in our Annual Report on Form 10-K filed on February 23, 2012.

In this quarterly report on Form 10-Q, references to "Ikanos," "we," "us" or "our" means Ikanos Communications, Inc. and our subsidiaries except where it is made clear that the term means only the parent company.

Overview

We are a leading provider of advanced broadband semiconductor and integrated firmware products for the digital home. Our broadband DSL, communications processors and other offerings power access infrastructure and customer premises equipment (CPE) for many of the world's leading network equipment manufacturers and telecommunications service providers. Our products are at the core of digital subscriber line access multiplexers (DSLAMs), optical network terminals (ONTs), concentrators, modems, voice over Internet Protocol (VoIP) terminal adapters, integrated access devices (IADs) and residential gateways (RGs). Our products have been deployed by service providers in Asia, Europe and North America.

We believe that we can offer advanced products by continuing to push existing limits in silicon, systems and software. We have developed programmable, scalable chip architectures, which form the foundation for deploying and delivering multi-play services. Expertise in the creation and integration of digital signal processor (DSP) algorithms with advanced digital, analog and mixed signal semiconductors enables us to offer high performance, high-density and low-power asymmetric DSL (ADSL) and very-high-bit rate DSL (VDSL) products. In addition, flexible communications processor architectures with wirespeed packet processing capabilities enable high-performance end-user devices for distributing advanced services in the home. These products thus support service providers' multi-play deployment plans to the digital home while keeping their capital and operating expenditures low.

We outsource all of our semiconductor fabrication, assembly and test functions, which allows us to focus on the design, development, sales and marketing of our products and reduces the level of our capital investment. Our direct customers consist primarily of original design manufacturers (ODMs), contract manufacturers (CMs), network equipment manufacturers (NEMs) and original equipment manufacturers (OEMs), who in turn sell our semiconductors as part of their product solutions to the service provider market.

We have entered into a master services and supply agreement under which a third party partner manages Ikanos' manufacturing operations and related logistics functions including supply chain management for the Company's products. We order and purchase our products from the third party partner, who, in turn contracts with foundries and subcontractors located primarily in Asia for the manufacture, assembly and testing of its products. We will continue to manage all aspects of the customer interface, forecasting and ordering. We started the transition during the fiscal second quarter of 2012 and expect to complete the majority of the transition in the fiscal third quarter of 2012.

We incurred net losses of $3.0 million and $6.7 million, respectively, for the fiscal quarter and six months ended July 1, 2012, respectively, and we had an accumulated deficit of $284.8 million as of July 1, 2012. To achieve consistent profitability, we will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for our business. Although we have the cash necessary to fund our operations for the foreseeable future, we may also seek additional financing as deemed appropriate to support future company needs and investments. We filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (SEC) on October 25, 2010 (declared effective on November 1, 2010) under which we can offer and sell up to $30.0 million of our common stock and warrants. On November 11, 2010 and December 7, 2010 we sold a total of 12.8 million shares of common stock under the Form S-3 in an underwritten offering for $13.5 million. After deducting underwriting fees, legal, accounting and other costs, we realized proceeds of $12.5 million.

We were incorporated in April 1999 and, through December 31, 2001 and were engaged principally in research and development. We began commercial shipment of our products in the fiscal fourth quarter of 2002. Over the last three fiscal years, our revenue was $130.7 million, $191.7 million and $136.6 million in fiscal years 2009, 2010 and 2011, respectively.

Quarterly revenue fluctuations are characteristic of our industry and affect our business, especially due to the concentration of our revenue among a few customers. These quarterly fluctuations can result from a mismatch of supply and demand. Specifically, service providers purchase equipment based on planned deployment. However, service providers may deploy equipment more slowly than initially planned, while OEMs continue for a time to manufacture equipment at rates higher than the rate at which equipment is deployed. As a result, periodically and usually without significant notice, service providers will reduce orders with OEMs for new equipment, and OEMs, in turn, will reduce orders for our products, which will adversely impact the quarterly demand for our products, even when deployment rates may be increasing.

Furthermore, our future revenue growth depends upon the successful qualification and adoption of our new product platforms at service providers and network equipment manufacturers. In addition to these qualifications, our operations may be adversely affected by our customers' transition strategies from existing systems that use our products to systems that may not use our products. It is inherently difficult to predict if and when platforms will pass qualification, when service providers will begin to deploy the equipment

and at what rate, because we do not control the qualification criteria or process, and the systems manufacturers and service providers do not always share all of the information available to them regarding qualification and deployment decisions. However we believe our team of engineers, DSL products, technology, patents and other intellectual property will allow us to create products that will allow us to extend our market leadership and enable us to implement our digital home initiatives and next generation VDSL2 development.

On June 14, 2012 we transferred our common stock from the NASDAQ Global Market to the NASDAQ Capital Market. In accordance with NASDAQ Marketplace Rule 5810(c)(3)(A), we were provided 180 calendar days from June 14, 2012, or until December 10, 2012, to regain compliance with the market price requirement of $1.00 per share of common stock.. If, at any time before December 10, 2012, the bid price of our common stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, we will be in compliance with the minimum bid price listing requirement and the matter will be closed. If we do not regain compliance, our common stock will be subject to delisting. We intend to actively monitor the bid price for our common stock and will consider available options to resolve the deficiency and regain compliance. There is no assurance that we will be able to comply with this rule and, therefore, may lose our eligibility for quotation on the NASDAQ Stock Market.

