ITEM 1. BUSINESS
The following information should be read in conjunction with audited consolidated financial statements and the notes thereto included in Part II, Item 8 of this annual report on Form 10-K.
Overview
We are a leading provider of advanced broadband semiconductor and integrated firmware products for the digital home. Our broadband DSL, communications processors and other offerings power access infrastructure and customer premises equipment (CPE) for many of the world’s leading network equipment manufacturers and telecommunications service providers. Our products are at the core of digital subscriber line access multiplexers (DSLAMs), optical network terminals (ONTs), concentrators, modems, voice over Internet Protocol (VoIP) terminal adapters, integrated access devices (IADs) and residential gateways (RGs). Our products have been deployed by service providers in Asia, Europe and North and South America.
We believe that we can offer advanced products by continuing to push existing limits in silicon, systems and firmware. We have developed programmable, scalable chip architectures, which form the foundation for deploying and delivering multi-play services. Expertise in the creation and integration of digital signal processor (DSP) algorithms with advanced digital, analog and mixed signal semiconductors enables us to offer high performance, high-density and low-power asymmetric DSL (ADSL) and very-high-bit rate DSL (VDSL) products. In addition, flexible communications processor architectures with wirespeed packet processing capabilities enable high-performance end-user devices for distributing advanced services in the home, regardless of the wide area network (WAN) technology. These products support various high speed broadband service providers’ multi-play deployment plans to the digital home while keeping their capital and operating expenditures low.
We outsource all of our semiconductor fabrication, assembly and test functions, which allows us to focus on the design, development, sales and marketing of our products and reduces the level of our capital investment. Our direct customers consist primarily of original design manufacturers (ODMs), contract manufacturers (CMs), network equipment manufacturers (NEMs) and original equipment manufacturers (OEMs), who in turn sell our semiconductors as part of their product solutions to the service provider market.
We offer multiple product lines. Our standalone communications processors support a variety of WAN topologies including Gigabit Ethernet devices for the Cable multiple system operator (MSO) space, products that work with passive optical network (PON), DSL, and wireless broadband and Ethernet. Our broadband DSL products enable up to 100 megabits per second (Mbps) for both downstream and upstream broadband over copper.
Corporate Information
Our principal executive office is located at 47669 Fremont Boulevard, Fremont, CA 94538. Our telephone number at that location is (510) 979-0400. Our website address is www.ikanos.com. This is a textual reference only. We do not incorporate the information on our website into this annual report on Form 10-K, and you should not consider any information on, or that can be accessed through, our website as part of this annual report on Form 10-K. We were incorporated in 1999 as Velocity Communications and changed our name to Ikanos Communications in December 2000. When we reincorporated in Delaware in September 2005, our name changed to Ikanos Communications, Inc.
Demand for Broadband Services and Market Opportunities for Service Providers
The growth of the Internet, the proliferation of advanced digital video and multimedia, and the advancement of communications infrastructure have fundamentally changed the way people work, shop, entertain and communicate. According to researchers at HIS/iSuppli, the world’s broadband subscriber base will cross one
billion by 2016.To remain competitive, service providers must deliver more bandwidth and increasing speed to enable revenue-enhancing advanced services. Today, these services include access to advanced digital media, video, communications and interactive broadband applications, including, among others:
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Broadcast television;
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High definition television (HDTV);
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Internet protocol television (IPTV);
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Video on demand (VOD);
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Distance learning;
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Telemedicine;
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Sending and receiving advanced digital media such as music, photos and video;
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Video conferencing;
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Video surveillance;
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Smart energy and home automation;
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Streaming video and audio;
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Fixed mobile convergence/femtocell;
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Online gaming and game hosting; and
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Voice over internet protocol (VoIP).
Additionally, users are increasingly creating, interacting with and transmitting advanced digital media as the number of smart phones and tablets has increased exponentially in recent years. As a result, the ability to send information upstream has become as important as the ability to receive information downstream. For example, the sharing of user-created content including video and online gaming have high bandwidth requirements for both upstream and downstream transmissions. As data and media files increase in size, we believe users will become increasingly dissatisfied with their existing first generation broadband technology, which does not maintain sufficient transmission rates for satisfactory delivery of these advanced digital media, video, communications and interactive broadband applications. The table below compares broadband applications and their bandwidth requirements:
Delivering video-intensive services requires increased bandwidth of at least 50 to 100 Mbps. Service providers can use a variety of network architectures to provide this increased demand for broadband. More often than not, service providers select a hybrid approach that combines fiber backbone networks with copper as the last mile. This architecture - referred to most commonly as fiber to the node (FTTN) - is chosen because
replacing an existing network with fiber is costly and time-consuming. The cost associated with wholesale replacement of copper with fiber to the home (FTTH) ranged from $1,350 to $3,400 or more per household. The table below reflects estimated costs to install and deploy FTTH network in various geographic locations. These costs do not include the full cost of central office (CO) upgrades, and other fiber-related infrastructure improvements.
* Source: AT Kearney, ING, NTT, AT&T, Ikanos
In contrast, the estimated cost per household using the hybrid approach, made possible by our products, is approximately $250. By using a combination of fiber and copper in the last mile service providers have a cost effective solution for delivering the needed 50 to 100 Mbps.
The Ikanos Solution
We are a leading provider of advanced broadband semiconductor and integrated firmware products for the digital home. We have developed these semiconductors using our proprietary semiconductor design techniques, specific purpose digital signal processor and advanced mixed-signal semiconductor design capabilities. Our communications processors are used in a range of devices in the digital home and offer high-performance, as well as the flexibility and programmability for advanced services such as security, firewall and routing.
Our products form the basis of communications systems that are deployed by service providers in their infrastructure, as well as in the home to enable subscribers to access data, voice and video. We offer highly programmable products that support the multiple international standards used in broadband deployments worldwide, including ADSL, ADSL2, ADSL2+, VDSL, and VDSL2. In addition, we are equipped to handle gigabit Ethernet interfaces and provide wire speed switching performance for FTTH and Cable deployments.
We have incorporated features and functions into our products that previously had to be developed by our customers as part of their own systems. We refer to these features and functions as our systems-level capabilities, which enable our customers to reduce costs, accelerate time-to-market and enhance the flexibility of their systems.
We believe that our key competitive advantages include our system-level expertise, the programmability of our products, our ability to integrate complex analog hardware, digital hardware, algorithms, systems and firmware into a complete product, our distributed accelerator processor architecture and our technology leadership and experience working directly with service providers in mass deployment of this technology. Our products are being deployed by leading service providers around the world and also actively evaluated by other leading service providers for deployment in their networks.
Key Features of Our Technology
Breakthrough NodeScale™ Vectoring technology. One of the challenges in deploying very-high-speed Internet access over existing infrastructure is the degradation that occurs as a result of crosstalk between coincident copper wire pairs. Each wire can often and intermittently interfere with neighboring wires, thereby introducing noise, severely limiting line quality and reducing VDSL performance. Ikanos’ NodeScale Vectoring technology that is currently in development will analyze the crosstalk and interference environment in real time and create a unique set of compensation signals that effectively eliminates both. Ikanos’ NodeScale Vectoring cancels noise across an entire network node with up to 384 ports, meeting the deployment requirements of the world’s leading service providers.
Integrated analog technology. One of the key technology differentiations of our semiconductors is our integrated analog technology. Our analog products perform the high-precision analog-to-digital and digital-to-analog conversion and the various analog functions necessary to interface between the digital signal processor and the physical transmission medium. Our integrated analog technology includes programmable transmit and receive filters, low-noise amplifiers, and a power-optimized line driver with synthesized impedance and hybrid cancellation. Our analog technology enables systems to increase performance, adapt to noisy signal conditions, reduce power consumption and be programmed for multiple international standards. Additionally, our analog technology eliminates the need for a large number of discrete components and hence reduces costs for our OEM customers and increases the number of connections, or ports, in OEM systems.
Highly programmable platform and integrated firmware. We provide a highly programmable platform for the interactive broadband industry that enables significant customization of reach, transmission rates and other specifications to optimize transmission performance. Our firmware enables the programmability of our digital signal processor as well as provides an interface to an external processor for diagnostic testing and configuration of key functions. Our integrated firmware can be remotely downloaded into our semiconductors for easy field upgrade and service expansion. This capability allows service providers to protect their investments and reduce costs. In addition, we provide application firmware that can be used by our customers to facilitate the incorporation of our semiconductors into their systems.
