ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
Facilities
Our headquarters are located in Fremont, California, where we lease approximately 73,500 square feet of space under lease agreements that expire in March 2016. The Fremont facility location is primarily utilized for research and development, sales and support, operations management, and general administrative functions. We also have other significant facility locations in the United States and India, including a 57,400 square foot research and development facility in Red Bank, New Jersey, whose lease expires in March 2018, and a 28,600 square foot research and development facility in Bangalore, India, whose lease expires in June 2017.
We believe that our facilities are adequate for the next 12 months and that, if required, suitable additional space will be available on commercially reasonable terms to accommodate our operations.
ITEM 3.
ITEM 3.
Legal Proceedings
From time-to-time, in the normal course of business, we are a party to litigation matters that have involved and may involve in the future, among other things, claims related to intellectual property infringement as well as employment-related disputes. We are subject to claims and litigation arising in the ordinary course of business, however, we do not believe, based on currently available facts and circumstances, that the final outcome of these matters, taken individually or as a whole, will have a material adverse effect on our consolidated results of operations or financial position. The results of litigation are inherently uncertain and material adverse outcomes are possible. We have not provided accruals for any legal matters in our financial statements as potential losses for such matters are not considered probable and reasonably estimable. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy any liabilities arising from the matters described above will not have a material adverse effect our consolidated results of operations, financial position, or cash flows.
ITEM 4.
ITEM 4.
Mine Safety Disclosures
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our common stock is quoted on The NASDAQ Capital Market under the symbol IKAN. The following table sets forth the high and low sales prices of our common stock as reported on The NASDAQ Capital Market for the fiscal periods indicated. The prices reflect retroactively the 1:10 reverse stock split that occurred on February 13, 2015.
As of March 11, 2015, there were approximately 32 holders of record of our common stock.
Dividend Policy
We have never declared or paid any cash dividends on our common stock or other securities. We currently anticipate that we will retain all of our future earnings for use in the expansion and operation of our business and do not anticipate paying any cash dividends in the foreseeable future. We also may incur indebtedness in the future that may prohibit or effectively restrict the payment of dividends on our common stock. Any future determination related to our dividend policy will be made at the discretion of our Board of Directors.
Equity Compensation Plan Information
The information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Part III, Item 12 of this Annual Report on Form 10-K.
Sale of Unregistered Securities
During the three years ended December 28, 2014, we issued 3,963,414 shares of unregistered common stock in a private placement as described below.
On September 29, 2014, Ikanos Communications, Inc. (the “Company”) sold an aggregate of 39.6 million shares of common stock, par value $0.001 per share (the “Common Stock”), at a purchase price of $4.10 per share (the “Purchase Price”), resulting in aggregate gross proceeds to the Company of approximately $16.25 million, pursuant to a Securities Purchase Agreement (the “Purchase Agreement”) by and among the Company, a group of investors affiliated with Tallwood Venture Capital (collectively, the “Tallwood Group”) and Alcatel-Lucent Participations, S.A. (“Alcatel-Lucent Participations”), in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), in reliance upon Section 4(a)(2) of the Securities Act (the “Private Placement”). The Tallwood Group and Alcatel-Lucent Participations purchased $11.25 million and $5.0 million, or 2.74 million and 1.22 million shares, of Common Stock, respectively. Alcatel-Lucent Participations and Alcatel-Lucent USA Inc. (“Alcatel-Lucent USA”) are subsidiaries of Alcatel-Lucent (collectively referred to herein as “Alcatel-Lucent”).
The Tallwood Group is the Company’s largest single stockholder and prior to the Private Placement held approximately 31.8% of the outstanding shares of Common Stock. Immediately following the Private Placement, the Tallwood Group held approximately 43% of the outstanding shares of Common Stock. The Tallwood Group purchased an additional 2.74 million shares of Common Stock at the Purchase Price of $4.10 for $11.25 million during our Rights Offering which concluded on February 4, 2015. Two members of the Company’s board of directors (the “Board of Directors”) are affiliated with the
Tallwood Group. Diosdado Banatao, the Chairman of the Board, is a Founder and Managing Partner of Tallwood Venture Capital, and George Pavlov, a director, is a General Partner of Tallwood Venture Capital. The proceeds from the private placement and the Rights Offering will be used for general corporate purposes.
On January 9, 2015, the Company filed a registration statement on Form S-3 to register for resale the shares of Common Stock acquired by Alcatel-Lucent Participations in the Private Placement. During the first quarter of 2015, we plan to file a registration statement on Form S-1 to register for resale the shares of the Common Stock acquired by the Tallwood Group in the Private Placement, the 31.6 million shares owned by the Tallwood Group prior to the Private Placement, and the 2.74 millon shares of common stock purchased by the Tallwood Group in the Rights Offering.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
We have retrospectively applied the effect of our 1:10 reverse stock split to all shares outstanding, earnings per share, and equity plan amounts for all periods presented in this 2014 Annual Report on Form 10-K.
The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Our fiscal years are the 52 or 53 week periods ended on the Sunday nearest the end of December. Historical results are not necessarily indicative of the results to be expected in the future.
(1)
Amounts include stock-based compensation as follows:
(2)
The basic and diluted net loss computations exclude potential shares of common stock issuable upon the exercise of options and warrants to purchase common stock when their effect would be anti-dilutive. See “Note 1. Ikanos and Summary of Significant Accounting Policies” to the consolidated financial statements included in this report.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K.
Overview
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 fourth quarter of 2002. Our revenue was $125.9 million in 2012, $79.7 million in 2013, and $48.4 million in 2014. Revenue fluctuations are characteristic of our industry and affect our business, especially due to the concentration of our revenue among a few customers and a limited number of products. These fluctuations can result from a variety of factors, including the inability to offset lower demand for products that near end-of-life with new product offerings as a result of development delays, competitive pricing pressures, or the inability to meet product requirements. 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. In order to obtain future revenue growth we must be successful in designing our new products to match customer requirements while delivering the requisite products within the customers' required development cycle.
We incurred a net loss of $43.3 million in 2014 and had an accumulated deficit of $369.4 million as of December 28, 2014. As a result of our planned increase in development spending associated with our next generation G.fast offering, recurring losses from operations, and our need to stay in compliance with our debt covenant, there is uncertainty regarding our ability to maintain liquidity sufficient to operate our business effectively, which raises substantial doubt as to our ability to continue as a going concern. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to us.
Beginning in January 2014, the price of our common stock began to trade below $1.00. Shortly thereafter, we received notice from The NASDAQ Stock Market that we were no longer in compliance with Marketplace Rule 5550(a)(2) and if we did not regain compliance within the time alloted our common stock would be subject to being delisted from NASDAQ. We were subsequently granted two 180 day periods to regain compliance, the second of which would have expired on March 16, 2015. To address this issue of noncompliance, on February 11, 2015, at a Special Meeting of Stockholders (the "Special Meeting"), our stockholders approved an amendment to our Restated Certificate of Incorporation to effect a reverse stock split of our common stock at a ratio to be determined by our Board of Directors at a ratio of not less than one-for-five (1:5) and not more than one-for-ten (1:10). At a meeting of the Board of Directors immediately following the Special Meeting, the Board of Directors directed Ikanos management to implement a 1:10 reverse stock split, effective immediately. We have retrospectively applied the effect of this 1:10 reverse stock split to all shares outstanding, earnings per share, and equity plan amounts for all periods presented in this Annual Report on Form 10-K. Subsequent to implementing the reverse stock split, we received notification from NASDAQ that we were in compliance with Marketplace Rule 5550(a)(2) and, therefore, that we had regained compliance with the continued listing requirements of NASDAQ.
We are a leading provider of advanced semiconductor products and software for delivering high speed broadband solutions to the connected home. Our broadband multi-mode and digital subscriber line ("DSL") processors and other semiconductor offerings power carrier infrastructure (referred to as "Access") and customer premises equipment (referred to as "Gateway") for network equipment manufacturers ("NEMs") supplying leading telecommunications service providers. Our products are at the core of DSL access multiplexers ("DSLAMs"), optical network terminals ("ONTs"), concentrators, modems, voice over Internet Protocol ("VoIP") terminal adapters, integrated access devices ("IADs"), and residential gateways ("RGs"). On September 29, 2014, we entered into a collaboration arrangement with Alcatel-Lucent USA, Inc. (along with Alcatel-Lucent Participations, collectively known as “ALU”) on the development of ultra-broadband products. We expect this collaboration to not only help increase our share of the broadband Access market but to also positively impact our global carrier engagements, as well as Gateway OEM interest in our products and technology. Our products have been deployed by service providers globally, including in Asia, Europe, and North and South America.
On October 7, 2014, we entered into a First Amended and Restated Loan and Security Agreement (the "Amended SVB Loan Agreement") with SVB. The Amended SVB Loan Agreement amends and restates the SVB Loan Agreement, originally dated January 14, 2011, and subsequently amended, and extends the maturity date until October 2017. Under the Amended SVB Loan Agreement, we may borrow up to $20.0 million, subject to certain limitations. As of December 28, 2014, $10.8 million was outstanding under the Amended SVB Loan Agreement. Interest on advances against the line was equal to 5.75% as of December 28, 2014 and was payable monthly. We utilize the line of credit with SVB to partially fund our
operations. We were in compliance with all covenants as of December 28, 2014, but were not in compliance with the covenant in January 2015 and received a waiver. We expect to be in compliance for the remainder of the quarter ended March 29, 2015. However, we anticipate that we may not be in compliance with all of the covenants contained in the Amended SVB Loan Agreement during certain periods of 2015 and, accordingly, have begun negotiations with SVB.
In connection with the collaboration noted above, ALU and a group of investors affiliated with Tallwood Venture Capital (the “Tallwood Group”) collectively agreed to a financial commitment of up to $45.0 million, consisting of the purchase through our private placement on September 29, 2014 of approximately 4.0 million shares of the Company’s common stock at $4.10 per share for proceeds of $15.1 million (net of issuance costs of $1.2 million); ALU’s commitment to loan the Company up to $10.0 million following the satisfaction of certain conditions (the “ALU Loan Agreement”); the Tallwood Group’s agreement to purchase from us an additional $11.2 million of common stock; and ALU’s agreement to provide an additional $7.5 million of other funding associated with the collaboration, subject to entry into a definitive collaboration agreement. The completion of the definitive collaboration agreement is a condition necessary for us to receive the $7.5 million and the loan proceeds.
We filed a Registration Statement on Form S-1 on October 20, 2014 and amended it thereafter (declared effective on November 26, 2014) under which we distributed to the holders of our common stock non-transferable subscription rights to purchase 14.5 million shares of our common stock (the "Rights Offering"). Each subscription right entitled the rights holder to purchase 1.459707 shares of our common stock at $4.10 per share. The Rights Offering closed on February 4, 2015 and we sold 3.0 million shares and realized $11.5 million, net of issuance costs of $0.8 million. The Tallwood Group participated in the Rights Offering and, thereby, fulfilled its commitment by investing $11.2 million to purchase an additional 2.7 million shares of our common stock.
Our products reflect advanced designs in silicon, systems, and firmware and are programmable and highly-scalable. Our expertise in the integration of our 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. We have released to production VDSL-based solutions to the market that offer vectoring and bonding to increase speeds over existing telecom carrier copper infrastructure. These products support high speed broadband service providers’ multi-play deployment plans to the connected home while keeping their capital and operating expenditures relatively low compared to competing frameworks. Our broadband DSL products consist of high performance Access and Gateway chips. We have demonstrated: (1) an aggregate downstream and upstream rate of 300 megabits per second (Mbps) over a single pair copper line at a distance of up to 200 meters, and (2) 150Mbps aggregate data rate up to a distance of 500 meters. Our next generation G.fast products for the ultra-broadband market are currently in development and will be designed to achieve speeds up to a gigabit per second (1Gbps or 1,000 Mbps). We also offer a line of multi-mode communications processors (CPs) for RGs that can support a variety of wide area network (WAN) topologies for telecom carriers, wireless carriers, and cable multiple system operators (MSOs), including Ethernet and gigabit Ethernet, passive optical network (PON), DSL, and LTE. In addition to our DSL and RG processors, our product portfolio also includes inSIGHT BXM software (inSIGHT), an innovative software suite of Gateway-based diagnostics and analytics software products.
