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IKAN > SEC Filings for IKAN > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for IKANOS COMMUNICATIONS


2-May-2013

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 (the 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, our anticipated cash needs, financing activities and our need for additional financing, our inventory, our anticipated tax rate, 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, 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 or 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 December 30, 2012, contained in our Annual Report on Form 10-K filed on February 28, 2013.


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In this quarterly report on Form 10-Q, references to "Ikanos," "we," "us," "our" or the "Company" 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 firmware. 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. In fiscal year 2012, we expanded our outsourced model by transitioning a majority of our day-to-day supply chain management, production test engineering and production quality engineering functions (Master Services) to eSilicon Corporation (eSilicon) under a master services and supply agreement (Service Agreement) . Pursuant to the Service Agreement, we place orders for our finished goods products with eSilicon, who, in turn, contracts with wafer foundries and the assembly and test subcontractors and manages these operational functions for us on a day-to-day level. During the first half of 2012, we began to transition these Master Services to eSilicon and to establish clear lines of communications among us, eSilicon, the wafer foundries and the assembly and test subcontractors. As of the end of fiscal year 2012, we had substantially completed the transition of Master Services to eSilicon.

We incurred a net loss of $4.4 million for the fiscal quarter ended March 31, 2013 and had an accumulated deficit of $300.1 million as of March 31, 2013. 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 believe that we have the cash necessary to fund our operations, we may also seek additional financing as deemed appropriate to support future company needs and investments. Future capital requirements will depend upon many factors including our rate of revenue growth, our ability to develop future revenue streams, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of its products.

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 this 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. As of March 31, 2013, we have $16.5 million available for future issuance under this Form S-3.

In January 2011, we entered into a Loan and Security Agreement (Loan Agreement) With Silicon Valley Bank (SVB) under which SVB makes advances under a revolving line of credit (Revolving Line) of up to $15.0 million, as described below. During fiscal years 2012 and 2013, we drew down on our Revolving Line for working capital purposes. As of March 31, 2013, $5.0 million was outstanding on our Revolving Line. Interest on advances against the line is equal to 4.75% as of March 31, 2013 and is payable monthly. We may prepay the advances under the Revolving Line, in whole or in part at any time, without premium or penalty. On February 19, 2013, we amended the Revolving Line including certain of its covenants and extended the term until April 14, 2015.

We were incorporated in April 1999 and, through December 31, 2001, were engaged principally in research and development. We began commercial shipment of our products in the fourth quarter of 2002. Over the last three years, our revenue was $191.7 million in 2010, $136.6 million in 2011and $125.9 million in 2012.

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.


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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. Our first quarter's revenue was to some extent adversely affected by a one to two quarter delay in the ramp in certain customers' end markets. We expect that the biggest impact of this delay will occur in the fiscal second quarter of 2013 as our customers sell off their inventory and begin to ramp certain major products in the coming quarters.

Our industry is continually transitioning to new technologies and products. Large industry transitions are unpredictable due to factors including, but not limited to, extended product trials, qualifications, and the transformation of existing platforms to new platforms. Furthermore, the environment in which we market and sell our products has become increasingly competitive and cost sensitive. Our competitors are able to provide higher degrees of integration due to their broader range of products.

Our future revenue growth depends on 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 product to systems that may not use our products. As is customary in our industry, we may elect to end-of-life certain products and, as a result, certain customers may enter into last time buy arrangements which could further impact revenues. Additionally, certain of our customers entered into last time buys of some products during 2012. In some cases products may become mature or uncompetitive causing customers to transition to solutions from other manufacturers or implement multi-sourcing procurement strategies in which we participate in a diminished capacity.

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. Additionally, we have limited visibility into the buying patterns of our OEMs, who, in turn, are affected by changes in the buying and roll out patterns of the service provider market. As a result of manufacturing inventory to a forecast, we may have excess inventory if the forecast differs from actual results.

On February 28, 2013, Mr. Michael Kelly resigned from his position as Vice-President of Worldwide Sales. On March 28, 2013, Mr. Douglas Norby resigned from 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, marketable securities, 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 December 30, 2012, and have not changed materially as of March 31, 2013.

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. Depending on the distributor, product sales to the distributor are recognized either based on contract terms or when the distributor has sold through to the end customer. 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 new broadband programs could be delayed.

Revenue continues to be distributed among a range of products and three customers who accounted for 56% of our total fiscal first quarter 2013 revenue. Revenue declined by $4.6 million, or 15%, to $26.2 million for the three months ended March 31, 2013 from $30.8 million in the three months ended April 1, 2012 and $5.6 million or 18%from $31.8 million in the fiscal fourth quarter of 2012. The first quarter's revenue included the recognition of previously deferred revenue of $2.5 million related to certain software that was


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fully completed and delivered during the quarter. Our customers' inventory buildup, caused by a one to two quarter push out in the ramp in certain end markets, had an adverse effect on our fiscal first quarter. We expect that there will be a greater impact on the fiscal second quarter as customers continue to consume their inventory and ramp certain major products in the next two quarters.