On June 11, 2012, Mr. Diosdado Banatao resigned as our interim President and Chief Executive Officer. Mr. Banatao will continue to serve as chairman of our Board of Directors. On June 11, 2012, our Board of Directors appointed Omid Tahernia as our President and Chief Executive Officer effective on that date and also elected him to our Board of Directors

Critical Accounting Policies and Estimates

In preparing our unaudited condensed consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical accounting estimates with the Audit Committee of our Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue, cost of revenue, accounts receivable, inventories, warranty, income taxes, impairment of goodwill and related intangibles, acquisitions and stock-based compensation expense have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.

The critical accounting policies, are described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the fiscal year ended January 1, 2012, and have not changed materially as of July 1, 2012.

Results of Operations

Revenue

Our revenue is derived from sales of our semiconductor products. Revenue from product sales is generally recognized upon shipment, net of sales returns, rebates and allowances. Revenue from product sales to a distributor is generally recognized when the distributor has sold through to the end customer. In multi-element arrangements that include a combination of products with firmware that is essential to the hardware products' functionality and undelivered firmware, revenue recognition may be deferred until essential firmware is delivered. As is typical in our industry, the selling prices of our products generally decline over time. Therefore, our ability to increase revenue is dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in greater quantities. Our ability to increase unit sales volume is dependent primarily upon our ability to increase and fulfill current customer demand and obtain new customers. The continuing effects of the worldwide recession have adversely affected the businesses of service providers around the world, causing them to re-evaluate how they employ capital. Consequently the rate at which broadband infrastructure is upgraded may slow or delay new broadband programs.

Revenue decreased by $2.0 million, or 6%, to $32.1 million in the three months ended July 1, 2012 from $34.1 million in the three months ended July 3, 2011. Revenue decreased by $2.9 million, or 4%, to $62.8 million in the six months ended July 1, 2012 from $65.7 million in the six months ended July 3, 2011. This decline reflects the decline in the certain legacy products offset partially by the new product introductions in our Fusiv product family.

We generally sell our products to OEMs through a combination of our direct sales force, third-party sales representatives and distributors. Sales are generally made under short-term, non-cancelable purchase orders. We also have volume purchase agreements, and certain customers who provide us with non-binding forecasts. Although certain OEM customers may provide us with rolling forecasts, our ability to predict future sales in any given period is limited and subject to change based on demand for our OEM customers' systems and their supply chain decisions. Historically, a small number of OEM customers, the composition of which has varied over time, have accounted for a substantial portion of our revenue. We expect that significant customer concentration will continue for the foreseeable future, but it may diversify across more carrier customers as we strive to market our new products to a broader range of service providers for their deployment of broadband solutions and gateway products. The following direct customers each accounted for more than 10% of our revenue for the periods indicated.

                                                   Three Months Ended                 Six Months Ended
                                               July 1,           July 3,         July 1,            July 3,
Our Direct Customer                              2012              2011            2012              2011
Sagemcom Tunisie                                     19 %              26 %            17 %               25 %
Flextronics Manufacturing (Hong Kong) Ltd.           15                21              14                 13
Askey Computer Corporation                           12                 *               *                  *
NEC Asia Pacific Pte. Ltd.                           11                 *              11                  *
Paltek Corporation                                    *                 *               *                 12

* Less than 10%

Revenue by Country as a Percentage of Total Revenue



                             Three Months Ended               Six Months Ended
                          July 1,          July 3,       July 1,           July 3,
                            2012             2011          2012             2011
          China                 13 %             10 %          12 %              11 %
          France                20               29            18                28
          Hong Kong             18               12            16                 8
          Japan                 17               13            23                19
          Taiwan                16               11            15                12
          Korea                  7                2             5                 3
          United States         -                 1             1                 1
          Other                  9               22            10                18

The table above reflects sales to our customers based on where they are headquartered. It does not necessarily reflect carrier deployment of our products as we do not sell directly to them. Although the percentage of revenue by country remained relatively stable, revenue in absolute dollars improved to our Asian customers, but declined to customers in Europe.

Revenue by Product Family as a Percentage of Total Revenue



                                      Three Months Ended            Six Months Ended
                                   July 1,          July 3,      July 1,        July 3,
                                    2012              2011         2012           2011
      Broadband DSL                      59 %             59 %         62 %           56 %
      Communications Processors          31               30           28             31
      Other                              10               11           10             13

The change in product mix reflects the increases in VDSL Central Office sales in the fiscal first quarter of 2012 compared to the prior year period.