Quality of Service/Quality of Experience. Firmware is a key component of our products. Ikanos Quality Video (iQV™) integrated firmware enables our chipsets to intelligently adjust its data rate instantly to provide optimal quality in any line condition. With iQV, IPTV services that may be severely degraded or even dropped by older/less sophisticated chipsets will not only stay connected, but will show no degradation in image quality, even in very noisy conditions. The enhanced capabilities of iQV enable service providers to utilize existing copper infrastructure to deliver bandwidth-intensive and quality sensitive applications, like multiple channels of HD-video, high quality VoIP and other revenue-enhancing advanced features.
High-performance DSP and advanced algorithms. Communications algorithms are special techniques used to transform signals between digital data streams and specially conditioned analog signals suitable for transmission over copper lines. In order to reliably transmit and receive signals at high-speed transmission rates, it is critical to execute advanced algorithms in real time. Algorithm processing is typically performed by the DSP. We have designed high-performance, low power usage DSPs for high transmission rate applications that utilize our proprietary integrated firmware. Our processing algorithms enable reliable transmission and recovery of signals at high-speed transmission rates over the existing copper lines even under noisy signal conditions. We believe the combination of speed and programmability of our DSP and our advanced algorithms provides us a competitive advantage.
Advanced bonding capabilities. Service providers can utilize two pairs of twisted copper wires and offer their customers bonded DSL technology. Bonding technology leverages the existing copper infrastructure and allows for increased data rates, longer loop lengths and increased reliability. Our flexible xDSL DSP core architecture is available 17MHz bandwidth, 2-pair bonded configurations that enable cost-optimized products for fiber-to-the-building (FTTB), FTTN and Central Office (CO) deployments, respectively.
Flexible network interfaces. Service providers globally use multiple communications protocols for transmitting data, voice and video over their networks. Such protocols include Asynchronous Transfer Mode (ATM) and IP. Our semiconductors have the capability to support multiple network protocols and interfaces, including ATM and IP, to a variety of different OEM systems. For example, service providers in Japan and Korea typically deploy IP-based line cards and platforms that use our semiconductors while service providers in Europe and North America have historically deployed ATM-based systems and are in the process of migrating to IP-based systems.
High-performance communications processing. The delivery of high-quality video and other services requires a high-performance processor to handle the digital data streams that travel in both the upstream and
downstream directions from the subscriber’s home. Common data processing functions include routing of IP-based packets, providing voice, video and data streams with different classes of priority within the system and implementing VoIP, network security and wireless LAN functionality. Our products include high-performance semiconductors that are designed to perform functions at rates of up to 1Gbps, which addresses both the latest generation of LAN and WAN technologies. We believe the combination of our high-performance communications processing products and our broad range of VDSL and ADSL2+ PHY products provides us a competitive advantage.
Key Benefits of Our Technology for Our Customers
Enabling the delivery of advanced digital video, multimedia, communications and interactive broadband applications. Our products provide downstream and upstream high-speed transmission rates of up to 100 Mbps and beyond on a single pair of telephone lines. These transmission rates enable service providers to deliver advanced digital media, video, communications and interactive broadband applications such as broadcast television, HDTV, IPTV, VOD, interactive television, peer-to-peer file sharing, sending and receiving advanced digital media, video conferencing, video surveillance, streaming audio and video, online gaming, game hosting and VoIP, as well as traditional telephony services.
Improving time-to-market with programmable systems-level products. Our products are programmable through our integrated firmware, which enables our customers to provide a single line card or residential gateway implementation, to support multiple international standards. Our systems-level capabilities enable us to design our semiconductors to accelerate our customers’ time-to-market. Because of the programmability of our products, service providers can deliver multiple service packages and charge different amounts for these packages.
Cost-effective, high-performance transmission over existing copper lines. Our semiconductors reduce service providers’ capital expenditures and costs, because they enable transmission of signals at high-speed rates over their existing copper lines. As a result, service providers can leverage their previous investments in their access network infrastructure to deliver advanced revenue-generating services to their customers. Our products are compatible with service providers’ existing systems, enabling these service providers to add line cards without having to replace existing systems, thus lowering upfront capital expenditures and reducing inventory costs. Moreover, we offer broadband semiconductors with combined ADSL2+ and VDSL2 support, thereby providing our customers with a convenient single source from which to purchase a wide range of broadband access semiconductors.
End-to-end products. We offer semiconductors for both CO and CPE to deliver seamless interoperability.
Proven technology. To date, we have shipped more than 400 million ADSL and VDSL CPE and CO ports. Our products are deployed or are in field testing at leading service providers worldwide such as AT&T, Belgacom, Bell Canada, France Telecom, KPN, Korea Telecom Corp., Nippon Telegraph and Telephone, Swisscom, Telecom Italia, and Telefónica. Our OEM customers and the service providers they serve conduct extensive system-level testing and field qualification of new semiconductors (generally over a six to eighteen month period) to ensure that it meets performance, standards compliance and stability requirements before that semiconductor is approved for mass deployment. Our semiconductors have been designed into systems offered by leading OEMs including: Alcatel-Lucent, Arcadyan, AVM, Cisco, Motorola, Inc., NEC Corporation, Sagemcom, Sumitomo Electronic Industries, Ltd., Xavi Technologies Corp, and ZTE Corporation.
Our Strategy
Our objective is to provide the leading semiconductor products for the universal delivery of new generations of broadband services that transform the way people work, live and play. We expect to continue to develop highly programmable semiconductors that deliver triple play and interactive services over broadband using fiber
and telephone copper lines and that distribute these services to the digital home. In addition, we intend to further expand into new applications and adjacent markets that include the delivery of broadband within a home. The principal elements of our strategy are:
Continuous innovation. We believe we have achieved a leadership position in the high-speed broadband market as well as in the triple play residential gateway markets. We invented discrete multi-tone (DMT) based VDSL and have been a leader in the development of the standards for interactive broadband over copper lines and our products are compliant with those standards. We continue to develop new technologies, such as bonding and NodeScale Vectoring, to extend our customers current broadband infrastructure as well as offer new customers cost effective products to deliver high-speed broadband. We will continue to drive the development of new standards for FTTB, FTTN, FTTH and home networking initiatives through our involvement in a range of industry groups and develop innovative products for these markets.
Expand our product portfolio to pursue new market opportunities. Today, our product line includes devices for all manner of broadband DSL deployments. Our communications processors are used in the customer premises equipment that supports those technologies, as well as those that support other broadband access types including cable, wireless broadband, PON and Ethernet. We also have a set of other products that complement these offerings and provide enhanced voice processing wireless networking and other capabilities. We expect to expand our product portfolio over time to include additional broadband technologies to address incremental market opportunities, as well as add new communications processors and broadband DSL devices to further strengthen our position in core markets.
Capitalize on our existing service provider and OEM relationships. We believe that our close relationships with service providers and OEMs provide us with a deep understanding of their needs and enable us to continue to develop customized technology to meet their requirements. Broadband technology requires customization for the specific needs of service providers. We intend to continue to capitalize on our close relationships with leading service providers and OEMs to facilitate the deployment of our products.
Our Target Markets
We address two primary markets with our products: the broadband DSL market and the communications processor market. In these markets, we sell our products primarily to service providers through the NEMs, OEMs, ODMs and CMs that supply them.
In the broadband DSL market, we are one of the leading technology providers. In fact, we are the number one supplier of VDSL in the world with a larger cumulative market share than all our competitors combined. Service providers use this technology to enable the cost-effective provisioning of advanced digital media, video, communications and interactive broadband applications including broadcast television, HDTV, IPTV, VOD, interactive television, peer-to-peer file sharing, sending and receiving advanced digital media, video conferencing, video surveillance, streaming video and audio, online gaming, game hosting and VoIP, as well as traditional telephony services.