Outsourcing all of our semiconductor fabrication, assembly, and test functions allows us to focus on the design, development, marketing, and sales of our products and reduces the level of our capital investment. In 2012, we expanded our outsourcing 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, which will expire in October 2015, 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.
Our semiconductor customers consist primarily of NEMs, original design manufacturers (ODMs), contract manufacturers (CMs), and original equipment manufacturers (OEMs), and include vendors such as Sagemcom Tunisie (Sagemcom), Askey Computer Corporation (Askey), NEC Corporation (NEC), and AVM Computersysteme Vertriebs GmbH (AVM). Our products are deployed in the networks of telecom carriers such as AT&T Inc. (AT&T), Bell Canada, Orange S.A. (formerly, known as France Telecom) (Orange), KDDI Corporation (KDDI), and Nippon Telegraph and Telephone Corporation (NTT).
Our families of DSL processors are designed for a range of devices that deliver high-speed access to the connected home. Following are overviews of the progress on our latest products:
•
We are currently shipping our Fusiv Vx185 and Vx183 family of chipsets which are high performance G.Vector-compliant communications processors designed specifically for the next generation of service gateways in the home.
•
The Vx585 family, currently sampling, maintains the distributed architecture of the Vx185/183, while supporting an even higher level of performance with a dual-core CPU architecture and additional, higher performance acceleration
processor engines. The Vx585 family of processors was previously scheduled for production in 2014, but is currently scheduled to be production ready by mid-2015.
•
Our Access Velocity-3 solution combines the rich feature set of the Velocity family with innovative Ikanos NodeScale vectoring technology. Velocity-3 started carrier and OEM trials in 2014 and continues into 2015.
•
Our families of multi-mode gateway processors complement our DSL broadband products and are designed to address a wide range of devices for value-added carrier services and high-speed access to the digital home. The Fusiv Multi-core Vx175 and Fusiv Vx173, and Fusiv Vx575 family, are built on our Fusiv family of processors and extend the range of access technologies and device types that can be supported by our products. The Vx575 family of processors was previously scheduled for production in 2014, but is currently scheduled to be production ready by mid-2015.
•
We are currently in development of our next generation Access platform, G.fast.
•
inSIGHT represents an expansion of our product portfolio by offering software as a product sold directly to carriers. Our inSIGHT monitoring and diagnostic software is in field trials and is now scheduled to be ready for production in the latter half of 2015.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and the results of operations are based on our consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). In preparing our consolidated financial statements, we make assumptions, judgments, and estimates that can have a significant impact on amounts reported in our consolidated financial statements. 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. We discuss below the critical accounting estimates associated with these policies. Historically, our assumptions, judgments, and estimates relative to our critical accounting policies have not differed materially from actual results.
Revenue Recognition
Our revenue is primarily derived from sales of our semiconductor products. Revenue from product sales is generally recognized upon shipment, net of sales returns, rebates, and allowances and other deferrals that pertain to software delivery obligations. Revenue from product sales to distributors is generally recognized under the sell-in method when product is delivered to the distributor offset by any contractual return rights.
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.
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. We expect that significant customer concentration will continue for the foreseeable future, but it may diversify across more carrier end customers as we expect more service providers worldwide to begin deployments of our broadband solutions. Sales through distributors are made under the sell-in method under which we recognize revenue when product is delivered to the distributor offset by any contractual return right at the time of sale.
We recognize revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred, 3) our price to the customer is fixed or determinable, and 4) collection is reasonably assured. Since our semiconductor products are reliant upon firmware, we defer revenue recognition until the essential firmware is delivered and when legal title and risk of ownership has transferred. In addition, we record reductions to revenue for estimated product returns and pricing adjustments, such as volume purchase incentives, in the same period that the related revenue is recorded. The amount of these reductions is based on historical sales returns, analysis of credit memo data, specific criteria included in volume purchase incentives agreements, and other factors known at the time. Additional reductions to revenue would result if
actual product returns exceed our estimates or if we settle any claims brought by our customers that are in excess of our standard warranty terms for cash payments. Revenue from product sales to distributors is recognized under the sell-in method when product is delivered to the distributor offset by any contractual return rights.
As noted above, in multi-element arrangements that include combination of semiconductor products with firmware that is essential to the semiconductor products’ functionality, when certain firmware elements are not yet delivered, judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. We allocate the arrangement consideration based on each element’s relative fair value using vendor-specific objective evidence, third-party evidence, or estimated selling prices, as the basis of fair value. The allocation of value to each element is derived based on management’s best estimate of selling price when vendor-specific evidence or third-party evidence is unavailable. Revenue is recognized for the accounting units when the basic revenue recognition criteria are met.
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 manufacturing 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 may incur yield loss related to the manufacturing process that creates usable die from the wafers. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process determined at the time that the product is tested. If our manufacturing yield decreases, our cost per unit increases. This could have a significant adverse effect on our cost of revenue. In addition to raw material costs and usage, the cost of revenue also includes payments to eSilicon under our Services Agreement, accruals for actual and estimated warranty obligations and write-downs of excess and obsolete inventories, payroll and related personnel costs, certain variable cost components such as gold adder, licensed third-party intellectual property, depreciation of equipment, and amortization of acquisition-related intangibles.
Research and Development Expenses
Research and development (R&D) expenses are recognized as incurred and generally consist of compensation and associated expenses of 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.
Accounts Receivable Allowance
We perform ongoing credit evaluations of our customers and adjust credit limits, as determined by our review of current credit information. We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience, our anticipation of uncollectible accounts receivable, and any specific customer collection issues that we have identified. While our credit losses have historically been low and within our expectations, we may not continue to experience the same credit loss rates that we have in the past. Our receivables are concentrated in a relatively small number of customers. Therefore, a significant change in the liquidity, financial terms, financial position, or willingness to pay timely, or at all, of any one of our significant customers would have a significant impact on our results of operations and cash flows.
Inventory
We value our inventory at the lower of cost or estimated market value. Cost is determined by the first-in, first-out method and estimated market value represents the estimated net realizable value. We estimate market value based on our current pricing, market conditions, and specific customer information. We write down inventory for estimated obsolescence of unmarketable inventory and quantities on hand in excess of estimated near-term demand and market conditions. If actual shipments are less favorable than expected, additional charges may be required. Additionally, we specifically reduce inventory to the lower of cost or market if pricing trends or forecasts indicate that the carrying value of inventory exceeds its estimated selling price. Once inventory is written down, a new accounting basis is established, and it is not written back up in future periods. However, if such inventory is subsequently sold, gross margins will be positively affected.
Warranty
We provide for the estimated cost of product warranties at the time revenue is recognized based on our historical experience of similar products. While we engage in product quality programs and processes, including monitoring and evaluating the quality of our suppliers, our warranty accrual is affected by our contractual obligations, product failure rates, and the estimated and actual cost incurred by us and our customers for replacing defective parts. Costs may include replacement parts, labor to rework, and freight charges. We monitor product returns during the warranty period and maintain an accrual for the related warranty expenses. Should actual failure rates, cost of product replacement, and inbound and outbound freight costs differ from our estimates, revisions to the estimated warranty reserve would be required.
Accounting for Income Taxes
We record the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the balance sheets, as well as operating loss and tax credit carry-forwards. We have recorded a full valuation allowance against our deferred tax assets except for certain foreign tax jurisdictions. Based on our historical losses and other available objective evidence, we have determined it is more likely than not that the deferred tax assets will not be realized. While we have considered potential future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the full valuation allowance, in the event that we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax assets would increase net income in the period such determination was made. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. Further, in accordance with authoritative guidance, we recognize liabilities for uncertain tax positions based on the two-step process prescribed within the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement.
Prior to the fourth quarter of 2011, we did not provide for Federal income tax and withholding taxes for unremitted foreign earnings of our foreign affiliates because the unremitted earnings were deemed to be permanently reinvested. Beginning in the fourth quarter of 2011, we began to provide for Federal income tax and foreign withholding taxes for those unremitted earnings because we determined that those funds may no longer be permanently reinvested.
Stock-Based Compensation Expense
We account for share-based compensation related to share-based transactions in accordance with authoritative guidance. Under the fair value recognition provisions, share-based payment expense is estimated at the grant date based on the fair value of the award and is recognized as an expense ratably over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of stock-based awards requires judgment, including estimating stock price volatility and expected life. We have estimated the expected volatility as an input into the Black-Scholes valuation formula when assessing the fair value of options granted. Our current estimate of volatility was based upon a blend of average historical volatilities of our stock price and that of our peer group. To the extent volatility of our stock price increases in the future, our estimates of the fair value of options granted in the future could increase, thereby increasing share-based payment expense in future periods. In addition, we apply an expected forfeiture rate when amortizing share-based payment expense. Our estimate of the forfeiture rate was primarily based upon historical experience of employee turnover. To the extent that we revise this estimate in the future, our share-based payment expense could be materially affected in the quarter of revision, as well as in following quarters. Our expected term of options granted was derived from the average midpoint between vesting and the contractual term. In the future, we may change or refine our approach of deriving these input estimates as empirical evidence regarding these input estimates becomes available. These changes could impact our fair value of options granted in the future.
The above items are not a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by authoritative guidance with no need for our management’s judgment in its application. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. See our consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K that contain accounting policies and other disclosures in accordance with authoritative guidance.
Results of Operations
Revenue by Product Family
The following table presents net revenue by reportable product family:
We track our products within two product families: Gateway and Access. The Access product family consists of semiconductor and software products that power the carrier infrastructure, as well as any node in a hybrid-fiber-copper network where fiber is terminated and copper is used to reach the consumer premises. The Gateway product family includes a variety of processors and the associated software designed for devices deployed at the customer premises.
Total revenue for 2014 declined by $31.3 million, or 39%, to $48.4 million from $79.7 million in 2013. Our four largest customers accounted for approximately 75% of our revenue in 2014. Our four largest customers accounted for approximately 60% of our revenue in 2013. During 2012, we began selling our next generation Gateway product chipsets (Fusiv Vx185, Vx183, Vx175, and Vx173). As noted above, even with the introduction of these new products, we continued to be adversely affected by the aging of our existing products as well as changes affecting the entire broadband industry generally. We have generally been experiencing quarterly revenue declines over the last three years.
Two factors were primarily responsible for the decline in our 2014 revenue. First, the decline in our legacy products was greater than the growth in revenue of our new products. However, concurrent with this, we did see a continuing shift in our revenue mix in favor of our new products. Revenue from new products (Vx 183/185/180/175/173 and Velocity-1) reached approximately 78% in 2014 versus approximately 58% in 2013. Secondly, we have continued to experience delays in our new product introduction, which, in turn, has pushed out the ramp of our new products in some end markets. We anticipate that customer ramps of our new products will continue to gain momentum.
The following table presents our direct customers that accounted for more than 10% of our revenue for the years indicated:
*
Less than 10%
**
Amod is a distributor whose purchases from us are contracted to its end customer, Askey.
***
Askey is a contract manufacturer for Sagemcom.
Revenue by Country as a Percentage of Total Revenue
The table above reflects sales to our direct customers based on where they are headquartered. It does not necessarily reflect carrier deployment of our products as we do not sell directly to carriers. Comparing 2014 to 2013, the increase in sales to Taiwan reflects the increase in sales to Amod, a distributor whose purchases from us are contracted to its end customer, Askey, who, in turn, is a contract manufacturer for Sagemcom. Sales to France reflect an increase in percent of our direct sales to Sagemcom. Comparing 2013 to 2012 by geography, revenue increases as a percent of sales in France and Germany were offset by declines in revenue from China and Hong Kong.
Cost of Revenue and Gross Margin
Gross margin decreased 3% from 2013 to 2014 due primarily to two factors. In 2014 we increased the amount of revenue sold through lower-margin distributors from 5% of revenue in 2013 to 38% of our revenue in 2014. Margins were also adversely affected by a change in product mix from higher margin Access products to lower margin Gateway products.
Gross margin improved 2% in 2013 from 2012 due to lower intangible amortization costs and lower royalty costs. Intangible amortization was $1.1 million, or 1% of total revenue, lower in 2013 compared to 2012. In 2012, charges related to the patent license agreement in 2012 and prior years amounted to $1.5 million, or 1% of total revenue. Costs related to this patent license agreement were $0.5 million, or 1% of total revenue, in 2013.
