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IKAN > SEC Filings for IKAN > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for IKANOS COMMUNICATIONS

Form 10-Q for IKANOS COMMUNICATIONS


1-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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.


Table of Contents

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. Additionally, we have recently started to expand this outsourced model by transitioning a majority of our day-to-day supply chain management, production test engineering and production quality engineering functions to a third party (Managed Services). In connection with this transition, we have entered into a master services and supply agreement with eSilicon Corporation (eSilicon) under which eSilicon provides Managed Services. Pursuant to the agreement, we place orders for our finished goods products with eSilicon, who, in turn, contracts with wafer foundries and the assembly and test subcontractors. While eSilicon manages these functions for us on a day-to-day level, we continue to manage the supply chain, test engineering and quality engineering functions at a senior level. During the first half of 2012, we began the transition of these day-to-day functions by migrating the daily inventory procurement to eSilicon and establishing clear lines of communications among us, eSilicon, the wafer foundries and the assembly and test subcontractors. As of the end of fiscal third quarter 2012, the Company has substantially completed the transition of Managed Services to eSilicon.

We incurred net losses of $6.4 million and $13.1 million, respectively, for the fiscal quarter and nine months ended September 30, 2012, respectively, and we had an accumulated deficit of $291.2 million as of September 30, 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.

On September 19, 2012 we took a $5.0 million advance against our revolving line of credit (Revolving Line) for working capital purposes under our $15.0 million Loan and Security Agreement (as amended April 12, 2012) (Loan Agreement) with Silicon Valley Bank (SVB). Interest on advances against the line is equal to 4.5% as of September 30, 2012 and is payable monthly. The Company may prepay the advances under the Revolving Line in whole or in part at any time without premium or penalty. The Loan Agreement's maturity date is April 14, 2013. (See Note 6 to the consolidated financial statements above for additional information.)

We were incorporated in April 1999 and, through December 31, 2001, we 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.


Table of Contents

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 that 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 closed at or above $1.00 per share for a minimum of 10 consecutive business days, we would be in compliance with the minimum bid price listing requirement and the matter will be closed. Our stock price has closed at or above $1.00 since September 10, 2012. As a result, we regained compliance and are not currently subject to delisting. However, there is no assurance that we will be able to continue to comply with this rule and, therefore, may in the future 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 September 30, 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.


Table of Contents

Revenue decreased by $4.0 million, or 11%, to $31.4 million in the three months ended September 30, 2012 from $35.4 million in the three months ended October 2, 2011. Revenue decreased by $7.0 million, or 7%, to $94.2 million in the nine months ended September 30, 2012 from $101.1 million in the nine months ended October 2, 2011. This decline reflects the decline in the certain legacy products offset partially by the new product introductions in our Fusiv product family. With respect to revenue from our Fusiv product family, we are seeing a one to two quarter push-out in the ramp in certain end markets and carrier product launches for new products that are expected to replace their legacy products.

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                             Nine Months Ended
                                    September 30,             October 2,           September 30,             October 2,
                                        2012                     2011                  2012                     2011
Our Direct Customer
Sagemcom Tunisie                                22 %                   21 %                    19 %                   23 %
Askey Computer Corporation                      14                        *                    11                        *
Flextronics Manufacturing
(Hong Kong) Ltd.                                10                        *                    12                        *
ZTE Corporation                                    *                   14                         *                   10
NEC Corporation of America                         *                   10                      10                        *
Paltek Corporation                                 *                      *                       *                   11

* Less than 10%

Revenue by Country as a Percentage of Total Revenue



                                             Three Months Ended                             Nine Months Ended
                                    September 30,             October 2,           September 30,             October 2,
                                        2012                     2011                  2012                     2011
China                                           12 %                   18 %                    12 %                   14 %
France                                          26                     21                      21                     23
Hong Kong                                       12                     12                      15                      9
Japan                                           15                     20                      20                     20
Taiwan                                          19                      7                      16                     11
Korea                                            5                      3                       5                      2
Netherlands                                     -                       5                      -                       6
United States                                   -                       4                       1                      2
Other                                           11                     10                      10                     13

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.

Revenue by Product Family as a Percentage of Total Revenue



                                              Three Months Ended                             Nine Months Ended
                                     September 30,             October 2,           September 30,            October 2,
                                         2012                     2011                  2012                    2011
Broadband DSL                                    55 %                    54 %                   60 %                  55 %
Communications Processors                        38                      34                     31                    32
Other                                             7                      12                      9                    13

The change in product mix reflects the decreases within the Broadband DSL family of VDSL Central Office sales in the three and nine months ended September 30, 2012 and increases in the Communications Processors Fusiv products during the same periods as compared to the prior year periods.


Table of Contents

Cost and Operating Expenses



                                                     Three Months Ended                                  Nine Months Ended
                                         September 30,       October 2,         %           September 30,       October 2,         %
                                             2012               2011          Change            2012               2011          Change
Cost of revenue                         $        16,620     $     17,590           (6 )    $        48,274     $     50,388           (4 )
Research and development                         16,581           14,402           15               43,423           42,727            2
Sales, general and administrative                 4,507            5,528          (18 )             13,835           17,332          (20 )
Restructuring charges (credits)                      -                -            -                 1,062             (109 )         nm

nm-Not meaningful

Cost and Operating Expenses as a Percentage of Total Revenue:

                                                 Three Months Ended                             Nine Months Ended
                                        September 30,             October 2,           September 30,            October 2,
                                            2012                     2011                  2012                    2011
Cost of revenue                                     53 %                    50 %                   51 %                  50 %
Research and development                            53                      41                     46                    42
Sales, general and administrative                   14                      16                     15                    17
Restructuring charges                               -                       -                       1                    -

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, wafer costs and services are subject to price fluctuations based on the cyclical demand for semiconductors among other factors. In addition, wafers purchased from foundries may 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 manufacturing yields decrease, cost per unit increases and could have a significant adverse impact on 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. (See Overview above.)

Cost of revenue decreased by $1.0 million, or 6%, to $16.6 million for the three months ended September 30, 2012 compared to $17.6 million for the three months ended October 2, 2011. Cost of revenue decreased by $2.1 million, or 4%, to $48.3 million for the nine months ended September 30, 2012 as compared to $50.4 million for the nine months ended October 2, 2011. The decrease in cost of revenue for both the three and nine month periods ended September 30, 2012 compared to the same periods 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 September 30, 2012 as compared to 50% for the three months ended October 2, 2011. The gross margin decline resulted from changes in product mix as sales declines in higher margin Broadband DSL products were replaced with lower margin Communications Processor products. During the fiscal third quarter of 2012 we sold $0.4 million of inventory previously written off. This compares to $0.6 million recognized in the fiscal third quarter of 2011.

Our gross margins were approximately 49% for the nine months ended September 30, 2012 as compared to 50% for the nine months ended October 2, 2011. Favorable . . .

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