Consumers demand a wide array of offerings from their service providers. They want VoIP telephony, IPTV, wireless connectivity, Personal Video Recorder (PVR) services, security, file and photo sharing, gaming and a host of other advanced offerings. But service providers face a significant challenge delivering those offerings. Not only is there a greater need for bandwidth, but service providers also need to provide an end-user device that has the processing power to handle new services while managing their operating expenses. That is where our communications processor products come into play.
Our communications processors are the heart of the residential gateways. And we believe that the residential gateway is poised to become the centerpiece of the digital home. Whether the access infrastructure is copper, fiber or wireless, the residential gateway - and the communications processor within it - must have adequate power to distribute bandwidth intensive services with appropriate security and other functionality.
Our Fusiv® and other communications processors enable service providers to efficiently and cost-effectively deliver multi-play services to the residential, small office/home office and small to medium enterprise markets. These devices utilize our unique distributed architecture, which includes multiple accelerator processors (AP) that offload switching, routing and other tasks from the host central processing unit (CPU). As a result, we provide high levels of processing power for combined advanced services including but not limited to VoIP, PVR, multi-mode DSL and security, while supporting best-in-class quality of service (QoS) and wire speed performance across all LAN and WAN interfaces.
Over time, we will adapt our product lines to address new markets and develop additional products specifically for them.
Our Products
We offer multiple product lines that are designed to address different segments of the communications processor and the high-speed broadband DSL markets. Service providers and OEMs choose our semiconductors from these multiple product lines based on a variety of factors such as the design of their networks, the distance between the fiber termination point and the customer premises, the technology that they want to deploy, the services that they want to offer and system design constraints such as performance, density and power consumption. By choosing our products for their hybrid fiber/xDSL networks, service providers are able to utilize their existing broadband infrastructure and maximize the return on their capital investments.
Communications Processors for a Range of Customer Premises Equipment
Our family of communications processors complements our broadband DSL products and is designed for a range of devices that deliver high-speed access to the digital home. We offer processors that include integrated broadband as well as standalone products for a variety of applications.
Integrated Communication Processors:
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Fusiv® Vx185 and Vx183 family of chipsets are high performance G.Vector-compliant communications processors designed specifically for the next-generation of service gateways. This family of products employs a unique distributed architecture that incorporates AP engines for data path functions, which is designed to ensure the maximum host CPU processing power is available for customer applications. The Vx185/183 are next-generation convergence devices that leverage the advancements from the previous Fusiv family, while adding more processing power and critical interfaces to form the foundation for next-generation residential gateways. The highest performance product in this new family, the Vx185-HP, provides leading edge processing power, high speed wireless LAN interfaces for dual-band concurrent 802.11n and 802.11ac, VoIP, multi-mode bonded DSL and security, while supporting carrier class quality of service (QoS) and Gigabit wire-speed performance. The entire family of Vx185/183 chipsets supports all DSL with a seventh generation single integrated front end (IFE) - IFE7, including ADSL, ADSL2, ADSL2+, and all bandplans of VDSL2, and further enhances IPTV and triple-play networks by being fully compliant with the ITU-T G.Vector standard. The Vx185 and Vx185-HP add support for VDSL2 bonding.
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Fusiv Vx180 is an integrated communication processor that features a MIPS-based™ CPU core, VoIP capabilities, security, and best-in-class QoS. It includes a multi-mode VDSL2 data pump that is backward compatible to ADSL2+, ADSL2, and ADSL for flexibility across a range of service provider deployments. The product easily integrates with home networking technologies such as 802.11a/b/g/n and the Fusiv Vx180 offers two IFE options. The IFE5 supports up to the 30a profile with 100 Mbps upstream and 100 Mbps downstream performance. The IFE6 (integrated front end and line driver) supports up to the 17a profile and fallback to ADSL, ADSL2 and ADSL2+.
Standalone Communication Processors:
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The Fusiv® Multi-core Vx175 and Fusiv Vx173 are built on our Fusiv family of processors and extend the range of access technologies and device types that can be supported by Ikanos products. With these dual-core products, Cable MSO’s, PON service providers and manufacturers can build a wide range of devices including femtocell gateways, energy gateways, mobile broadband routers, optical networking terminals, network attached storage and others. In the Vx175, the host cores provide1GHz of processing power while the Vx173 host cores support 800MHz of host processing power. This family of products can run femtocell stacks, VoIP and a range of other computational-intensive tasks. In addition to the dual core MIPs processors, the Vx175 and Vx173 also include hardware accelerator processors delivering up to an additional 4GHz of processing to provide flexibility and improved performance. The accelerator processor implementation enables bi-directional Gigabit routing performance while consuming a small fraction of the Fusiv’s processing power.
Broadband DSL
We serve the dynamic broadband market with an extensive line of products for CO and CPE. These products are complemented by our communications processors. The combination of these complementary products enables triple- and quadruple-play services around the world.
We have a range of broadband DSL semiconductor integrated firmware products for VDSL and ADSL implementations. Our VDSL chipsets for DSLAMs and other CO equipment include industry’s first NodeScale™-Ikanos Velocity™, Fx™100100-5 and Fx10050-5. Our VDSL standalone chipsets for CPE like residential gateways include Accelity-DA87781, Fx100100S-5 and Fx10050S-5. Maxtane™-CX955xx is our ADSL chipset for CO equipment, and our SHDSL chipsets include Orion™-GS2237 CO and Orion-GS2237 CPE.
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The Ikanos Velocity family of low-power, full-featured A/VDSL access chipsets provide up to 100 Mbps symmetrical bandwidth and operate at a sub one watt per port power consumption. Both chipsets support 8a/b/c/d, 12a/b, 17a and 30a VDSL2 profiles as well as ADSL2+, ADSL2 and ADSL standards. Compliant with European Code of Conduct (CoC) power consumption standards, the Velocity chipsets utilize up to 30 MHz of spectrum. In addition, Velocity chipsets include iQV technology which enables exceptional delivery of data-intensive triple play applications, including multi-channel HD IPTV, high-speed data transmission, VoD and VoIP.
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The Ikanos Velocity-3 solution in development combines the rich feature set of the Velocity family with breakthrough NodeScale™ vectoring technology. This will provide full cancellation of cross talk at the node level, full scalability to address various node sizes from 8 to 384 ports/node, while enabling easier deployment of vectored VDSL with key features like Ikanos Easy-vectoring and NodeScale™ bonding.
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Fx™100100-5 and Fx10050-high bandwidth multi-port A/VDSL CO chipsets enable service providers to deliver a full suite of revenue-generating interactive broadband services and features from a single platform. Utilizing up to 30 MHz of spectrum, our Fx100100-5 is the industry’s first chipset to be IPTV-optimized with up to 100 Mbps symmetrical performance and built-in QoS capabilities. And our IPTV-optimized Fx10050-5 chipset utilizes up to 17.6 MHz of spectrum, and enables up to 100 Mbps downstream and up to 50 Mbps upstream performance. Both products incorporate advanced QoS capabilities and are ideal for DSLAMs and ONUs providing the port density levels and low power consumption necessary to support MDUs.
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Fx100100S-5 and Fx10050S-5 high bandwidth A/VDSL CPE chipsets enable service providers to deliver a full suite of revenue-generating interactive broadband services and features from a single platform. Interoperable with deployed CO equipment and utilizing up to 30 MHz of spectrum, our Fx100100S-5 is the industry’s first chipset to be IPTV-optimized with up to 100 Mbps symmetrical performance. And our IPTV-optimized Fx10050S-5 chipset enables up to 100 Mbps downstream and up to 50 Mbps upstream performance. Both chipsets offer built-in QoS capabilities, have multi-mode support and are ideal for modems, residential gateways, optical network terminals and routers.
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Maxtane CX955xx ADSL chipsets are ADSL/ADSL2/ADSL2+ CO transceivers enabling advanced triple play services. The chipsets offer features such as enhanced impulse noise protection (INP) and dual interleaving for simultaneous video, voice and data services with appropriate protection for each service. Advanced features of Maxtane enable better service levels for triple play services, including IPTV, high-speed Internet access, VOD, HDTV, VoIP, videoconferencing, remote office connectivity, and telecommuting. Maxtane devices enable feature rich IPTV line card solutions for next-generation exchange, remote unit (DLC/ONU), or MDU applications. The Maxtane includes a 16-port DSP and two AFE chips while the Maxtane includes a DSP in a 24-port configuration and three AFEs.