Research and Development Expenses (in millions except percent)
Research and development (R&D) expenses are recognized as incurred and generally consist of compensation (including stock compensation expense) and associated expenses of 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.
The following table presents details of research and development expense:
The 2014 decrease of 6% in R&D expenses is attributable to an 11% decrease in salaries and benefits, the result of a 24 person reduction during 2014. These reductions were offset somewhat by higher development and design expense associated with costs related to our VX 58x/57x product lines. The 2013 decrease of 11% in R&D expenses is attributable to higher development and design costs related to Velocity 3 product development in 2012 than in 2013. In 2015, we expect that our salaries and benefits as well as our development and design costs will increase in association with the development of our next generation G.fast Access products.
Selling, General, and Administrative Expenses (in millions except percent)
Selling, general, and administrative (SG&A) expenses generally consist of compensation and related expenses for personnel; public company expenses; legal, recruiting and auditing fees; and depreciation.
The following table presents details of selling, general and administrative expenses:
The 7% decrease in SG&A costs in 2014 is attributable to a 6% decrease in personnel costs, the result of a seven person reduction in 2014, and lower legal and accounting costs. SG&A costs in 2013 were relatively flat compared to 2012.
Interest and Other Income (Expense), Net
Interest income and other, net consists of interest income earned on our cash, cash equivalents, and short-term investments, other non-operating expenses, and interest expense, primarily related to loans under our Loan Agreement with SVB. It also includes other non-operating income and expense items such as gains and losses on foreign exchange and the sales of fixed assets.
Other expense, net was $0.2 million in 2014 compared to $0.6 million in 2013 and to $0.1 million in 2012. The expense in 2014 was primarily driven by interest costs related to our Amended SVB Loan Agreement. The expense of $0.6 million in 2013 was attributable to exchange losses resulting from a decline in the Indian rupee and the euro and interest expense related to the Loan Agreement of $0.2 million. The $0.1 million expense in 2012 resulted predominantly from foreign exchange losses recognized on the Indian rupee and euro offset by interest income of $0.1 million on our certificates of deposit.
Provision for Income Taxes
Income taxes are comprised mostly of federal income tax, foreign income taxes, and state minimum taxes. The income tax provision decreased by $0.4 million to $0.6 million for 2013 compared to $1.0 million for 2012. There was no significant tax contingency recorded during 2014. Our income tax provision primarily represents foreign taxes on certain of our international subsidiaries as well as federal taxes on unremitted earnings of foreign subsidiaries.
We are subject to taxation in the U.S., various states, and certain foreign jurisdictions. We are currently undergoing an income tax audit in India. Otherwise, there are no ongoing examinations by income taxing authorities at this time. We do not expect any material adjustments to our reserves. Our tax years from 2007 to 2014 remain open in various tax jurisdictions.
Liquidity, Capital Resources, and Going Concern
Working Capital, Cash and Cash Equivalents and Short-Term Investments
The following table presents working capital, cash and cash equivalents, and marketable securities:
We have funded our operations primarily through cash from private and public offerings of our common stock, our line of credit, cash generated from the sale of our products, proceeds from the exercise of stock options, and stock purchased under our employee stock purchase plan. Our uses of cash include payroll and payroll-related expenses, manufacturing costs, purchases of equipment, tools, and software as well as operating expenses, such as product tapeouts, marketing programs, travel, professional services, facilities, and other costs. We incurred net losses of $43.3 million, $30.4 million, and $17.6 million in 2014, 2013, and 2012, respectively, and had an accumulated deficit of $369.4 million as of December 28, 2014.
Primarily as a result of our net losses, our cash and cash equivalents, net of our revolving line, decreased by $22.6 million to $4.9 million for the year ended December 28, 2014. On February 4, 2015, we completed our Rights Offering and realized $11.6 million, net of transaction costs of $0.8 million. However, there can be no assurance that we will be able to raise additional capital necessary to fund our operations in 2015. Further, we anticipate that we may not be in compliance with the covenant contained in the Amended SVB Loan Agreement during certain periods of 2015 and, accordingly, we have begun discussions with SVB. As a result of our planned increase in development spending during 2015, recurring losses from operations and the need to stay in compliance with a debt covenant, if we are unable to raise sufficient additional capital through alternative debt or equity arrangements, there will be uncertainty regarding our ability to maintain liquidity sufficient to operate its business effectively, which raises substantial doubt as to our ability to continue as a going concern. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to us.
Cash, cash equivalents, and short-term investments held by foreign subsidiaries was $4.6 million, $6.5 million, and $6.6 million at year end 2014, 2013, and 2012, respectively.
ALU Collaboration and Rights Offering
On September 29, 2014, as part of our collaboration with ALU on the development of ultra-broadband products, ALU and a group of investors affiliated with Tallwood Venture Capital (the “Tallwood Group”) collectively agreed to a financial commitment of up to $45.0 million, which consists of the purchase of approximately 4.0 million shares of the Company’s common stock at $4.10 per share for aggregate gross proceeds of $16.3 million, ALU’s commitment to loan the Company up to $10.0 million following the satisfaction of certain conditions (the “ALU Loan Agreement”), the Tallwood Group’s agreement to purchase an aggregate of an additional $11.2 million of common stock at the same per share price in the rights offering, and ALU’s agreement to provide an additional $7.5 million of other funding associated with the collaboration, subject to entry into a definitive collaboration agreement. Entry into the definitive collaboration agreement is a condition necessary for the Company to receive the remaining payments and other funding which makes up the remainder of in the financial commitment.
Our Rights Offering closed on February 4, 2015 and we issued 3.0 million shares and received gross proceeds of $12.3 million. After deducting legal, accounting, and other costs we realized net proceeds of $11.5 million from the Rights Offering. Tallwood participated in the Rights Offering and, thereby, fulfilled its agreement by investing $11.2 million to purchase an additional 2.7 million shares of our common stock.
Amended SVB Loan Agreement
We utilize the line of credit under the Amended SVB Loan Agreement to partially fund our operations, which agreement was originally entered into in January 2011 and amended periodically thereafter. On October 7, 2014, we entered into the Amended SVB Loan Agreement which amends and restates the prior agreement and extends the maturity date until October 2017. The Amended SVB Loan Agreement is collateralized by a first priority lien on all of our present and future assets, other than our intellectual property, and a second lien on our intellectual property. The Amended SVB Loan Agreement also requires that we maintain a minimum monthly Adjusted Quick Ratio requirement of 1.2 to 1.0, as defined in the Amended SVB Loan Agreement. We will need to continue to take further actions during the remainder of 2014 to generate adequate cash flows or earnings to ensure compliance with the Amended SVB Loan Agreement and fund our capital requirements.
As of December 28, 2014, $10.8 million was outstanding under the Amended SVB Loan Agreement. Interest on advances against the line is equal to 5.75% as of December 28, 2014 and is payable monthly.
We were in compliance with the Adjusted Quick Ratio covenant as of December 28, 2014, but we were not in compliance with the covenant at the end of January 2015; we sought and received a waiver from SVB with respect to this noncompliance. We expect to be in compliance with all of the covenants contained in the Amended SVB Loan Agreement through the remainder of the first quarter of 2015. However, we anticipate that we may not be in compliance with all of the covenants contained in the Amended SVB Loan Agreement during certain later periods of 2015 and, accordingly, we have begun discussions with SVB to address these potential instances of noncompliance.
Operating, Investing, and Financing Activities
The following table summarizes our statement of cash flows (in millions):
Operating Activities
During 2014, we used $34.4 million in net cash from operating activities while incurring a loss of $43.3 million. Included in the net loss were non-cash charges amounting to $8.5 million that resulted from depreciation of $4.3 million, stock-based compensation of $3.8 million and the amortization of intangible assets and acquired technology of $0.5 million. Favorable cash flow resulted from a reduction in accounts receivable of $2.0 million, but was offset by lower accounts payable and accrued liabilities of $1.7 million. Accounts receivable days sales outstanding increased from 86 days at the end of 2013 to 109 at the end of 2014 due principally to the timing of shipments with a greater percentage being shipped in the latter part of the quarter. Inventories remained flat from the end of 2013 to 2014. Purchase commitments increased from $5.1 million at the end of 2013 to $6.7 million at the end of 2014. Prepaid wafers purchased by eSilicon on our behalf increased from $0.8 million at the end of 2013 to $1.0 million at the end of 2014 .
During 2013, we used $20.0 million in net cash from operating activities while incurring a loss of $30.4 million. Included in the net loss were non-cash charges amounting to $8.7 million that resulted from amortization of intangibles and acquired technology of $0.8 million, stock-based compensation of $3.6 million, and depreciation and amortization of $4.3 million. Favorable cash flow resulted from a decrease in inventories of $6.1 million and in prepaid expenses and other assets of $3.3 million. This improvement was offset by a decrease in accounts payable and accrued liabilities of $7.5 million and an increase in accounts receivable of $0.1 million. Prepaid expenses declined primarily due to lower prepaid wafer purchases for eSilicon. Prepayment to eSilicon was $0.8 million as of December 29, 2013 compared to $2.7 million as of December 30, 2012. Accounts receivable days sales outstanding have grown from 45 days as of December 30, 2012 to 86 days as of December 29, 2013 as sales declines and timing of shipments have changed from 2012 to 2013, with a higher percentage of shipments being later in our fiscal periods, resulting in higher receivables at our period end.
During 2012, we used $2.3 million in net cash from operating activities while incurring a loss of $17.6 million. Included in the net loss were non-cash charges amounting to $10.2 million that resulted from amortization of intangibles and acquired technology of $2.1 million, stock-based compensation of $2.9 million, depreciation and amortization of $5.2 million.
Cash flow from reductions in accounts receivable of $2.6 million and inventory of $1.4 million and increases in accounts payable and accrued liabilities of $5.2 million were partially offset by an increase in prepaid expense and other assets of $4.1 million. The decrease in accounts receivable reflects lower fourth quarter sales ($31.8 million in 2012 versus $35.4 million in 2011). Days sales outstanding were 45 days as of December 30, 2012 compared to days sales outstanding of 47 days as of January 1, 2012. The lower inventory balance reflects the effect of our Services Agreement with eSilicon, who is responsible for purchasing and assembling our products as discussed above. Prepaid expenses increased primarily due to prepayments to eSilicon of $2.7 million as of December 30, 2012. There was no prepayment to eSilicon as of January 1, 2012.
Investing Activities
During 2014, cash used in investing activities was $2.8 million, which was comprised of the purchases of property and equipment of $3.9 million, offset in part by the net maturities and sales of certificates of deposit of $1.1 million. During 2013, cash flow used in investing activities was $5.0 million, which was comprised of the purchases of property and equipment of $4.3 million and the net purchases of certificates of deposit of $0.7 million. During 2012, cash flow used in investing activities was $9.7 million, which was comprised of the purchases of property and equipment of $6.9 million and the net purchases of certificates of deposit of $2.8 million.
Financing Activities
During 2014, cash flow from financing activities provided $14.5 million. In September we sold an aggregate of 4.0 million shares of our common stock in a private placement to the Tallwood Group and ALU for $16.3 million. After deducting legal, accounting and certain other fees we realized net proceeds of $15.1 million. We also realized $0.5 million from stock purchases of our stock under our Employee Stock Purchase Plan. Net repayment under our Revolving Line was $1.2 million.
During 2013, cash flow from financing activities provided $32.6 million. In November 2013 we sold an aggregate of 26.4 million shares of common stock in an underwritten offering for $26.4 million. After deducting underwriting fees, legal, accounting, and other costs, we realized net proceeds of $24.0 million. Employee purchases of our common stock under our Employee Stock Purchase Plan amounted to $1.6 million. Net proceeds under our Loan Agreement were $7.0 million as we drew down $35.3 million and repaid $28.3 million.
During 2012, cash flow from financing activities provided $5.6 million. Employee purchases of our stock under the Employee Stock Purchase Plan amounted to $0.6 million. Net proceeds under our Revolving Line Loan Agreement were $5.0 million as we drew down a total of $10.0 million under the agreement during the third and fourth quarters and repaid $5.0 million in the fourth quarter.
Contractual Commitments and Off Balance Sheet Arrangements
We do not use off balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off balance sheet arrangements such as special purpose entities and research and development arrangements. Accordingly, our liquidity and capital resources are not subject to off balance sheet risks from unconsolidated entities.