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 with 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, and we expect that significant customer concentration will continue for the foreseeable future. However, customer concentration may diversify across more carrier customers as we expect more service providers world-wide to begin deployments of our broadband solutions.

The following direct customers accounted for more than 10% of our revenue for the periods indicated. Sales made to OEMs are based on information that we receive at the time of ordering.

                                                       Three Months Ended
                                                  March 31,           April 1,
     Our Direct Customer                             2013               2012
     Sagemcom Tunisie                                     24 %               15 %
     Askey Computer Corporation**                         22                  *
     Paltek Corporation                                   10                 12
     Flextronics Manufacturing (Hong Kong) Ltd.            *                 13
     NEC Corporation of America                            *                 11

* Less than 10%

** Askey is a contract manufacturer for Sagemcom.

Revenue by Country as a Percentage of Total Revenue

                                         Three Months Ended
                                    March 31,           April 1,
                                       2013               2012
                    France                  25 %               15 %
                    Taiwan                  23                 13
                    Japan                   18                 30
                    China                    7                 11
                    Germany                  6                  7
                    Hong Kong                3                 15
                    United States            4                  1
                    Other                   14                  8

The table above reflects sales to our direct customers based on the country in which the customer's headquarters is located. It does not necessarily reflect carrier deployment of our products as we do not sell directly to them. Sales to France and Taiwan increased in fiscal first quarter 2013 by $1.8 million and $2.2 million, respectively, versus the fiscal first quarter of 2012. Japanese sales continued to decline falling $4.5 million in the first quarter of 2013 versus the comparable 2012 period. Sales to China and Germany also declined by $1.6 million and $0.5 million, respectively.

Revenue by Product Family as a Percentage of Total Revenue



                                               Three Months Ended
                                          March 31,           April 1,
                                             2013               2012
              Broadband DSL                       50 %               64 %
              Communications Processors           41                 25
              Other                                9                 11

The change in mix reflects increases in VDSL central office sales in the fiscal first quarter of 2012 compared to the prior year period and reductions in both the communications processors and other categories.


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Cost and Operating Expenses



                                                    Three Months Ended
                                           March 31,       April 1,         %
                                             2013            2012         Change
                                                (in millions)
      Cost of revenue                     $      12.2     $     14.7          (17 )%
      Research and development                   13.5           14.0           (3 )
      Sales, general and administrative           4.8            4.7            2
      Restructuring charges                        -             1.1            *

* Not meaningful

Cost and Operating Expenses as a Percentage of Total Revenue:



                                                   Three Months Ended
                                              March 31,           April 1,
                                                 2013               2012
          Cost of revenue                             47 %               48 %
          Research and development                    52                 46
          Sales, general and administrative           18                 15
          Restructuring charges                       -                   4

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.

Cost of revenue was $12.2 million for the three months ended March 31, 2013 compared to $14.7 million for the three months ended April 1, 2012. Gross margin improved by 1% to 53% in the fiscal first quarter of 2013 from 52% in the fiscal first quarter of 2012. The major contributor to this improvement was the recognition of $2.5 million of previously deferred revenue until certain software delivery obligations were fully completed and delivered in the fiscal first quarter of 2013. Offsetting this improvement was the decline in sales of the high margin Broadband DSL family in the fiscal first quarter of 2013 versus the same period in 2012. Sales and margin improvement in our Communications Processor family were not enough to offset the Broadband DSL declines.

Research and development

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

R&D expenses declined $0.5 million, or 3%, to $13.5 million for the three months ended March 31, 2013 compared to $14.0 million for the three months ended April 1, 2012. Personnel costs were flat while consulting costs and depreciation expenses were lower by $0.2 million and $0.4 million respectively. Tapeout costs were lower by $0.8 million in the fiscal first quarter of 2013 compared to the comparable 2012 period. Materials and services costs and software licensing and maintenance fees were increased by $0.6 million and $0.2 million, respectively, in the fiscal first quarter of 2013 compared to the fiscal first quarter of 2012.

The majority of our R&D personnel are located in the United States or India. At March 31, 2013, we had 206 people engaged in R&D, of which 65 were located in India, 138 were located in the United States and 3 were located in China. At April 1, 2012, we had 213 people engaged in R&D, of which 72 were located in India, 138 were located in the United States and 3 were located in China.

Selling, general and administrative

Selling, general and administrative (SG&A) expenses generally consist of compensation and related expenses for personnel; legal, recruiting and auditing fees; and depreciation. SG&A expenses increased by $0.1 million for the three months ended March 31, 2013, or 2%, to $4.8 million compared to $4.7 million for the three months ended April 1, 2012. Personnel costs were marginally higher by . . .

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