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Orion™ and Orion™-Plus CO and CPE chipsets for symmetric high bit-rate digital subscriber line (SHDSL) offer unsurpassed functionality and density for SHDSL. It provides G.991.2 or G.shdsl compliance for both single and dual copper pair systems. Our SHDSL chipset provides value added features well beyond the scope of existing products, enabling system vendors to enter new markets and significantly differentiate their offerings. Examples of such features include provision for rates up to 4.6 Mbps for MDU applications, via SHDSL 4 wire support.
Advanced Firmware for Enhanced Products
Integrated firmware is a key component of our semiconductor products. In our central office and customer premises chipsets, we have advanced iQV firmware, a combination of technologies that enhances link robustness. Ikanos’ Programmable Operating System™ firmware (iPOS) facilitates the customization of Fx and FxS™ chipsets to specific applications. Our Integrated Firmware on Silicon® (ISOS) firmware accelerates development time for devices like the Solos and others. And our processor firmware-FusivWare™-allows for increased flexibility and reuse in the design of modems, gateways and other devices expediting time-to market for our customers’ new generations of products.
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iQV technology which enables exceptional delivery of data-intensive triple play applications, including multi-channel HD IPTV, high-speed data transmission, VoD and VoIP. Ikanos iQV protects against all noise types including dynamic, impulse, and repetitive impulse noise (REIN) by employing retransmission, Rapid Rate Adaptation™ (RRA) and other innovative technologies.
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Key Features
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Sustains link connectivity with large noise change
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Fast rate adaptation to rapid noise changes less than 750ms
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Erasure decoding providing twice the impulse protection without increasing delay
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Retransmission technology
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iPOS is an integrated real-time operating system (RTOS) kernel and set of management application programming interfaces (APIs) that enable equipment vendors to easily tailor Fx and FxS chipsets to specific applications. iPOS is highly configurable and controls the chipset’s Burst Mode Engine (BME). It’s based on a RTOS operating system and can be easily ported to other operating systems and host processors.
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FusivWare is advanced Linux-based firmware that enables network equipment manufacturers to jump start their development processes. The firm ware incorporates routing, bridging, a complete VoIP stack, packet classification, marking, bandwidth management and fast-path assisted QoS functions to ensure better performance, drivers and more. FusivWare enables manufacturers to reduce product development cycles, rapidly prototype and quickly enter production with everything from simple modems to sophisticated gateways. The FusivWare flexible firmware architecture provides customers with the ability to design this equipment with any transport methodology - or multiple methodologies - including Ethernet, xDSL and PON. This dramatically reduces time to market for subsequent generations of products.
Our industry is continually transitioning to new technologies and products. Large industry transitions are unpredictable due to factors including, but not limited to, extended product trials, qualifications and the transformation of existing platforms to new platforms. Furthermore, the environment in which we market and sell our products has become increasingly competitive and cost sensitive.
Customers and Service Providers
Customers
The markets for systems utilizing our products and services are mainly served by large NEMs, OEMs, ODMs and CMs. We market our products to service providers, but we primarily sell our products to equipment suppliers. We have in the past and expect in the future to derive a substantial portion of our revenue from sales to a relatively small number of customers. The loss of a significant customer would materially and adversely affect our financial condition and results of operations.
During 2012 Sagemcom Tunisie, Askey Computer Corporation and Flextronics Manufacturing (Hong Kong) Ltd. accounted for 19%, 13% and 12% of revenue, respectively. During 2011 Sagemcom Tunisie and Paltek Corporation accounted for 20% and 10% of revenue, respectively. While in 2010 Alcatel Lucent and Sagemcom Tunisie accounted for 18% and 15% of revenue, respectively. Historically, substantially all of our sales have been to customers outside the United States. Sales to customers in Asia accounted for 68% of revenue in 2012, 62% in 2011 and 60% in 2010. Sales to customers in Europe and North Africa accounted for 29% of revenue in 2012, 36% in 2011 and 37% in 2010.
Telecommunication Service Providers
We work directly with various major service providers and their OEMs worldwide in connection with the optimization of our technology for mass deployment or trials into the service providers’ networks. Our OEM customers have sold products that include our semiconductors to major service providers, including:
AT&T (North America)
KPN (The Netherlands)
Belgacom (Belgium)
Nippon Telegraph & Telephone Corporation (Japan)
Bell Canada (Canada)
Swisscom (Switzerland)
Bouygues Telecom (France)
Telecom Italia (Italy)
France Telecom (France)
Telefonica (Spain)
Korea Telecom Corp. (Korea)
Our Service and Support for Customers and Service Providers
To accelerate the design and development of our customers’ systems and the qualification and mass deployment of our technology, we have a Product Applications Engineering (PAE) team and a Field Application Engineering (FAE) team. These teams work closely with the OEMs as well as directly with the service providers. Applications engineers have expertise in hardware and firmware and have access to the various expertises within our company to ensure proper service and support for our OEM and service provider customers.
Our service and support involves multiple stages including working with the service providers’ evaluation of our technology through the utilization of our reference platforms, and the optimizing our technology to meet the individual service providers’ performance and other requirements.
In parallel, our engineers help our customers with the design and review of their system designs. Our application engineers and field application engineers help the customers’ engineers design their systems by providing the necessary reference designs, gerber files, schematics, data sheets, sample firmware and other documentation. By doing this, we assist our customers and the service providers they serve in meeting their
deployment requirements. Once the hardware incorporating our chipsets is built by our customers, we work closely with the customers’ engineers to integrate our firmware into systems through site visits and extensive field-testing with the service providers which may include inter-operation with legacy equipment already deployed in the service provider’s served area. This entire qualification cycle may take six to eighteen months depending upon the region, service provider requirements and deployment plans.
Sales, Business Development and Product Marketing
Our sales and marketing strategy is to achieve design wins with leading suppliers and mass deployment with service providers worldwide. We consider a design win to occur when an OEM notifies us that it has selected our products to be incorporated into its system. We refer to our sales and marketing strategy as “direct touch” since we have significant contact directly with the customers of our OEMs, the telecommunication service providers. We believe that applications support at the early stages of design is critical to reducing time to deployment and minimizing costly redesigns for our customers and the service providers. By simultaneously working with our customers and the service providers, we are able to use the pull of service provider network compatibility and interoperability to push design wins with our customers, which is further augmented by our support and service capabilities.
We market and sell our products worldwide through a combination of direct sales and third-party sales representatives. We utilize sales representatives to expand the impact of our sales team. We have strategically located our sales, business development and marketing personnel, field applications engineers and sales representatives near our major customers in China, Europe, Japan, Korea, Taiwan, and the United States.
Our product marketing teams focus on our product strategy and management, product development road maps, product pricing and positioning, new product introduction and transition, demand assessment, competitive analysis and marketing communications and promotions. Our marketing teams are also responsible for ensuring that product development activities, product launches, channel marketing program activities and ongoing demand and supply planning occur on a well-managed, timely basis in coordination with our development, operations and sales groups, as well as our customers.
Competition
The semiconductor industry and the broadband communications markets are intensely competitive. In the xDSL, PON and communications processing markets, we currently compete or expect to compete with, among others, Alcatel Lucent, Broadcom Corporation, Cavium Networks, Inc., Cortina Systems, Inc., Lantiq Deutschland GmbH, Marvell Technology Group Ltd., Mindspeed Technologies, Inc. PMC-Sierra, Inc., Metanoia Communication, QUALCOMM Incorporated, Realtek Semiconductor Corp. and MediaTek Inc. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage. Our competitors may be able to adopt more aggressive pricing policies and devote greater resources to the development, promotion and sale of their products than we can. In addition, new competitors or alliances among existing competitors could emerge. Competition has resulted, and may continue to result, in declining average selling prices for our products and market share. We believe that our products are not easily interchangeable with the products of our competitors, due to the level of collaboration in product design and development that is typically demanded by our customers from the earliest stages of development. But nevertheless, we must constantly maintain our technology developments in order to continue to achieve design wins with our customers.