We lease certain office facilities, equipment, and software under non-cancelable operating leases. The following table summarizes our contractual obligations as of December 28, 2014 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in millions):
For the purpose of this table, purchase obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding 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 fulfilled by our vendors within short time horizons. In addition, we have purchase orders that represent authorizations to purchase rather than binding agreements. We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements.
Computer aided design (CAD) tools are expensed when utilized. We expect to have a majority of the tools expensed prior to the fulfillment of payment obligations as a result of the ongoing G.fast related product development.
Non-current income tax payable represents both the tax obligation and related accrued interest. We are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to the uncertainties in the timing of tax outcomes.
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant, and we are unable to estimate the maximum potential impact of these indemnification provisions on our future consolidated results of operations.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This guidance applies to any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. This guidance supersedes existing revenue recognition guidance, including most industry-specific guidance, as well as certain related guidance on accounting for contract costs. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. An entity should apply the guidance using one of two methods: retrospectively to each prior reporting period presented, with practical expedients or retrospectively with the cumulative effect of initial adoption of the guidance recognized at the date of initial application. We are currently evaluating the effect that the standard will have upon our consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), to provide guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. We are in the process of evaluating the provisions of ASU 2014-15.
ITEM 7A.
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 investment portfolio and our line of credit. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal and meet liquidity needs, while maximizing yields and without significantly increasing risk. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer, or type of investment. As of December 28, 2014, we had investments of $2.4 million in certificates of deposit. Our cash and cash equivalents consist of cash and money market accounts.
As of December 28, 2014, we had cash and cash equivalents totaling $13.3 million. We do not enter into investments for trading or speculative purposes. If the return on our investments were to change by one hundred basis points, the effect would be de minimis.
As of December 28, 2014, we had $10.8 million outstanding under our line of credit with SVB. The interest rate was variable and was 5.75% under the revolving line at December 28, 2014. If the rates were to change by one hundred basis points and the balance remained the same, the effect would be approximately $0.1 million.
Foreign Currency Risk
Our revenue and cost of revenue are predominately denominated in U.S. dollars. An increase of the U.S. dollar relative to the currencies of the countries in which our customers operate would make our products more expensive to them and increase pricing pressure or reduce demand for our products. We also incur a portion of our expenses in currencies other than the U.S. dollar, including the euro, the Japanese yen, Korean won, Indian rupee, Singapore dollar, the Chinese yuan, and the Taiwanese dollar. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. We expect that our foreign currency exposure will increase as our operations in India and other countries expand. If exchange rates were to change by ten percent, the effect would be to increase/decrease income by approximately $1.0 million.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
IKANOS COMMUNICATIONS, INC.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Ikanos Communications, Inc.:
We have audited the accompanying consolidated balance sheet of Ikanos Communications, Inc. and subsidiaries (the “Company”) as of December 28, 2014, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the year ended December 28, 2014. We also have audited the Company’s internal control over financial reporting as of December 28, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting 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 and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included 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, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ikanos Communications, Inc. and subsidiaries as of December 28, 2014, and the consolidated results of their operations and their cash flows for the year ended December 28, 2014, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Ikanos Communications, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 28, 2014 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited the adjustments to the 2013 and 2012 consolidated financial statements of the Company to retroactively apply the change in accounting resulting from the reverse stock split, as described in Note 15. In our opinion, such adjustments are appropriate and have been properly applied. We were not engaged to audit, review, or apply any procedures to the 2013 and 2012 consolidated financial statements of the Company other than with respect to the adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2013 and 2012 consolidated financial statements taken as a whole.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, is subject to certain debt covenants and may require additional financing to fund future capital and operating requirements. These factors raise substantial doubt about the ability of the Company to continue as a going concern. Management’s plans in regard to these matters are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to that matter.
/s/ Moss Adams LLP
San Francisco, California
March 19, 2015
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Ikanos Communications, Inc:
In our opinion, the accompanying consolidated balance sheet as of December 29, 2013 and the related consolidated statements of operations, stockholders’ equity, comprehensive loss and cash flows present fairly for each of the two years in the period ended December 29, 2013, before the effects of the adjustments to retrospectively apply the effect of the reverse stock split described in Note 15, present fairly, in all material respects, the financial position of Ikanos Communications, Inc. and its subsidiaries (the “Company”) at December 29, 2013, and the results of their operations and their cash flows for each of the two years in the period ended December 29, 2013, in conformity with accounting principles generally accepted in the United States of America (the 2013 financial statements before the effects of the adjustments discussed in Note 15 are not presented herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements on our audits. We conducted our audits, before the effects of the adjustments described above, of these statements 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, is subject to certain restrictive debt covenants and may require additional financing to fund future capital and operating requirements that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively apply the effect of the reverse split of the Company’s common stock described in Note 15 and accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have properly applied. Those adjustments were audited by other auditors.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 28, 2014
IKANOS COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
IKANOS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
IKANOS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
IKANOS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
IKANOS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
IKANOS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1-Ikanos and Summary of Significant Accounting Policies
The Company
Ikanos Communications, Inc. (“Ikanos” or the “Company”) was incorporated in the State of California in April 1999 and reincorporated in the State of Delaware in September 2005. The Company is a provider of advanced semiconductor products and software for delivering high speed broadband solutions to the connected home. The Company’s broadband multi-mode and digital subscriber line (“DSL”) processors and other semiconductor offerings power carrier infrastructure (referred to as “Access”) and customer premise equipment (referred to as “Gateway”) for network equipment manufacturers (“NEMs”) who, in turn, serve leading telecommunications service providers.
On September 29, 2014, the Company entered into a collaboration arrangement with Alcatel-Lucent USA, Inc. (along with Alcatel-Lucent Participations, collectively known as “ALU”) on the development of ultra-broadband products. In connection with this collaboration, ALU and a group of investors affiliated with Tallwood Venture Capital (the “Tallwood Group”) collectively agreed to a financial commitment of up to $45.0 million, which consisted of the purchase of approximately 4.0 million shares of the Company’s common stock at $4.10 per share for aggregate gross proceeds of $16.3 million, ALU’s commitment to loan the Company up to $10.0 million following the satisfaction of certain conditions (the “ALU Loan Agreement”), the Tallwood Group’s agreement to purchase, in aggregate, an additional $11.2 million of common stock at the same per share price in the rights offering (discussed below), and ALU’s agreement to provide an additional $7.5 million of other funding associated with the collaboration, subject to entry into a definitive collaboration agreement. Entry into such definitive collaboration agreement is a condition necessary for the Company to receive the remaining payments and other funding. The Company will seek to increase its share in the Access market by leveraging the ALU Access customer relationships to increase carrier interest in minimizing interoperability risk when deploying new gear in consumers' homes, which include the Company’s complimentary Gateway products. End-to-end products from a single silicon vendor also provide an additional opportunity for customized features which allow carriers to differentiate the services they offer their customers.
The accompanying consolidated financial statements of the Company have been prepared on a basis that assumes that the Company will continue as a going concern and contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.
Liquidity
The Company incurred net losses of $43.3 million, $30.4 million, and $17.6 million in 2014, 2013, and 2012, respectively, and had an accumulated deficit of $369.4 million as of December 28, 2014. As discussed above, the Company has received a financial commitment of up to $45.0 million from ALU and the Tallwood Group. Associated with this commitment, in December 2014, the Company commenced a rights offering pursuant to which stockholders of record on September 26, 2014 were offered the right to purchase shares of the Company’s common stock (the “Rights Offering”). On February 4, 2015, the Company completed its Rights Offering and realized $11.6 million, net of transaction costs of $0.8 million. (See Note 15 Subsequent Events.) However, there can be no assurance that the Company will be able to raise additional capital necessary to fund its operations other than from ALU's remaining commitment to loan $10.0 million and its agreement to provide $7.5 million of other funding associated with the collaboration.
To achieve consistent profitability, the Company will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for its business. In 2015, the Company expects that the development costs associated primarily with the Access product family will increase over previous levels incurred during 2014. Further, the Company utilizes a line of credit from Silicon Valley Bank (“SVB”) to partially fund its operations, which line of credit is subject to certain loan covenants, as discussed below.
As a result of the Company’s planned increase in development spending in 2015, recurring losses from operations and the need to maintain compliance with a debt covenant, if the Company is unable to raise sufficient additional capital through alternative debt or equity arrangements, there will be uncertainty regarding the Company’s ability to maintain liquidity sufficient to operate its business effectively, which raises substantial doubt as to the Company’s ability to continue as a going concern. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to the Company.
The Company utilizes an existing revolving line of credit under a Loan and Security Agreement (“Loan Agreement”) with Silicon Valley Bank (“SVB”) to partially fund its operations. On October 7, 2014, the Company entered into the Amended SVB Loan Agreement ("Amended Loan Agreement"). The Amended SVB Loan Agreement amends and restates the SVB Loan
Agreement, originally dated January 14, 2011, and subsequently amended. Under the Amended SVB Loan Agreement, we may borrow up to $20.0 million, subject to certain limitations. The Amended SVB Loan Agreement is collateralized by a first priority lien on all of our present and future assets, other than our intellectual property, and a second lien on our intellectual property. The Amended SVB Loan Agreement also requires that the Company maintain a minimum monthly Adjusted Quick Ratio requirement of 1.2 to 1.0, as defined in the Amended SVB Loan Agreement. The Company was in compliance with the Adjusted Quick Ratio covenant as of December 28, 2014. However, the Company was not in compliance with the covenant at the end of January 2015 and received a waiver from SVB with respect to this noncompliance. The Company expects to be in compliance through the first quarter of 2015, however, the Company anticipates that it may not be in compliance with all of the covenants contained in the Amended SVB Loan Agreement during certain later periods of 2015 and, accordingly, has begun discussions with SVB to address those potential instances of noncompliance. The Company may need to take further actions to generate adequate cash flows or earnings to ensure compliance with the Amended SVB Loan Agreement and fund its future capital requirements, including the potential need for additional financing. There can be no assurance that sufficient debt or equity financing will be available or, if available, that such financing will be on terms and conditions acceptable to the Company. Additionally, there can be no assurance the Company will be successful in revising the covenants with SVB, if necessary. If the Company is unsuccessful in these efforts, it will need to implement significant cost reduction strategies that could affect its long-term business plan. These efforts may include, but are not limited to: consolidating locations, reducing capital expenditures, and reducing overall headcount.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
The Company’s fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year, in which case the additional week falls into the fourth quarter of that fiscal year. There were 52 weeks in fiscal year 2014.
Reverse Stock Split
On February 11, 2015, the Company's stockholders approved and the Company thereafter effected a reverse stock split of our common stock at a ratio of one-for-ten shares (1:10). (See Note 10 Equity Plans and Related Equity Activity.) Accordingly, all references to common stock, equity plans, and related activity as well as share and per share data in the accompanying financial statements have been retroactively adjusted to reflect the reverse stock split (see Note 15 Subsequent Events).
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make certain estimates, judgments, and assumptions. The Company believes that the estimates, judgments and assumptions upon which it relies are reasonable based upon information available to it at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates and actual results, the Company’s financial statements would have been affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.
Summary of Significant Accounting Policies
Revenue Recognition
In accordance with authoritative guidance, revenue from sales of semiconductors is recognized upon shipment when persuasive evidence of an arrangement exists, the required firmware is delivered, legal title and risk of ownership has transferred, the price is fixed or determinable, and collection of the resulting receivable is reasonably assured.
The Company records reductions to revenue for estimated product returns and pricing adjustments, such as competitive pricing programs and volume purchase incentives, in the same period that the related revenue is recorded. The amount of these reductions is based on historical sales returns, analysis of credit memo data, specific criteria included in volume purchase incentive agreements, and other factors known at the time. Additional reductions to revenue would result if actual product returns or pricing adjustments exceed its estimates.
In multi-element arrangements that include combination of semiconductor products with software that is essential to the hardware products functionality and undelivered software elements, the Company allocates revenue to all deliverables based on their relative selling prices. The Company allocates the arrangement consideration based on each element’s relative fair value using vendor-specific objective evidence (“VSOE”), third-party evidence, or estimated selling prices, as the basis of fair value. The allocation of value to each element is derived based on management’s best estimate of selling price when VSOE or third party evidence is unavailable. Revenue is recognized for the accounting units when the basic revenue recognition criteria are met.