Cost and Operating Expenses



                                                 Three Months Ended                       Six Months Ended
                                         July 1,      July 3,         %          July 1,      July 3,         %
                                           2012         2011        Change         2012         2011        Change
Cost of revenue                          $ 17,001     $ 17,647           (4 )    $ 31,654     $ 32,798           (3 )
Research and development                   12,842       14,669          (12 )      26,842       28,325           (5 )
Sales, general and administrative           4,648        5,659          (18 )       9,328       11,804          (21 )
Restructuring charges                         (30 )       (156 )        (81 )       1,062         (109 )         nm

nm-Not meaningful

Cost and Operating Expenses as a Percentage of Total Revenue:

                                          Three Months Ended            Six Months Ended
                                       July 1,          July 3,      July 1,        July 3,
                                        2012              2011         2012           2011
  Cost of revenue                            53 %             52 %         50 %           50 %
  Research and development                   40               43           45             43
  Sales, general and administrative          15               17           19             18
  Restructuring charges                      nm               nm            2             -

nm-Not meaningful

Cost of Revenue

Our cost of revenue consists primarily of the cost of silicon wafers purchased from third-party foundries and third-party costs associated with assembling, testing and shipping of our semiconductors. Because we do not have formal, long-term pricing agreements with our outsourcing partners, our wafer costs and services are subject to price fluctuations based on the cyclical demand for semiconductors among other factors. In addition, after we purchase wafers from foundries, we also incur yield loss related to manufacturing these wafers into usable die. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested. When our manufacturing yields decrease, our cost per unit increases which could have a significant adverse impact on our cost of revenue. Cost of revenue also includes accruals for actual and estimated warranty obligations and write-downs of excess and obsolete inventories, payroll and related personnel costs, licensed third-party intellectual property, depreciation of equipment, stock-based compensation expenses and amortization of acquisition-related intangibles.

We have entered into a master services and supply agreement under which a service provider will manage our manufacturing operations and related logistics functions including supply chain management for the our products. We will order and purchase our products from the service provider, who, in turn will contract with foundries and subcontractors located primarily in Asia for the manufacture, assembly and testing of our products. We will continue to manage all aspects of our customer interface, forecasting and ordering. We started the transition during the fiscal second quarter of 2012 and expect to complete the majority of the transition in the fiscal third quarter of 2012.

Cost of revenue decreased to $17.0 million for the three months ended July 1, 2012 compared to $17.6 million for the three months ended July 3, 2011. Cost of revenue decreased to $31.7 million for the six months ended July 1, 2012 as compared to $32.8 million for the six months ended July 3, 2011. The decrease in cost of revenue for both the three and six month periods ended July 1, 2012 compared to the same period last year is directly attributable to our decreased sales volume and certain changes in product mix. Our gross margins were 47% for the three months ended July 1, 2012 as compared to 48% for the three months ended July 3, 2012. During the fiscal second quarter of 2012 we recognized revenue of $0.3 million related to the sales of inventory previously written off. This compares to $1.2 million recognized in the fiscal second quarter of 2011. In addition, fiscal second quarter 2012 gross margin was adversely affected by a $1.3 million charge related to a patent license agreement covering the current and certain prior periods. The patent license will not have a material impact on future results or margins.

Our gross margins were approximately 50% for the six months ended July 1, 2012 and the six months ended July 3, 2011. Favorable product mix for the six months ended July 1, 2012 was offset by the $1.3 million of higher license costs discussed above. In addition, during the first six months of 2011 we sold $2.9 million of inventory previously written off. In the first six months of 2012, we sold $0.7 million of inventory previously written off. Gross margins are expected to decline in the fiscal third quarter of 2012 compared to the fiscal second quarter of 2012 due to our product mix and yields associated with new product ramp.

Research and development expenses

All research and development (R&D) expenses are expensed as incurred and generally consist of compensation and associated expenses for employees engaged in research and development; contractors; tape-out costs; reference board development; development testing, evaluation kits and tools; stock based compensation expenses and depreciation expense. Before releasing new products, we incur charges for mask sets, amortization of acquisition-related intangibles, prototype wafers, mask set revisions, bring-up boards and other qualification materials, which we refer to as tape-out costs. These tape-out costs may cause our R&D expenses to fluctuate because they are not incurred uniformly every quarter.

R&D expenses decreased $1.8 million, or 12%, to $12.8 million for the three months ended July 3, 2012 compared to $14.7 million for the three months ended July 3, 2011. Personnel costs were lower by $1.4 million as R&D personnel levels declined by 44 persons compared to the level as of July 3, 2011. The headcount level of 191 as of July 1, 2012 was marginally lower than the headcount level of 196 as of April 1, 2012. The decline in personnel costs was offset by higher consulting costs of $0.3 million compared to the fiscal second quarter 2011 period. Deferred compensation charges increased by $0.4 million, while tapeout cost increased by $0.3 million. We expect that fiscal third quarter R&D will be higher by approximately $4.0 million compared to the second fiscal quarter of 2012 primarily due to higher tape-out costs and engineering related expenses.

R&D expenses decreased $1.5 million, or 5%, to $26.8 million for the six months ended July 3, 2011 compared to $28.3 million for the six months ended July 3, 2011. The decreased costs resulted from lower personnel costs of $2.5 million due to the attrition discussed above, and lower deferred compensation charges of $0.2 million offset by an increase in consulting costs of $0.9 million, and tape-out costs of $0.5 million.

. . .