We also consider other companies that have access to broadband or communications processing technology as potential future competitors. In addition, we may also face competition from newly established competitors, suppliers of products based on new or emerging technologies, and customers who choose to develop their own technology.
We believe that we are competing effectively with respect to the following factors:
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product performance;
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compliance with industry standards;
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differentiated and disruptive technology features;
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price and cost effectiveness;
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energy efficiency;
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physical footprint;
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functionality;
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time-to-market; and
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customer service and support.
Research and Development
Our research and development efforts are focused on the development of advanced semiconductors and related firmware. We have experienced engineers who have significant expertise in interactive broadband and communications processing technologies. These areas of expertise include communication systems, system architecture, digital signal and communications processing, data networking, analog design, digital and mixed signal, very large scale integration development, firmware development, reference boards and system design. In addition, we work closely with the research and development teams of our OEM customers and service providers. Our research and development expense was $57.5 million in 2012, $55.8 million in 2011and $60.8 million in 2010.
Operations
Master Services and Supply Agreement
We outsource all of our semiconductor fabrication, assembly and test functions, which allows us to focus on the design, development, sales and marketing of our products and reduces the level of our capital investment. Our direct customers consist primarily of ODMs, CMs, NEMs and OEMs, who in turn sell our semiconductors as part of their product solutions to the service provider market. In fiscal year 2012 we expanded our outsourced model by transitioning a majority of our day-to-day supply chain management, production test engineering and production quality engineering functions (Master Services) to eSilicon Corporation (eSilicon) under a master services and supply agreement (Service Agreement). Pursuant to the Service Agreement, we place orders for our finished goods products with eSilicon, who, in turn, contracts with wafer foundries and the assembly and test subcontractors and manages these operational functions for us on a day-to-day level. During the first half of 2012, we began the transition of these Master Services to eSilicon and to establish clear lines of communications among us, eSilicon, the wafer foundries and the assembly and test subcontractors. As of the end of fiscal 2012, we have substantially completed the transition of Master Services to eSilicon.
Semiconductor Fabrication
As noted above, we do not own or operate a semiconductor fabrication, packaging or testing facility, except for some of the test equipment that we place at our subcontractors sites for Ikanos usage. By owning some of the test equipment, we gain cost benefits and assurance of capacity. Through eSilicon, we depend upon third-party subcontractors to manufacture, package and test our products. By outsourcing manufacturing, we are able to substantially avoid the upfront capital and cost associated with owning and operating a captive manufacturing facility. This allows us to focus efforts on the design and marketing of the products.
We currently outsource all semiconductor wafer manufacturing. We continue to work closely with the foundries to forecast our manufacturing capacity requirements on a monthly basis. Our semiconductors are
currently fabricated in several advanced, sub-micron manufacturing processes. Because finer manufacturing processes lead to enhanced performance, smaller silicon chip size and lower power requirements, we continually evaluate the benefits and feasibility of migrating to smaller geometry process technologies in order to reduce cost and improve performance. We believe that the fabless manufacturing approach provides the benefits of superior manufacturing capability as well as flexibility to move the manufacturing, assembly and testing of the products to those subcontractors that offer the best capability at an attractive price. Nevertheless, because we do not have formal, long-term pricing agreements with any of the subcontracting partners, the wafer costs and services are subject to sudden price fluctuations based on the cyclical demand for semiconductors. Our engineers work closely with the foundries and other subcontractors to increase yields, lower manufacturing costs and improve quality.
Assembly and Test
Our products are generally shipped from the third-party foundries to third-party sort, assembly and test facilities where they are assembled into finished semiconductors and then tested. We outsource all product packaging and all testing requirements for these products to several assembly and test subcontractors. Our products are designed to use low cost, standard packages and to be tested with widely available test equipment. In addition, we specifically design our semiconductors for ease of testability, thereby further reducing production costs.
Quality Assurance
Our quality assurance program begins with the design and development processes both in hardware and firmware. Our hardware designs are subjected to extensive circuit simulation under extreme conditions of temperature, voltage and processing before being committed to be manufactured. Our firmware goes through testing per specified test plans and customer requirements. As defects are identified, engineers rewrite code to optimize performance before the firmware is released. We pre-qualify each of the subcontractors and conduct periodic quality audits. We monitor foundry production to ensure consistent overall quality, reliability and yield levels. All of the independent foundries and assembly and test subcontractors have been awarded ISO 9000 certification as well as other internationally accepted quality standards. In August 2006, we were certified to ISO 9001 standards and passed an ISO 9001:2008 surveillance audit in May 2011.
Environmental Regulation
We are also focusing on managing the environmental impact of our products. The manufacturing flows at all the subcontractors used by us are registered to ISO 14000, the international standard related to environmental management. We believe that the products are compliant with the Restriction of Hazardous Substance (RoHS) directives and that materials are available to meet these emerging regulations.
Intellectual Property
Our success and future growth will depend on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark and trade secret laws, contractual provisions and licenses to protect our intellectual property. We also attempt to protect our trade secrets and other proprietary information through agreements with our customers, suppliers, employees and consultants and through other security measures.
As of December 30, 2012, we held a total of 288 issued patents in the United States and abroad; we also had a number of provisional patents and applications pending. Our patents and patent applications cover features, arts and methodology employed in each of our existing product families. The expiration dates range from 2015 through 2031. We continue to actively pursue the filing of additional patent applications.
We claim copyright protection for the proprietary documentation used in our products and for the firmware and firmware components of our products. Ikanos Communications, Ikanos, the Ikanos logo, the “Bandwidth
without boundaries” tagline, Fusiv, Ikanos NodeScale, Ikanos SmartCPE and Ikanos Velocity are among the trademarks or registered trademarks of Ikanos Communications.
Employees
As of December 30, 2012, we had a total of 263 full-time employees, of whom 205 were involved in research and development and 58 in sales, marketing, operations, finance and administration. None of our employees is represented by a labor union. We have not experienced any work stoppages and believe that our relationships with our employees are good.
In an effort to manage the Company’s operating expense to its projected revenue forecast, on January 30, 2012 the Board of Directors approved and management initiated a corporate restructuring plan that reduced our workforce by approximately16%. Employees were notified of their termination on February 1 and 2, 2012. The restructuring plan was completed in 2012.
Backlog
Our sales are made pursuant to short-term purchase orders. These purchase orders are made without deposits and may be rescheduled or modified on relatively short notice without substantial penalty in most cases. Therefore, we believe that the purchase orders may not be a reliable indicator of future sales.
Executive Officers of the Registrant
The following table sets forth the names, ages and positions of our executive officers as of February 21, 2013:
There are no family relationships among any of our directors and executive officers.
Omid Tahernia has served as our President, Chief Executive Officer and a member of the board of directors since June 2012. Prior to joining Ikanos Mr. Tahernia served as President and CEO of Tilera Corporation from October 2007 to October 2011. Mr. Tahernia was with Xilinx first as Vice President and General Manager of the DSP Division from July 2004 to June 2006 and later as Vice President and General Manager of the Processing Solutions Group from June 2006 to September 2007. Mr. Tahernia was employed by the Motorola, Inc. Semiconductor Group as Vice President and Director of Strategy and Business Development from June 2003 to July 2004 and Vice President and General Manager of the Wireless & Mobile Systems Division from December 1998 until June 2003. Mr. Tahernia holds a B.S.E.E. from Virginia Polytechnic Institute & State University, and an M.S.E.E. from Georgia Institute of Technology.
Dennis Bencala has served as our Chief Financial Officer (CFO) and Vice President of Finance since June 2010. Prior to joining Ikanos Mr. Bencala was CFO of the Renewable Energy Test Center from October 2009 to June 2010. Mr. Bencala held successive positions at SiRF Technology Inc. (SiRF) beginning with Corporate Controller in January 2000 and becoming Senior Director, Investor Relations and Business Development, in August 2007. He became acting CFO at SiRF in August 2008 and CFO from Sept 2008 until October 2009. Prior to joining SiRF Mr. Bencala served as Corporate Controller at ScanVision, Inc., a developer of image sensing semiconductor products from June 1995 to December 1999. Mr. Bencala holds a B.S. in Finance from San Diego State University.