In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) VSOE of fair value, (ii) third-party evidence of selling price, and (iii) best estimate of the selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original maturity of 90 days or less at the date of purchase to be cash equivalents. Short-term investments consist of highly liquid securities with original maturities in excess of 90 days. Non-liquid investments with original maturities in excess of one year are classified as long term.
The Company classifies marketable securities as available-for-sale at the time of purchase and re-evaluates such designation as of each consolidated balance sheet date. As of December 28, 2014, the Company’s short-term investments consisted solely of certificates of deposit. The Company evaluates both qualitative and quantitative factors such as duration and severity of the unrealized loss, credit ratings, repayment speeds, defaults, and loss rates of the underlying collateral, structure, and credit enhancements to determine if a credit loss may exist.
Fair Value of Financial Instruments
The carrying amounts of certain of the Company’s financial instruments including, cash and cash equivalents, investments, accounts receivables, accounts payable, and accrued liabilities, approximate fair value due to their relatively short maturity periods.
Inventory, net
Inventory is stated at the lower of cost or market. Cost is determined by the first-in, first-out method and market represents the estimated net realizable value. The Company records inventory write-downs for estimated obsolescence of unmarketable inventory based upon assumptions about future demand and market conditions. Additionally, the Company specifically reduces inventory to the lower of cost or market if pricing trends or forecasts indicate that the carrying value of inventory exceeds its estimated selling price. Once inventory is written down, a new accounting basis is established and, accordingly, is not written back up in future periods.
Property and Equipment, net
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the term of the lease. All repairs and maintenance costs are expensed as incurred.
The depreciation and amortization periods for property and equipment categories are as follows:
Intangible Assets
Intangible assets resulting from the acquisition of entities accounted for using the purchase method of accounting are estimated by management based on the fair value of assets received. Identifiable intangible assets are comprised of existing and core technology, patents, order backlog, customer relationships, trademarks, and other intangible assets. The Company also
licenses intellectual property necessary for research and development and the production of inventory. Identifiable intangible assets that have finite useful lives are being amortized over their useful lives.
Impairment of Long-Lived Assets
The Company evaluates long-lived assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. There was no material impairment recorded in 2014, 2013, or 2012.
Software Development Costs
Software development costs are capitalized beginning when technological feasibility has been established and ending when a product is available for general release to customers. To date, the period between achieving technological feasibility and the issuing of such software has been short and software development costs qualifying for capitalization have been insignificant.
Research and Development
Research and development costs consist primarily of compensation and related costs for personnel as well as costs related to software tools, mask tooling expenses, materials, supplies, and equipment depreciation. All research and development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred. To date, advertising costs have been insignificant.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash, cash equivalents, accounts receivable, and short-term investments. Cash and cash equivalents are held with a limited number of financial institutions. Deposits held with these financial institutions may exceed the amount of insurance provided on such deposits. Management believes that the financial institutions that hold the Company’s deposits are credit worthy and, accordingly, minimal credit risk exists with respect to those deposits. As of December 28, 2014 and December 29, 2013, the Company’s short-term investments consisted solely of certificates of deposit. All investments were classified as available-for-sale. The Company does not hold or issue financial instruments for trading purposes.
Credit risk with respect to accounts receivable is concentrated due to the number of large orders recorded in any particular reporting period. Three customers represented 44%, 21%, and 16% of accounts receivable at December 28, 2014. Three customers represented 35%, 10%, and 10% of accounts receivable at December 29, 2013. Three customers represented 29%, 22%, and16%, of revenue in 2014. Four customers represented 24%, 14%, 11%, and 10% of revenue in 2013. Three customers represented 19%, 13%, and 12% of revenue in 2012.
Concentration of Other Risk
The semiconductor industry is characterized by rapid technological change, competitive pricing pressures, and cyclical market patterns. The Company’s results of operations are affected by a wide variety of factors, including general economic conditions; economic conditions specific to the semiconductor industry; demand for the Company’s products; the timely introduction of new products; implementation of new manufacturing technologies; manufacturing capacity; the availability of materials and supplies; competition; the ability to safeguard patents and intellectual property in a rapidly evolving market; reliance on assembly and wafer fabrication subcontractors; and reliance on independent distributors and sales representatives. As a result, the Company may experience substantial period-to-period fluctuations in future periods due to the factors mentioned above or other factors.
Warranty
The Company generally warrants its products against defects in materials and workmanship and non-conformance to its specifications for varying lengths of time, generally one year. If there is a material increase in customer claims compared with historical experience or if costs of servicing warranty claims are greater than expected, the Company may record additional charges against cost of revenue.
Net Loss per Share
Basic net loss per share is computed using the weighted-average number of common shares outstanding during the period. The calculation of basic and diluted net loss per common share is as follows (in thousands, except per share amounts):
The following potential common shares have been excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive (in thousands):
Income Taxes
The Company accounts for income taxes under the liability method, whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. In accordance with authoritative guidance, the Company recognizes liabilities for uncertain tax positions based on the two-step process prescribed within the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This guidance applies to any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. This guidance supersedes existing revenue recognition guidance, including most industry-specific guidance, as well as certain related guidance on accounting for contract costs. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. An entity should apply the guidance using one of two methods: retrospectively to each prior reporting period presented, with practical expedients or retrospectively with the cumulative effect of initial adoption of the guidance recognized at the date of initial application. The Company is currently evaluating the effect that the standard will have upon our consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), to provide guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company is in the process of evaluating the provisions of ASU 2014-15.
Note 2-Cash and Cash Equivalents, Short-Term Investments and Fair Value Measurements
Cash and cash equivalents include cash and money market securities for which quoted active prices are available. The Company considers all highly liquid investments with a maturity of 90 or fewer days at the date of purchase to be cash
equivalents. The Company held no marketable securities as of December 29, 2013 and December 28, 2014. The investments in money market funds are included in cash equivalents based on their original maturity.
As of December 28, 2014 and December 29, 2013, the Company’s short-term investments consisted solely of certificates of deposit.
The following is a summary of the Company’s investments (in thousands):
There were no unrealized losses on investments aggregated by category as of December 28, 2014.
Fair Value Measurements
Fair value is an exit price which represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, authoritative guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (“Level 1”); inputs other than the quoted prices in active markets that are observable either directly or indirectly (“Level 2”); and unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions (“Level 3”). This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures certain financial assets, mainly comprised of marketable securities, at fair value.
The Company’s cash and investment instruments at December 28, 2014 and December 29, 2013 are classified within Levels 1 and 2 of the fair value hierarchy, respectively. The types of Level 1 instruments, valued based on quoted market prices in active markets, include money market securities. Level 2 types of instruments consist of short-term certificates of deposit. The investments are not traded on an open market, but reside within a bank. The certificates of deposit are highly liquid and have maturities of less than one year. Due to their short-term maturities, the Company has determined that the fair value of these instruments is their face value. Level 3 types of instruments are valued based on unobservable inputs in which there is little or no market data, and which require the Company to develop its own assumptions. The fair value hierarchy of the Company’s short-term investments as of December 28, 2014 and December 29, 2013 was (in thousands):
There were no Level 3 securities as of December 28, 2014 or December 29, 2013.
Note 3-Allowance for Doubtful Accounts
The following table summarizes the activity related to the allowance for doubtful accounts (in thousands):
Note 4-Inventory
Inventory consisted of the following (in thousands):
The Company has an agreement with eSilicon Corporation (“eSilicon”) under which a majority of its day-to-day supply chain management, production test engineering, and production quality engineering functions (“Master Services”) have been transferred to eSilicon under a Master Services and Supply Agreement (“Service Agreement”). Pursuant to the Service Agreement, which will expire in October 2015, the Company places orders for its finished goods products with eSilicon, who, in turn, contracts with wafer foundries and assembly and test subcontractors and manages these operational functions for the Company on a day-to-day basis.
As part of its Service Agreement, the Company transferred ownership of certain work-in-process and raw materials to eSilicon as prepayment for the future delivery of finished goods. In addition, the Company has prepaid for certain wafers purchased by eSilicon on behalf of the Company. Prepayments under the arrangement were $1.0 million as of December 28, 2014 and $0.8 million as of December 29, 2013. The prepayments are classified in prepaid expenses and other current assets. As of December 28, 2014, the Company has $6.7 million of non-cancelable purchase obligations with eSilicon.
Note 5-Property and Equipment
Property and equipment consisted of the following (in thousands):
Depreciation expense for property and equipment was $4.3 million, $4.3 million, and $5.3 million for 2014, 2013, and 2012, respectively.
Note 6-Purchased Intangible Assets
The carrying amount of intangible assets is as follows (in thousands):
The amortization of technology is charged to cost of revenue and the amortization of customer relationships is charged to selling, general and administrative. For 2014, 2013, and 2012, the amortization of intangible assets was $0.5 million, $0.8 million, and $2.1 million, respectively. The remaining intangible asset of $0.2 million will be amortized during the first six months of 2015.
Note 7-Loans and Security Agreement
On October 7, 2014, the Company entered into the Amended SVB Loan Agreement replacing the original SVB Loan Agreement. The Amended SVB Loan Agreement amends and restates the SVB Loan Agreement, originally dated January 14, 2011, and subsequently amended. Under the Amended SVB Loan Agreement, we may borrow up to $20 million subject to certain limitations. The Amended SVB Loan Agreement is collateralized by a first priority lien on all of our present and future assets, other than our intellectual property, and a second lien on our intellectual property. The Amended SVB Loan Agreement also requires that the Company maintain a minimum monthly Adjusted Quick Ratio requirement of 1.2 to 1.0, as defined in the Amended SVB Loan Agreement. At December 29, 2013 and December 28, 2014, the Company had advances of $12.0 million and $10.8 million, respectively, against the line of credit. All collections of the Company's receivables are applied to the outstanding loan balance, but may be borrowed immediately after pay down. At December 29, 2013 and December 28, 2014, respectively, interest on advances against the Loan Agreement was equal to 6.5% and 5.75% of the outstanding principal and is payable monthly. The Company may repay the advances under the Loan Agreement, in whole or in part, at any time, without premium or penalty. As discussed in Note 1, the Company anticipates that it may not be in compliance with the covenant contained in the Loan Agreement during certain periods of 2015 and, therefore, has begun discussions with SVB to address the potential instances of noncompliance.
As discussed in Note 1, on September 29, 2014, the Company entered into a collaboration arrangement with Alcatel-Lucent USA, Inc. (along with Alcatel-Lucent Participations, collectively known as “ALU”) on the development of ultra-broadband products. ALU a committed to loan the Company up to $10.0 million following the satisfaction of certain conditions (the “ALU Loan Agreement”). As of December 28, 2014, the Company has not satisfied the conditions of the ALU Loan Agreement, and, accordingly, has not drawn on the loan.
Note 8-Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
The following table summarizes the activity related to the warranty accrual (in thousands):
Note 9-Tallwood Investment
During 2009, in order to facilitate its acquisition of the Broadband Access product line from Conexant Systems, Inc., the Company negotiated a $42.0 million cash investment by Tallwood III, L.P., and certain of their affiliates (collectively, the “Tallwood Investors”) pursuant to which the Company sold to the Tallwood Investors (i) 2.4 million shares of Ikanos common stock, par value $0.001 per share (the “Common Stock”), and (ii) warrants to purchase up to 0.8 million shares of Common Stock (the “Warrants”). The transaction was completed on August 24, 2009, and the purchase price of each share of Common Stock and the exercise price of each warrant to purchase a share of Common Stock under the securities purchase agreement was $17.50. In addition, the Company issued to the Tallwood Investors one share (the “Voting Share”) of Series A Preferred Stock, which provides the Tallwood Investors certain voting rights solely with respect to the election of members of the Board of Directors but does not share in the economics of Ikanos. The 2.4 million shares of Common Stock, Warrants, and the Voting Share collectively are referred to as the Tallwood Investment. The net proceeds for the Tallwood Investment were $38.8 million after capitalizing transaction-related costs of $3.2 million. The $3.2 million in transaction related costs consisted of investment banker, legal, and accounting fees.
The value attributed to the Warrants was $7.6 million and was estimated as of August 24, 2009 using the Black-Scholes option pricing model with the assumptions of an expected volatility of 62.5%, expected term of five years, no expected dividends, and a risk free interest rate of 2.5%. The expected volatility is based on a blend of the volatility of the Company’s peer group in the industry in which it does business and the Company’s historical volatility. The expected term is five years which is equal to the life of the Warrants. The risk free interest rate is the yield on zero-coupon U.S. treasury securities for a period that is commensurate with the expected term assumption. The Warrants expired on August 24, 2014.
In November 2010 and again in November 2013, the Tallwood Investors participated in the Company’s stock issuances (see Note 11, below) and purchased an additional 0.6 million shares and 0.2 million shares, respectively. As of December 28, 2014, the Tallwood Investors owned approximately 37% of the Company’s outstanding common stock.
As part of the investment associated with the collaboration arrangement discussed in Note 1, the Tallwood Investors purchased 2.7 million shares of the Company's common stock for $11.3 million in a private placement on September 29, 2014. Under the terms of the private placement, Tallwood has agreed to vote its shares in excess of 35% of the outstanding common stock in the same proportion on all matters voted by non-Tallwood stockholders. At December 28, 2014, Tallwood Investors owned approximately 42% of the Company's common stock outstanding. As noted below in Note 15, Tallwood participated in the Company's Rights Offering and purchased an additional 2.7 million shares of the Company's common stock for $11.2 million. After the Rights Offering, Tallwood owned approximately 51% of the Company's outstanding common stock.
Note 10-Equity Plans and Related Equity Activity
Programs subsequent to December 28, 2014
Subsequent to December 28, 2014, five activities or programs have been completed that have or may have a significant effect upon equity plans and related equity activity. See Note 15 - Subsequent events for additions details.
Reverse stock split - The Company implemented a stockholder-approved 1:10 reverse stock split effective February 13, 2015, retroactive for all financial statements, stock and equity transactions, and related calculations such as earnings per share and option pricing.
Rights Offering - During the fourth quarter of 2014, the Company commenced a stockholder-approved Rights Offering under which stockholders of record on September 26, 2014 were given a subscription right to purchase 1.459707 shares of common stock for each share owned at $4.10 per share. The Rights Offering closed on February 4, 2015. Stockholders purchased 3.0 million shares of stock from the Company. The Company realized $11.6 million from the offering.
Special Equity Grant - To enable employees to maintain their ownership level prior to the Private Placement with ALU and Tallwood, on February 11, 2015 employees were given options and restricted stock units with a vesting commencement date of September 29, 2014. Participating employees received restricted stock units and stock options priced at $4.10. Under the program, the Company issued 0.9 million options and 0.8 million restricted stock units. Included within these grants were options and restricted stock units of 90,288 and 94,892, respectively, issued to Omid Tahernia, the Company's CEO.
2015 Executive Performance Grants- On February 16, 2015, in addition to the modifications of the previous performance grant to Omid Tahernia and the new 2015 Tahernia Performance Grant (See “Stock Option Agreement for Omid Tahernia” discussed below), the Company issued executive performance grants of 115,000 shares to Omid Tahernia, 24,000 shares to Dennis Bencala, 47,000 shares to Debajyoti Pal, 21,000 shares to Stuart Krometis, and 20,000 shares to Jim Murphy. All of these non-qualified stock options have an exercise price of $4.10 per share and will vest over a one year period, if at all, in two equal installments, if the price of the Company’s common stock during any 20 consecutive trading period exceeds $8.20 and $12.30, respectively. In addition, in the event of a change-of-control transaction, as defined in each individual’s pre-existing agreement with the Company, if the stock price performance targets have not been previously achieved, a portion of the grant will vest if the change of control deal price on the day the change-of-control transaction is announced is equal to or greater than $5.74.
Option exchange - On February 20, 2015, the Company commenced a stockholder-approved plan to enable employees to exchange options whose price is greater than the fair market value for options whose price will be the closing price of the Company's stock at the expiration of the tender offer. The offering period is scheduled to terminate on March 20, 2015.
Common Stock Issuance
On August 23, 2013, the Company filed with the Securities and Exchange Commission (“SEC”) a Registration Statement on Form S-1 which was subsequently amended and declared effective on November 6, 2013. Under this Registration Statement the Company could offer and sell in a public offering up to $35.0 million of common stock. In November 2013, the Company sold an aggregate of 2.6 million shares of its common stock resulting in net proceeds of $24.0 million after deducting underwriting discount and offering expenses of $2.4 million.
On September 29, 2014, as part of its collaboration arrangement with and among ALU and Tallwood, the Company realized, after issuance costs, $15.1 million on the sale of 3.9 million shares of the Company's common stock in a Private Placement to the Tallwood Group (2.7 million shares) and ALU (1.2 million shares). In addition, Tallwood committed to purchase an additional 2.7 million shares from the Company (see Note 1). Tallwood purchased the additional shares in February 2015 as part of the Company's Rights Offering and the Company realized $11.6 million before issuance costs from the sale. (See Note 15 - Subsequent Events.)
Warrants
As part of the collaboration agreement with ALU, the Company issued warrants to purchase the Company's stock to ALU. The first warrant was issued on September 29, 2014 for 315,789 shares with a purchase price of $4.75. The second warrant was issued on December 10, 2014 for 157,894 shares with a purchase price of $4.10. The warrants may be exercised at any time and will expire on November 30, 2017. Using the Black-Scholes-Merton model, the Company calculated that the aggregate value of the warrants was $558 thousand. The assumptions used for the calculation were; 1) the exercise prices and fair market values at issuance, 2) expected term of three years, 3) expected volatility of 62.10%, 4) risk free interest rate of 1.63%, and 5) no dividends. The expected volatility is based on a blend of the volatility of the Company’s peer group in the industry in which it does business and the Company’s historical volatility. The expected term is three years which is equal to the life of the Warrants. The risk free interest rate is the yield on zero-coupon U.S. treasury securities for a period that is commensurate with the expected term assumption.
Common Stock Reserved
As of December 28, 2014, the Company has reserved 8.8 million shares of common stock for future issuance under its various stock plans.
1999 Stock Plan
In September 1999, the Company adopted the 1999 Stock Plan (the “1999 Plan”). Options under the 1999 Plan were granted at a price equal to the fair market value of the stock at the date of grant, as determined by the Board of Directors, and terminated 10 years after the date of grant. Upon completion of the Company’s initial public offering, the 1999 Plan was terminated and no shares were available for future issuance under the 1999 Plan. As of December 28, 2014, the Company had 1,000 options outstanding under the 1999 Plan.
2004 Equity Incentive Plan
In September 2005, the Company adopted the 2004 Equity Incentive Plan (the “2004 Plan”) upon the closing of its initial public offering. Options under the 2004 Plan were granted at a price equal to the fair market value of the stock at the date of grant, as determined by the Board of Directors, and terminated seven years after the date of grant. The 2004 Plan allowed for the issuance of incentive and nonqualified stock options, restricted stock, restricted stock units, stock appreciation rights, deferred stock units, performance units, and performance shares to the Company’s employees, directors, and consultants. The
2004 Plan terminated on June 24, 2014 and no shares were available thereafter for future issuance under the 2004 Plan. Any shares under the 2004 Plan were transferred to the 2014 Stock Incentive Plan. At December 28, 2014, the Company had 1.7 million awards and options outstanding under the 2004 Plan.
2014 Stock Incentive Plan
In June 2014, at the Annual Meeting of Stockholders, the stockholders approved and the Company adopted the 2014 Stock Incentive Plan (the “2014 Plan”) upon the termination of the 2004 Plan. The 2014 Plan allows for the issuance of nonqualified stock options, restricted stock, restricted stock units, stock appreciation rights, deferred stock units, performance units, and performance shares to the Company’s employees, directors, and consultants. Options generally vest over four years at a rate of 25% on the first anniversary of the grant date and 6.25% quarterly thereafter. Generally, options terminate seven years after the date of grant and are non-statutory stock options. Restricted stock units represent the right to receive shares of common stock in the future, with the right to future delivery of the shares subject to a risk of forfeiture or other restrictions that will lapse upon satisfaction of specified conditions. The Plan will terminate in January 2014 unless the administrator terminates earlier.
At inception, the 2014 Plan contained approximately 3.0 million shares comprised of: 1) 0.5 million shares authorized under the 2014 Plan; 2) the number or shares reserved, but not issued under the terminated 2004 Plan; 3) options outstanding under the 1999 Plan to the extent forfeited to the Company due to failure to vest; and 4) any shares issued pursuant to the 2004 Plan and the 1999 Plan that are repurchased by us or forfeited by failure to vest. At a Special Meeting of Stockholders in November 2014, stockholders approved an amendment to the 2014 Plan to increase the number of shares of common stock reserved for issuance under the 2014 Plan by 7.5 million shares and also to increase the individual annual grant limits with respect to equity awards.
The 2014 Plan provides for the automatic grant of non-statutory stock options to its non-employee directors. Each non-employee director appointed to the Board will receive an initial option to purchase 4,500 shares upon such appointment except for those directors who become non-employee directors by ceasing to be employee directors. Initial option grants shall vest at the rate of one third of the shares on the first anniversary of the date of grant and 1/12th of the shares each quarter thereafter, subject to the director’s continuing to serve as a director as of each vesting date. Effective January 1, 2013, the Plan was amended such that non-employee directors receive a subsequent option to purchase shares and a restricted stock award on the date of each annual meeting of its stockholders as follows:
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For one year of service, the equity award is 850 stock options and a restricted stock award of 300 shares;
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For two years of service, the equity award is 1,250 stock options and a restricted stock award of 400 shares; and
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For three or more years of service, the equity award is 1,950 stock options and a restricted stock award of 700 shares.
These subsequent stock option grants shall vest as to 1/12th of the shares each month following the date of grant, subject to the director’s continuing to serve as a director on each vesting date. The restricted stock award will vest immediately on date of grant. All options granted under these automatic grant provisions have a term of seven years and an exercise price equal to the fair market value of its common stock on the date of grant.
As of December 28, 2014, the Company had 0.6 million options and awards outstanding and 8.4 million options and awards available for future grant under the 2014 Plan. (See Special Equity Grant above for options and awards issued on February 13, 2015.)
2004 Employee Stock Purchase Plan
In September 2005, the Company adopted the 2004 Employee Stock Purchase Plan (the “ESPP”), upon the closing of its initial public offering. The ESPP will expire in 2024. As of December 28, 2014, the Company had 0.4 million shares available for grant under the ESPP. All of the Company’s employees, with the exception of employees located in China, are eligible to participate if they are employed by the Company or any participating subsidiary for at least 20 hours per week. The Company’s ESPP is intended to qualify under Section 423 of the Internal Revenue Code and provides for consecutive, overlapping 24-month offering periods. Each offering period includes four 6-month purchase periods. The offering periods generally start on the first trading day on or after May 1 and November 1 of each year.
Doradus 2004 Amended and Restated Stock Option Plan
In August 2006, in connection with the Doradus acquisition, the Company assumed Doradus’ 2004 Amended and Restated Stock Option Plan (the “Doradus Plan”). Each unvested option to acquire shares of Doradus common stock
outstanding under the Doradus Plan immediately prior to the closing date was converted into the right to acquire 0.079365 shares of Ikanos common stock. As of December 28, 2014, no stock options were outstanding and the Doradus Plan terminated as of December 31, 2014. Options granted under the Doradus Plan may be incentive stock options or non-statutory stock options. Options generally vest at a rate of 25% on the first anniversary of the grant date and 1/12th per quarter thereafter and terminate 10 years after the date of grant.
Stock Option Agreement for Omid Tahernia
In June 2012, the Company adopted a stand-alone Stock Option Agreement for Omid Tahernia (the "Omid Tahernia Plan"), under which 210,000 shares of the Company’s common stock were reserved for issuance to the Company’s CEO, Omid Tahernia, in connection with the commencement of his employment with the Company beginning in June 2012. The Stock Option Agreement and related stock option grant were granted outside of the Ikanos Amended and Restated 2004 Equity Incentive Plan and without stockholder approval pursuant to NASDAQ Marketplace Rule 4350(i)(1)(A). The Company granted an option (the “Option”) to purchase its common stock as an inducement to Mr. Tahernia to accept employment with the Company. The terms and conditions of the grant were included in his offer letter dated May 31, 2012 (the “Offer Letter”). The grant included among other items the following terms: the option has been classified as a non-qualified stock option; has an exercise price equal to $8.90 (the fair market value on the grant date); and has a term of seven years.