Debajyoti Pal has served as our Chief Technology Officer since August 2009. From April 2004 until August 2009, Dr. Pal was Chief Technology Officer and Executive in Residence at Tallwood Venture Capital. Prior to joining Tallwood, Dr. Pal founded Telicos Corporation in May 2002 and was President until April 2004. Dr. Pal was Vice President of Technology & Product Development of Virata/Globespan Virata from August 2000 until April 2002. In May 1998 he founded Excess Bandwidth Corporation and was Chief Technology Officer and Vice President Engineering until August 2000 when it was acquired by Virata. Dr. Pal received a bachelors degree in electronics and electrical communication engineering from the Indian Institute of Technology (IIT) Kharagpur, India, a M.S.E.E. degree from Washington State University and a Ph.D. in electrical engineering from Stanford University. Dr. Pal is a Fellow of the Institute of Electrical and Electronics Engineers (IEEE).
Jim Murphy has served as our Vice President, Worldwide Human Resources since June 2010. Prior to joining Ikanos he served as Vice President, Human Resources for North America and Asia Pacific for CSR plc from August 2009 until May 2010. From March 2006 until August 2009, Mr. Murphy was Vice President, Human Resources for SiRF. Prior to joining SiRF, Mr. Murphy was Senior Human Resources Director for North America at LSI Logic. Mr. Murphy holds a B.A. from Lawrence University and an M.B.A. from the University of Michigan.
Michael Kelly has served as our Vice President of Worldwide Sales since July 2010. Prior to joining Ikanos, he was Vice President, Sales at CSR plc from July 2009 until July 2010 and Vice President of Worldwide Sales at SiRF Technology, Inc. from August 2008 until July 2009. Mr. Kelly joined SiRF in August 1998 as Director, North America Sales and became Senior Director, North America Sales, in August 2006.
Where Can You Find Additional Information
With respect to the statements contained in this annual report on Form 10-K regarding the contents of any agreement or any other document, in each instance, the statement is qualified in all respects by the complete text of the agreement or document, a copy of which has been filed as an exhibit to the registration statement. You may inspect a copy of the reports and other information we file without charge at the Public Reference Room of the Securities and Exchange Commission (SEC) at 100 F Street, N.E., Room 1580, Washington D.C. 20549. You may obtain copies of all or any part of this annual report on Form 10-K from such offices at prescribed rates. You may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers, including our information which we file electronically with the SEC.
We are subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and, in accordance therewith, file periodic reports, proxy statements and other information with the SEC. Such periodic reports, proxy statements and other information are available for inspection and copying at the Public Reference Room and web site of the SEC referred to above. We maintain a web site at www.ikanos.com. You may access our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act with the SEC, free of charge at our web site as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. The reference to our web address does not constitute incorporation by reference of the information contained at this site.
Item 1A.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this annual report on Form 10-K, and in our other filings with the SEC, before deciding whether to invest in shares of our common stock. Additional risks and uncertainties not presently known to us may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on us, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock will likely decline and you may lose all or part of your investment.
Risks Related to Our Customers and Markets
We are in a product transition phase and we may not be able to adequately develop, market or sell new products.
Revenues from certain existing products are decreasing as these products near end-of-life and, beginning in the third fiscal quarter of 2012, we began selling our next generation CPE product Fusiv® Vx185, Vx183, Vx175, and Vx173 chipsets. Further, we are currently developing a new broadband DSL CO platform based on vectoring technology. The successful customer migration to our new products is critical to our business, and there is no assurance that we are or will be able to market and or sell new products and services in a timely manner. New products or services developed in the future may be delayed, and new products may not be accepted by the market, or may be accepted for a shorter period than anticipated. Our sales and operating results may be adversely affected if we are unable to bring new products to market, if customers delay purchases or if acceptance of the new products is slower than expected or to a smaller degree than expected, if at all. Failure of future offerings to be accepted by the market could have a material adverse effect on our business, operations, financial condition, or reputation.
We have had a history of losses, and future losses or the inability achieve or sustain profitability in the future may adversely impact our relationships with customers and potential customers and, therefore, financial condition and liquidity.
Since our inception, we have never been profitable on an annual basis and we have incurred significant net losses leading to an accumulated deficit of $295.7 million as of December 30, 2012. To achieve profitability, we will need to generate and sustain higher revenue and to improve our gross margins while maintaining expense levels that are appropriate and necessary for our business. We may not be able to achieve profitability and, even if it were able to attain profitability, we may not be able to sustain profitability on an on-going quarterly or an annual basis in the future. Since we compete with companies that have greater financial stability, our customers or potential customers may be reluctant to enter into arrangements with us due to the perceived risks to our long term viability.
Our common stock previously traded below $1.00 and was subject to delisting from the NASDAQ Capital Market. If our common stock trades below $1.00 in the future, our stock could be subject to delisting, which would adversely affect the market liquidity of our common stock and harm our business.
On June 14, 2012 our common stock was transferred from the NASDAQ Global Market to the NASDAQ Capital Market.” Our common stock is currently traded on the NASDAQ Capital Market under the symbol “IKAN.” In accordance with NASDAQ Marketplace Rule 5810(c)(3)(A), we were provided 180 calendar days from June 14, 2012, or until December 10, 2012, to regain compliance. Since September 10, 2012, the bid price of our common stock closed at $1.00 or more per share and NASDAQ provided written notice that we have regained compliance with the Marketplace Rule. However, there can be no guarantee that we will be able to remain in compliance with the continued listing requirement of the Rule.
If in the future our common stock trades below $1.00 per share for a specified period of time, we could again be subject to delisting. Any delisting could adversely affect the market price of and liquidity of the trading
market for our common stock, our ability to obtain financing for the continuation of its operations and could result in the loss of confidence by investors, suppliers and employees.
Our operating results have fluctuated significantly over time and are likely to continue to do so, and as a result, we may fail to meet or exceed our revenue forecasts or the expectations of securities analysts or investors, which could cause the market price of our common stock to decline.
Our industry is highly cyclical and is characterized by constant and rapid technological change, product obsolescence and price erosion, evolving standards, uncertain product life cycles and wide fluctuations in product supply and demand. The industry has, from time to time, experienced significant and sometimes prolonged, downturns, often connected with or in anticipation of maturing product cycles and declines in general economic conditions. To respond to these downturns, some service providers have decreased their capital expenditures, changed their purchasing practices to use refurbished rather than purchasing new equipment, canceled or delayed new developments, and taken a cautious approach to acquiring new equipment and technologies from OEMs, usually with very little notice. This, in turn, has reduced the demand for new semiconductors by our direct customers which could result in significant fluctuations of revenue as the economy changes.
Any future downturns may reduce our revenue and result in us having excess inventory. By contrast, any upturn in the semiconductor industry could result in increased demand and competition for limited production capacity, which may affect our ability to ship products and prevent us from benefiting from such an upturn. Accordingly, our operating results may vary significantly as a result of the general conditions in the semiconductor or broadband communications industry, which could cause the market price of our common stock to decline.
Fluctuations in our expenses could affect our operating results.
Our expenses are subject to fluctuations resulting from various factors, including, but not limited to, higher expenses associated with new product releases, for example, addressing technical issues arising from development efforts, costs associated with additional or unanticipated costs for manufacturing or components increasing without notice because we do not have formal pricing arrangements with our subcontractors, costs of design tools and large up-front license fees to third parties for intellectual property integrated into our products, as well as other factors identified throughout these risk factors.
Because many of our expenses are relatively fixed in the short term, or are incurred in advance of anticipated sales, we may not be able to reduce our expenses sufficiently to mitigate any reductions in revenue. Therefore it may be necessary to take other measures to align expenses with revenue. For example, on January 30, 2012, the Board of Directors approved and management initiated a corporate restructuring plan that included a reduction in force by approximately16%. The restructuring plan was completed in fiscal 2012. Restructuring charges included expenses related to the severance for terminated employees and other exit-related costs arising from contractual and other obligations.
General macroeconomic conditions could reduce demand for services based upon our products.