With respect to 150,000 shares subject to the Option (the “Time-Based Option Shares”), 25% of such Shares shall vest twelve months from June 11, 2012 (the “Vesting Commencement Date”) on the same day of the month as the Vesting Commencement Date and 6.25% of the Shares subject to the Option shall vest each quarter thereafter on the same day of the month as the Vesting Commencement Date, subject to Mr. Tahernia’s continuing to be an employee of the Company through each such date, such that all 150,000 Shares shall have completely vested on the four-year anniversary of the Vesting Commencement Date.
With respect to the remaining 60,000 shares subject to the Option (the “Tahernia 2012 Performance-Based Option Shares”), (i) 30,000 shares begin vesting when the average closing stock price of the Company’s common stock on the Nasdaq Stock Market over any period of twenty (20) consecutive trading days reaches $25.00; and (ii) the remaining 30,000 shares begin vesting when the average closing stock price of the Company’s common stock on the Nasdaq Stock Market over any period of twenty (20) consecutive trading days reaches $35.00. The Performance-Based Option Shares will vest in equal quarterly installments over the one year period after the respective stock price target is achieved, subject to Mr. Tahernia’s continued employment. The Performance-Based Option Shares were valued using the Monte Carlo model to simulate future stock price movements in order to determine the fair values of a performance option grant. The simulations account for the vesting and exercise provisions of the grant. Effective February 11, 2015, the Compensation Committee (the “Committee”) modified part of the Tahernia 2012 Performance-Based Option Shares to change the stock price goals to $8.20 and $12.30, respectively, but made no other changes to the grant.
Also, effective on February 11, 2015, the Committee granted Mr. Tahernia an option (the "2015 Tahernia Performance Grant") to purchase 42,488 shares, with an exercise price of $4.10, that will vest over a one-year period, if at all, in two equal installments, if the price of the Company’s common stock during any 20 consecutive trading day period exceeds $8.20 and $12.30, respectively. Once vesting begins, these shares will vest in equal quarterly installments over the one-year period after the applicable stock price goal is achieved. In addition, in the event of a change-of-control transaction, as defined in Mr. Tahernia,s pre-existing agreement with the Company, the stock price performance targets (if not previously achieved) will be evaluated against the change of control deal price on the day the change-of-control transaction is announced to determine what, if any, accelerated vesting may be recognized.
Vesting and price targets are subject to certain acceleration if the Company should terminate Mr. Tahernia’s employment “without cause” or if Mr. Tahernia should terminate his employment for “good reason,” both as defined in the Offer Letter.
Stock-Based Compensation
Stock-based compensation expense related to all stock-based compensation awards was $3.8 million, $3.6 million, and $2.9 million for 2014, 2013, and 2012, respectively.
As of December 28, 2014, there was $5.2 million of total unrecognized stock-based compensation expense related to unvested share-based compensation arrangements. That expense is expected to be recognized over a weighted-average period of 3.0 years.
Summary of Assumptions for Stock Options and ESPP
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table.
Expected volatility: The expected volatility is based on a blend of the volatility of the Company’s peer group in the industry in which it does business and the Company’s historical volatility.
Expected term: The expected term is based on several factors including historical observations of employee exercise patterns during the Company’s history, peer company employee exercise behavior, and expectations of employee exercise behavior in the future giving consideration to the contractual terms of the stock-based awards. The expected term of options granted is derived from the average midpoint between vesting and the contractual term.
Risk-free interest rate: The yield on zero-coupon U.S. treasury securities for a period that is commensurate with the expected term assumption for each group of employees is used as the risk-free interest rate.
Pre-vesting forfeitures: Estimates of pre-vesting option forfeitures are based on Company experience and industry trends. The Company will adjust its estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ.
Equity Plan Activity
A summary of option activity is presented below (in thousands, except per share):
The weighted average grant date fair value of options granted during 2014, 2013, and 2012, was $2.91, $7.10, and $4.60, respectively. The total intrinsic value of options exercised during the years ended December 28, 2014, December 29, 2013, and December 30, 2012 was insignificant.
The following table summarizes information about stock options as of December 28, 2014 (in thousands, except per share and years):
Restricted Stock Units
A summary of the restricted stock unit activity is presented below (in thousands, except per share):
The table above includes 44,000 bonus awards, issued under a 2013 Bonus Awards Program, that were outstanding at December 29, 2013. The awards were retired and replaced with restricted stock units in June 2014. Fifty percent of the award will vest in January 2015 and the remaining 50% will vest in April 2015. The Company amortizes the fair value of the awards on a straight-line basis.
The weighted average grant date fair value per restricted stock units granted was $3.67, $13.20, and $13.90 during 2014, 2013, and 2012, respectively. The total fair value of restricted stock units that vested was $0.1 million for 2014, 2013, and 2012, respectively. The restricted stock units have one to four years vesting terms and are scheduled to vest through 2015. Tax related withholdings of restricted stock units was insignificant during 2014, 2013, and 2012.
Disclosures Pertaining to All Stock-Based Award Plans
Cash received from option exercises and ESPP contributions under all share-based payment arrangements was $0.5 million, $1.6 million, and $0.6 million for 2014, 2013, and 2012, respectively. The Company has maintained a full valuation allowance on its deferred tax assets since inception and has not been recognizing excess tax benefits from share-based awards. The Company does not anticipate recognizing excess tax benefits from stock-based payments for the foreseeable future, and the Company believes it would be reasonable to exclude such benefits from deferred tax assets and net loss per common share calculations. Accordingly, the Company did not realize any tax benefits from tax deductions related to share-based payment awards during 2014, 2013, or 2012.
Note 11-Employee Benefit Plans
The Company has a retirement savings plan, which qualifies as a deferred savings plan under section 401(k) of the Internal Revenue Code. All U.S. employees are eligible to participate in the savings plan and allowed to contribute up to 60% of their total compensation, not to exceed the maximum amount allowed by the applicable statutory prescribed limit. The Company is not required to contribute, nor has it contributed, to the savings plan for any of the periods presented.
Note 12-Commitments and Contingencies
Lease Obligations
The Company leases office facilities, equipment, and software under non-cancelable operating leases with various expiration dates through 2018. Rent expense for 2014, 2013, and 2012, was $2.4 million, $2.4 million, and $2.6 million, respectively. The terms of the facility leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred, but not paid.
Future minimum lease payments as of December 28, 2014 under non-cancelable leases with original terms in excess of one year are $2.5 million in 2015; $2.0 million in 2016; $1.6 million in 2017; and $0.4 million in 2018.
Purchase Commitments
As of December 28, 2014, the Company had $6.7 million of inventory purchase obligations that are expected to be paid during the first quarter of 2015.
Indemnities, Commitments and Guarantees
During its normal course of business, the Company has made certain indemnities, commitments, and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property indemnities to the Company’s customers in connection with the sales of its products, indemnities for liabilities associated with the infringement of other parties’ technology based upon the Company’s products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease. The duration of these indemnities, commitments, and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments, and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the various agreements that include indemnity provisions. In addition, the Company requires its employees to sign a proprietary information and inventions agreement, which assigns the rights to its employees’ development work to the Company. The Company has not recorded any liability for these indemnities, commitments, and guarantees in the accompanying consolidated balance sheets. The Company does, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and the amount of the loss can be reasonably estimated, in accordance with authoritative guidance.
In addition, the Company indemnifies its officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to its certificate of incorporation, bylaws, and applicable Delaware law. To date, the Company has not incurred any expenses related to these indemnifications.
Litigation
From time-to-time, in the normal course of business, the Company and its subsidiaries are parties to litigation matters and claims that have involved and may involve in the future, among other things, claims related to intellectual property infringement as well as employment-related disputes. The Company is subject to claims and litigation arising in the ordinary course of business, however, we do not believe, based on currently available facts and circumstances, that the final outcome of these matters, taken individually or as a whole, will have a material adverse effect on its consolidated results of operations or financial position. The results of litigation are inherently uncertain and material adverse outcomes are possible. The Company has not provided accruals for any legal matters in its financial statements as potential losses for such matters are not considered probable and reasonably estimable. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy any liabilities arising from the matters described above will not have a material adverse effect on its consolidated results of operations, financial position, or cash flows.
Note 13-Income Taxes
The components of loss before provisions for income taxes are as follows (in thousands):
The provision for income taxes consists of Federal, state minimum taxes and foreign taxes as follows (in thousands):
The reconciliation between the provision for income taxes computed by applying the US federal tax rate to loss before income taxes and the actual provision for income taxes is as follows:
Deferred income taxes reflect the effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of the deferred tax assets are as follows (in thousands):
The increase of $14.0 million from $43.0 million in 2013 to $57.4 million in 2014 of net operating loss carry-forwards and deferred tax assets is attributable mainly to a significant operations loss.
Realization of deferred tax assets is dependent upon future taxable earnings, the timing and amount of which are uncertain. The valuation allowance for deferred tax assets increased by $15.2 million to $75.3 million as of December 28, 2014 compared to an increase of $35.8 million to $60.2 million as of December 29, 2013. Due to cumulative losses in earlier years
and a significant amount of loss in the most recent year, the Company believes that it is more likely than not that the majority of its deferred tax assets will not be realizable in future periods. Consistent with this, the Company has applied a valuation allowance to offset completely both the increase in and the total value of the net operating loss carry-forwards.
Changes in the valuation allowance for deferred tax assets for 2014, 2013, and 2012, are as follows:
As of December 28, 2014, the Company had net operating loss carry-forwards for federal and state of California tax purposes of $155.3 million and $26.4 million, respectively. The net operating loss carry-forwards will expire beginning in 2030 for federal and 2031 for California, if not utilized. The Company has research and development tax credits of approximately $4.3 million and $2.0 million for federal and California state income tax purposes, respectively. If not utilized, the federal credit carry-forward will begin to expire in 2029. The California credit can be carried forward indefinitely. As of December 28, 2014, the Company has federal and state capital loss carry-forwards for income tax purposes of approximately $3.0 million and $3.6 million, respectively. If not utilized, both the federal and California state capital loss carry-forwards will begin to expire in 2015.
Utilization of net operating losses and tax credit carry-forwards may be subject to substantial annual limitations due to ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could impair the ability to utilize the net operating losses and tax credit carry-forwards before they can be utilized. The Company reviewed the ownership of shares both before and subsequent to the transactions to determine whether there had been any significant change in control. Based on the results of that review, the Company concluded that there had been no significant change in control, as defined, in 2014. However, future changes in ownership can significantly impair the Company’s ability to utilize the net operating losses and tax credit carry-forwards.
The Company has elected to track the portion of its federal and state net operating loss carry-forwards attributable to stock option benefits outside of its financial statements. Therefore, these amounts are no longer included in the Company’s gross or net deferred tax assets. The benefit of these net operating loss carry-forwards will only be recorded to equity when they reduce cash taxes payable. The cumulative amounts as of December 28, 2014 are not material for either federal or state tax purposes.
Prior to 2011, the Company did not provide for federal income tax and withholding taxes for unremitted foreign earnings because the unremitted earnings of its foreign subsidiaries were deemed to be permanently reinvested. Beginning in the fourth quarter of 2011, the Company began to provide for federal income tax and foreign withholding taxes for the unremitted earnings of foreign subsidiaries because the Company has determined that those funds may no longer be permanently reinvested. Any additional U.S. income taxes will be minimal due to the utilization of net operating loss carry-forwards and foreign tax credits.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
The Company has adopted the accounting policy that interest and penalties will be classified within the provision for income taxes. The amount of accrued interest and penalty recorded was $0.2 million as of and for the fiscal year ended December 28, 2014.
The Company does not anticipate any significant changes to its liability for unrecognized tax benefits within twelve months of this reporting date of its unrecognized tax benefits.
The Company’s operations are subject to income and transaction taxes in the U.S. and in multiple foreign jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result. The majority of the unrecognized tax benefit is related to gross deferred tax assets, and accordingly, if and when recognized, would not result in a change in Company’s effective tax rate due to the existence of a full valuation allowance. In addition, we recorded additional long-term tax liability for certain income tax benefits related to its India subsidiary’s transfer pricing policy. If such tax benefit is recognized, it would result in a change in the Company’s effective tax rate.
The Company does not expect any material adjustment to its reserves within the next twelve months. The Company’s tax years starting from 2010 to 2013 remain open in various tax jurisdictions. There are on-going examinations by the India tax authority for India transfer pricing issues for 2009, 2010, and 2011.
Note 14-Significant Customer Information and Segment Reporting
FASB establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The method for determining the information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance.
The Company’s chief operating decision-maker is considered to be the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. On this basis, the Company is organized and operates in a single segment: the design, development, marketing, and sale of semiconductors and integrated firmware.
The following table summarizes revenue by geographic region, based on the country in which the customer headquarters office is located (in thousands):
The Company tracks its products within two product families: Gateway and Access. The Access product family consists of semiconductor and software products that power the carrier infrastructure for the central office (“CO”), as well as any node in a hybrid-fiber-copper network where fiber is terminated and copper is used to reach the consumer premises. The Gateway product family includes a variety of processors and the associated software designed for devices deployed at the customer premises. Gateway products enable service providers to offer their subscribers a variety services, including internet access, voice, over-the-top content, and security.
Revenue by product family is as follows (in thousands):
The distribution of long-lived assets (excluding intangible assets and other assets) was as follows (in thousands):
Note 15-Subsequent Events
Rights Offering and Registration Statement on Form S-1
We filed a Registration Statement on Form S-1 on October 20, 2014 and amended it thereafter (declared effective on November 26, 2014) under which we distributed rights to the holders of our common stock as of September 26, 2014 (the "Record Date") non-transferable subscription rights to purchase 14.5 million shares of our common stock (the "Rights Offering"). Each subscription right entitled the rights holder to purchase 1.459707 shares of our common stock at $4.10 per share. Therefore, each holder of record would have the opportunity to maintain the same ownership percentage of the Company subsequent to the September 29, 2014 Private Placement of shares as the stockholder had at the record date. The Rights Offering closed on February 4, 2015. The Company issued 3.0 million shares of the Company's common stock and realized $11.6 million after issuance costs of $0.8 million.
Special Equity Grant
In order to for employees to maintain the same level of ownership after the September 29, 2014 private placement sale of shares of common stock to ALU and Tallwood Investors, management proposed and the Board of Directors approved special equity grants for virtually all employees. Grants of options and restricted stock units were made on February 11, 2015 with an initial vesting date of September 29, 2014. Under the special equity grant, the Company issued 0.9 million options and 0.8 million restricted stock units.
2015 Executive Performance Grants
On February 16, 2015, the Company issued executive performance grants of 115,000 shares to Omid Tahernia, 24,000 shares to Dennis Bencala, 47,000 shares to Debajyoti Pal, 21,000 shares to Stuart Krometis, and 20,000 shares to Jim Murphy. All of these non-qualified stock options have an exercise price of $4.10 per share and will vest over a one year period, if at all, in two equal installments, if the price of the Company’s common stock during any 20 consecutive trading period exceeds $8.20 and $12.30, respectively. In addition, in the event of a change-of-control transaction, as defined in each individual’s pre-existing agreement with the Company, the stock price performance targets (if not previously achieved) will be evaluated against the change of control deal price on the day the change-of-control transaction is announced to determine what, if any, accelerated vesting may be recognized.
Reverse Stock Split
On February 11, 2015, at a Special Meeting of Stockholders (the "February 2015 Special Meeting"), the Company's stockholders approved an amendment to our Restated Certificate of Incorporation to effect a reverse stock split of its common stock at a ratio, to be determined by the Board of Directors, of not less than one-for-five shares (1:5) and not more than one-for-ten shares (1:10). At a meeting of the Board of Directors immediately following the February 2015 Special Meeting, the Board of Directors approved and directed Ikanos management to implement a 1:10 reverse stock split, effective February 13, 2015.
The reverse stock split applies to all stock outstanding, restricted stock units, stock appreciation rights, and stock options. As of February 13, 2015, the effect of the reverse stock split was to reduce the number of shares issued and outstanding from 170.1 million to 17.0 million. Neither the total authorized shares nor the preferred stock was affected by the reverse stock split. Awards and options outstanding of 24.8 million shares and shares available for grant of 84.9 million were reduced to 2.5 million and 8.5 million, respectively.
On February 13, 2015, the stock closed at $0.33 per share on The NASDAQ Capital Market and opened on February 17, 2015, the next business day, at $3.30 per share.
Unless otherwise noted, the effect of the reverse stock split has been retroactively applied to all common stock, equity plans and related activity as well as share and per share data in this Annual Report on Form 10-K.
Option Exchange
Generally, throughout 2014 and also in prior years, due to the decline in our stock price, all the Company's stock options have had exercise prices greater than the closing prices of our stock on The NASDAQ Capital Market. At a Special Meeting of Stockholders on November 21, 2014, Company management and the Board of Directors proposed and the stockholders approved a one-time stock option exchange program (the "Tender Offer") for the Company's active employees and directors to exchange certain outstanding stock options (the "Eligible Options") for new stock options. The exercise price of each new option will be the closing price of the Company's stock on The NASDAQ Capital Market on the date of grant, defined as the date immediately following the expiration of the tender offer. Eligible Options are options (including Stock Appreciation Rights) issued prior to January 1, 2014 that have an exercise price equal to or greater than $4.10. All eligible
options will be exchanged for new options on a one-for-one basis except for those held by Directors and Executive Officers who will receive four new options for every five options held. Vesting will be thirty-six months for those eligible options partially vested and twenty-four months for those eligible options fully vested at the time that the tender offer expires. The tender offer began on February 20, 2015 and will expire on March 20, 2015.
SUPPLEMENTARY FINANCIAL DATA
Quarterly Financial Information (Unaudited)
(In thousands, except per share amounts)
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
We changed our independent registered public accounting firm effective March 7, 2014 from PricewaterhouseCoopers LLP to Moss Adams LLP. Information regarding the change in the independent registered public accounting firm was disclosed in our Current Report on Form 8-K filed with the SEC on March 7, 2014. There were no disagreements with PricewaterhouseCoopers LLP or any reportable events requiring disclosure under Item 304(b) of Regulation S-K.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded these disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for Ikanos. Ikanos’ internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the fair presentation of published financial statements for external purposes in accordance with GAAP. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Further, because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate, the effectiveness of internal controls may vary over time.
Our management assessed the effectiveness of our internal control over financial reporting as of December 29, 2013. In making this assessment we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on our assessment using those criteria, we concluded that, as of December 28, 2014, our internal control over financial reporting is effective.
The Company’s independent registered public accounting firm, Moss Adams LLP, has issued an attestation report on the Company’s internal control over financial reporting. The report on the audit of internal control over financial reporting appears in Part II, Item 8 of this Form 10-K.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the fourth quarter ended December 28, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
On March 18, 2015, Ikanos Communications, Inc. (the “Company”) entered into Amendment No. 1 to the First Amended and Restated Loan and Security Agreement and Limited Waiver (the “Amendment”) with Silicon Valley Bank (“SVB”). The Amendment provides a waiver by SVB of the Company’s failure to comply, as of the end of January 2015, with the covenant set forth in Section 6.7(a) (Adjusted Quick Ratio) of the First Amended and Restated Loan and Security Agreement dated as of October 7, 2014 (the “Agreement”). The Amendment also provides a modification to Section 2.5 of the Agreement eliminating the nightly sweep of collections in favor of daily application. The foregoing description of Amendment No. 1 to the First Amended and Restated Loan and Security Agreement and Limited Waiver is a summary, does not purport to be complete, and is qualified in its entirety by reference to the full text of the Amendment to the Agreement filed as Exhibit 10.16 to this Annual Report on Form 10-K and incorporated herein by reference.
PART III
Certain information required by Part III is omitted from this Annual Report on Form 10-K but will be included in the definitive proxy statement that we will file within 120 days after the end of our fiscal year pursuant to Regulation 14A (the “Proxy Statement”) for our 2015 Annual Meeting of Stockholders, and certain of the information to be included therein is incorporated by reference herein.
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information regarding our executive officers required by this Item is incorporated by reference from the section entitled “Executive Officers of Registrant” in Part I of this Annual Report on Form 10-K.
The information regarding our directors, the identification of Audit Committee members and the Audit Committee Financial Expert is incorporated by reference from “Proposal One-Election of Directors” in our Proxy Statement.
The information concerning Section 16(a) reporting is incorporated by reference from “Other Information-Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement.
Information regarding material changes, if any, to the procedures by which security holders may recommend nominees to our Board of Directors is incorporated by reference from “Consideration of Stockholder Recommendations and Nominations” in our Proxy Statement.
We have adopted a Code of Business Conduct and Ethics applicable to all our employees. Our Code of Business Conduct and Ethics is available at our investor relations website at www.ikanos.com/investor. Any waiver or amendment to our Code of Business Conduct and Ethics that applies to our Chief Executive Officer, President, Chief Financial Officer, or any other officer providing financial information, will be disclosed on our website at www.ikanos.com or in a Current Report on Form 8-K filed with the SEC.
The information included under the following captions in our Proxy Statement is incorporated herein by reference: “Compensation Discussion and Analysis,” “2014 Summary Compensation Table,” “Grants of Plan-Based Awards in 2014,” “Outstanding Equity Awards at 2014 Fiscal Year End,” “Option Exercises and Stock Vested in 2014,” “Potential Payments upon Termination or Change in Control,” “Director Compensation” and “Compensation Committee Interlocks, and Insider Participation.”
The information included under the heading Compensation Committee Report in our Proxy Statement is incorporated herein by reference; however, this information shall not be deemed to be “soliciting material” or to be “filed” with the Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information regarding stock ownership by principal stockholders and management required by this Item is incorporated by reference from "Share Ownership by Principal Stockholders and Management" in our Proxy Statement.
Equity Compensation Plan Information
The following table provides information as of December 28, 2014 with respect to common stock that may be issued upon the exercise of equity awards under our Amended and Restated 1999 Stock Option Plan (the “1999 Plan”), Amended and Restated 2004 Equity Incentive Plan (the “2004 Plan”), the Amended and Restated 2014 Stock Incentive Plan (the "2014 Plan), 2004 Employee Stock Purchase Plan (the “2004 ESPP”) and the Doradus Technologies, Inc. 2004 Amended and Restated Stock Option Plan (the “Doradus Plan”).
(1)
Includes: (i) shares of common stock issuable upon the exercise of outstanding options grants (subject to vesting) for 1,788,074 shares (ii) shares of common stock issuable upon the vesting of restricted stock units for 685,256 shares.
(2)
No further equity awards may be granted under the 1999 Plan.
(3)
Includes 8,369,974 shares available for future issuance under the 2014 Plan, 356,400 shares available for future issuance under the 2004 ESPP, and 105,915 under other legacy plans.
(4)
Shares available for future issuance under the Doradus Plan of 14,925 and under the Omid Tahernia Plan of 210,000.
Doradus 2004 Amended and Restated Stock Option Plan
Options granted under the Doradus Plan may be incentive stock options or non-statutory stock options. Options generally vest at a rate of 25% on the first anniversary of the grant date and 1/12th per quarter thereafter and terminate ten years after the date of grant. The Doradus Plan has a term of 10 years from the date of adoption, which was in 2004.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference to “Certain Relationships and Related Transactions” in our Proxy Statement. The information regarding director independence is incorporated herein by reference from the subsection entitled “Board Independence” in the section entitled “Proposal 1-Election of Directors” in our Proxy Statement.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information regarding principal accounting fees and services is incorporated herein by reference from the section entitled “Proposal 2-Ratification of Appointment of Independent Registered Public Accounting Firm” in our Proxy Statement.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements: The financial statements are set forth under Part II, Item 8 of this Annual Report on Form 10-K.
2. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
The following documents are filed as part of this Report:
3. Exhibits:
Exhibit
Number
Description
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
*
Indicates a management contract or compensatory plan or arrangement.
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.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dennis Bencala and Andrew S. Hughes, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto each of said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purpose s as he or she might or could do in person, hereby ratifying and confirming all that each of said attorneys-in-facts and agents, or his substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Exhibit Index
*
Indicates a management contract or compensatory plan or arrangement.