Our business is susceptible to macroeconomic and other world market conditions. As an example, we believe that consumer-targeted broadband services, which are deployed using our technology, are part of most households’ discretionary spending. We believe the global financial economic downturn that began in 2008 and continued through 2012, particularly in Europe, affected consumer confidence and spending negatively. These outcomes and behaviors may adversely affect our business and financial condition. If individual consumers decide not to install-or decide to discontinue purchasing-broadband services in their homes in order to save money in an uncertain economy, the resulting drop in demand could cause telecommunications service providers to reduce or stop placing orders for OEM equipment containing our products. Accordingly, the OEMs’ demand for our products could drop further, potentially having a materially negative effect on our revenue.
We may need additional capital, and the sale of additional shares of common stock or other securities would result in additional dilution to our stockholders.
We believe that our current cash and cash equivalents, as well as our line of credit, will be sufficient to meet our anticipated cash needs in the foreseeable future. However, we may require additional cash resources during 2013 as a result of changes in our business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities, which could result in additional dilution to our stockholders. Incurring indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot be assured that financing will be available in amounts or on terms acceptable to us, if at all.
Our success is dependent upon achieving new design wins into commercially successful systems sold by our OEM and ODM customers.
Our products are generally incorporated into our OEM and ODM customers’ systems at the design stage. As a result, we rely on OEMs and ODMs to select our products to be designed into their systems, which we refer to as a “design win.” At any given time, we are competing for one or more of these design wins. We often incur significant expenditures over multiple fiscal quarters without any assurance that we will achieve a design win. Furthermore, even if we achieve a design win, we cannot be assured that the OEM or ODM’s equipment that we are designed into will be marketed, sold or commercially successful and, accordingly, we may not generate any revenue from the design win. In addition, our OEM and ODM customers can choose at any time to discontinue their systems that include our products or delay deployment, which has occurred in the past from time to time. If we are unable to achieve design wins or if our OEM customers’ systems incorporating our products are not commercially successful or deployed, our operating results would suffer.
Industry consolidation may lead to increased competition and may harm our operating results.
There has been a trend toward industry consolidation in our industry. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete for customers. This could have a material adverse effect on our business, financial condition and results of operations. Furthermore, rapid consolidation could result in a decrease in the number of customers we serve. Loss of a major customer could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to develop, introduce or achieve market acceptance of our new semiconductor products, our operating results would be adversely affected.
Our industry is characterized by rapid technological innovation and intense competition. Our future success will depend on our ability to continue to predict what new products are needed to meet the demand of the broadband, communication processor or other markets addressable by our products and then introduce, develop and distribute such products in a timely and cost-effective manner. The development of new semiconductor products is complex, and from time to time we have experienced delays in completing the development and introduction of new products. We have in the past invested substantial resources in developing and purchasing emerging technologies that did not achieve the market acceptance that we had expected.
Our ability to develop and deliver new semiconductor products successfully will depend on various factors, including our ability to:
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successfully integrate our products with our OEM customers’ products
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gain market acceptance of our products and our OEM customers’ products.
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successfully integrate certain technologies acquired in acquisitions into our product lines;
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accurately predict market requirements and evolving industry standards;
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accurately define new semiconductor products;
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timely complete and introduce new product designs or features;
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timely qualify and obtain industry interoperability certification of our products and the equipment into which our products will be incorporated;
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ensure that our subcontractors have sufficient foundry capacity and packaging materials and achieve acceptable manufacturing yields;
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shift our products to smaller geometry process technologies to achieve lower cost and higher levels of design integration; and
If we are unable to develop and introduce new semiconductor products successfully and in a cost-effective and timely manner, we will not be able to attract new customers or retain our existing customers, which would harm our business.
If we do not successfully manage our inventory in the transition process to next generation semiconductor products, our operating results may be harmed.
If we are successful in timely developing new semiconductor products ahead of competitors but do not cost-effectively manage our inventory levels of existing products when making the transition to the new semiconductor products, our financial results could be negatively affected by high levels of obsolete inventory and our operating results would be harmed.
The average selling prices and gross margins of our products are subject to declines, which may harm our revenue and profitability.
Our products are subject to rapid declines in average selling prices due to pressure from customers and competitive pressures, including lowering average selling prices in order to maintain or increase market share. We have lowered our prices significantly at times to gain or maintain market share, and we expect to do so again in the future. In addition, we may not be able to reduce our costs of goods sold as rapidly as our prices have declined. Our financial results, in particular (but not limited to) our gross margins, will suffer if we are unable to maintain or increase pricing, or are unable to offset any future reductions in our average selling prices by increasing our sales volumes, reducing our manufacturing costs or developing new or enhanced products that command higher prices or better gross margins on a timely basis.
Our product sales mix is subject to frequent changes, which may impact our revenue and margin.
Our product margins vary widely by product and customer. As a result, a change in the sales mix of our products could have an impact on the forecasted revenue and margins for the quarter. For example, our Broadband DSL product family generally has higher margins as compared to our Communication Processor product family. Furthermore, the product margins within our Broadband DSL product family can vary based on the type and performance of deployment being used as customers typically pay higher selling prices for higher performance. While we forecast a future product mix and make purchase decisions based on that forecast, actual results can be materially different which could negatively impact our revenue and margins.
Because we depend on a relatively small number of significant customers for a substantial portion of our revenue, the loss of any of our key customers, our inability to continue to sell existing and new products to our key customers in significant quantities or our failure to attract new significant customers could adversely impact our revenue and harm our business.
We have in the past and expect in the future to derive a substantial portion of our revenue from sales to a relatively small number of customers. The composition of these customers has varied in the past, and we expect
that it will continue to vary over time. As a result, the loss of any significant customer or a decline in business with any significant customer would materially and adversely affect our financial condition and results of operations. In addition, we may experience pressure from significant customers to agree to customer-favorable sales terms and price reductions. The following customers accounted for more than 10% of our revenue in the periods indicated below:
* Less than 10%
Recent changes in our senior management positions could negatively affect our operations and relationships with our customers and employees.
We have experienced recent changes in our senior management team, the resignations of our President and Chief Executive Officer in June 2011, our Vice President of Operations in March 2011, our Vice President of Marketing in September 2011, and our Vice President of Program Management in April 2012 and the appointments of our new President and Chief Executive officer in June 2012 and our new Vice President of Operations in September 2012. Changes in our senior management or technical personnel could affect our customer relationships, employee morale, and our ability to operate in compliance with existing internal controls and regulations and harm our business. If we are unable to maintain a consistent senior management team or successfully integrate our current and future members of senior management, our business could be negatively affected.
Because competition for qualified personnel is intense in our industry, we may not be able to recruit and retain necessary personnel, which could impact our product development and sales.
Our future success depends on our ability to continue to attract, retain and motivate other senior management and qualified technical personnel, particularly software engineers, digital circuit designers, mixed-signal circuit designers and systems and algorithms engineers. Competition for these employees is intense and many of our competitors may have greater name recognition and significantly greater financial resources to better compete for these employees. If we are unable to retain our existing personnel, or attract and train additional qualified personnel, our growth may be limited due to our lack of capacity to develop and market our products. All of our key employees are employed on an “at will” basis. The loss of any of these key employees could slow our product development processes and sales efforts or harm the perception of our business. We may also incur increased operating expenses and be required to divert the attention of other senior management to recruit replacements for key employees. Also, our depressed common stock price may result in difficulty attracting and retaining personnel as stock options and other forms of incentive equity grants generally comprise a significant portion of our compensation packages for all employees, which could harm our ability to provide technologically competitive products.
On January 30, 2012, the Board of Directors approved and management initiated a corporate restructuring plan that included a reduction in force by approximately 15%. Restructuring charges included expenses related to the severance for terminated employees and other exit-related costs arising from contractual and other obligations. We substantially completed our restructuring plan during the first fiscal quarter of 2012. As a result of these restructurings, we may have difficulty in attracting and retaining qualified personnel.
Further the changes in senior management and the multiple restructurings and reductions in workforce have had and may continue to have a negative effect on employee morale.
Risks Related to the Tallwood Investment
Tallwood Investors may exercise significant influence over us, including through their ability to elect three members of our Board of Directors.
In August 2009, we sold 24 million shares of our common stock and warrants to purchase up to an additional 7.8 million shares of our common stock (such common stock and warrants collectively referred to as the Securities) to Tallwood III, L.P., a Delaware limited partnership, Tallwood III Partners, L.P., a Delaware limited partnership, Tallwood III Associates, L.P., a Delaware limited partnership, and Tallwood III Annex, L.P., a Delaware limited partnership (collectively referred to as the Tallwood Investors). The funds raised for the sale of the Securities funded a portion of our acquisition of the Broadband Access product line from Conexant Systems, Inc. In addition, one of the Tallwood Investors participated in our public offering of our common stock in fiscal year 2010 and purchased an additional 5.6 million shares of our common stock. The common stock owned by Tallwood Investors represented approximately 42% of the outstanding shares of our common stock (excluding the exercise of warrants) as of December 30, 2012. Assuming the full exercise of the warrants, the common stock owned by the Tallwood Investors would represent 48% of the outstanding shares of our common stock. Until the third anniversary of the closing of the original issuance of the Securities to the Tallwood Investors, the Tallwood Investors have agreed to vote all of their shares in excess of the shares constituting 35% of our outstanding common stock in the same proportion as the votes cast by all our other stockholders. We also entered into a stockholder agreement with the Tallwood Investors, which, among other things, contains certain governance arrangements and various provisions relating to board composition, stock ownership, transfers by the Tallwood Investors and their affiliates, voting and other matters. Subject to certain exceptions, the Tallwood Investors are permitted under the terms of the stockholder agreement to maintain their ownership interest in Ikanos in subsequent equity offerings. As a result, the Tallwood Investors may have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders. The Tallwood Investors may have interests that diverge from, or even conflict with, our interests and those of our other stockholders. In addition, the Certificate of Designation of the Series A Preferred Stock provides that the Tallwood Investors have the right to designate three directors to our Board of Directors while the Tallwood Investors hold at least 35% of our outstanding common stock, and a number of directors to our Board of Directors proportional to the Tallwood Investors’ ownership position in us at such time as the Tallwood Investors hold less than 35% of our outstanding common stock. As a result, the directors elected to our Board of Directors by the Tallwood Investors may exercise significant influence on matters considered by our Board of Directors.
The market price of our common stock may decline as a result of future sales of our common stock by the Tallwood Investors.
We are unable to predict the potential effects of the Tallwood Investors’ ownership of our outstanding common stock on the trading activity in and market price of our common stock. Pursuant to the stockholder agreement, we have granted the Tallwood Investors and their permitted transferees’ registration rights for the resale of the shares of our common stock and shares of our common stock underlying the warrants. Under the terms of the registration rights, we have filed a registration statement that permits the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. Sales by the Tallwood Investors or their permitted transferees of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock.
Risks Related to Our Operations and Technology
We rely on third-party technologies for the development of our products, and our inability to use such technologies in the future or the failure of such technology would harm our ability to remain competitive.
We rely on third parties for technologies that are integrated into some of our products, including the memory cells, input/output cells, hardware interfaces and core processor logic. If we are unable to continue to use or license these technologies on reasonable terms, or if these technologies fail to operate properly, we may not be able to secure alternatives in a timely manner and our ability to remain competitive would be harmed. Further, if we were to seek to obtain such a license and such license were available, we could be required to make significant payments with respect to past and/or future sales of our products, and such payments may adversely affect our financial condition and operating results. If the party determines to pursue claims against us for patent infringement, we might not be able to successfully defend against such claims. In addition, the third party intellectual property could also expose us to liability and, while we have not experienced material warranty costs in any period as a result of third party intellectual property, there can be no assurance that we will not experience such costs in the future.
We are a fabless semiconductor company and failure to secure and maintain sufficient capacity with our service provider and its subcontractors could significantly disrupt shipment of our products, impair our relationships with customers and decrease sales, which would negatively impact our market share and operating results.
We are a fabless semiconductor company and currently use multiple wafer foundries and factory subcontractors, located primarily in Israel, Malaysia, Singapore and Taiwan to manufacture, assemble and test all of our current semiconductor devices. While we have worked with multiple suppliers, generally each product is made by one foundry and one assembly and test subcontractor. Accordingly, we have been and will continue to be greatly dependent on a limited number of suppliers to deliver quality products on time. In past periods of high demand in the semiconductor market, we have experienced delays in meeting our capacity demand and as a result were unable to deliver products to our customers on a timely basis. In addition, we have experienced similar delays due to technical and quality control problems. In 2012, we entered into the Service Agreement with eSilicon to handle our Master Services. We began the transition of our Master Services in the fiscal second quarter of 2012 and completed the majority of the transition by the end of fiscal year 2012. We will be dependent on eSilicon and, in turn, its suppliers to deliver our products on time as noted above.
If we and/or eSilicon were to need to qualify a new facility to meet our capacity, or if a foundry or subcontractor ceased working with our service provider, as has happened to us in the past, or if production is disrupted, we may be unable to meet our customer demand on a timely basis, or at all. We may be required to incur additional costs and may need to successfully qualify an alternative facility in order to not disrupt our business.
In the event we or our service provider seek to use new wafer foundries to manufacture a portion of our semiconductor products, we may not be able to bring the new foundries on-line rapidly enough and may not achieve anticipated cost reductions.
As indicated above, we have used and our service provider will use a limited number of independent wafer foundries to manufacture all of our semiconductor products which could expose us to risks of delay, increased costs and customer dissatisfaction in the event that any of these foundries are unable to meet our semiconductor requirements. Additional wafer foundries may be sought to meet our future requirements but the qualification process typically requires several months or more. By the time a new foundry is qualified, the need for additional capacity may have passed or we may have lost the potential opportunity to a competitor. If qualification cannot be met in a timely manner, we would experience a significant interruption in supply of the affected products which could in turn cause our costs of revenue to increase and our overall revenue to decrease. This would harm our customer relationships and our market share and operating results would suffer as a result.
When demand for manufacturing capacity is high, we may take various actions to try to secure sufficient capacity, which could be costly and negatively impact our operating results.
Although we have purchase order commitments to supply specified levels of products to our OEM customers, neither we nor our service provider have a guaranteed level of production capacity from any of our foundries or subcontractors’ facilities that we depend upon to produce semiconductors. Facility capacity may not be available when we need it or at reasonable prices. We place our orders on the basis of our OEM customers’ purchase orders or our forecast of customer demand, and our service provider or its foundries and subcontractors may not be able to meet our requirements in a timely manner, or at all.
In order to secure sufficient manufacturing facility capacity when demand is high and mitigate the risks described in the foregoing paragraphs, we may enter into various arrangements with our service provider that could be costly and negatively affect our operating results, including minimum order quantities over extended periods, and higher costs to secure necessary lead-times.
We may not be able to make any such arrangements in a timely fashion or at all, and any arrangements may be costly, reduce our financial flexibility, not be on terms favorable to us and may contain financial penalties if we do not use all of our allocated facility capacity. These penalties and obligations may be expensive and could harm our business.
Defects and poor performance in our products could result in loss of customers, decreased revenue, unexpected expenses and loss of market share, and we may face warranty and product liability claims arising from defective products.
We have in the past, and may in the future experience, defects (commonly referred to as “bugs”) in our products which may not always be detected by testing processes. Defects can result from a variety of causes, including but not limited to manufacturing problems or third party intellectual property incorporated into our products. If defects are discovered after our products have shipped, we have experienced, and could continue to experience, warranty and consequential damages claims from our customers. If we are unable to deliver quality products, our reputation would be harmed, which could result in the loss of, future orders and business with our customers. Further, we may experience difficulties in achieving acceptable yields on some of our products, which may result in higher per unit cost, shipment delays, and increased expenses associated with resolving yield problems. If any of these adverse risks are realized and we are not able to offset the lost opportunities, our revenue, margins and operating results would decline.
If our forecasts of our OEM customers’ demand are inaccurate, our financial condition and liquidity would suffer.
We place orders with our suppliers based on the forecasts of our OEM customers’ demand. Our forecasts are based on multiple assumptions, each of which may introduce errors into our estimates. If we do not accurately forecast customer demand, we may forego revenue opportunities, lose market share, damage customer relationships or allocate resources to manufacturing products that we may not be able to sell. As a result, as we experienced in the second and third quarters of fiscal 2010, we could have excess or obsolete inventory, resulting in a decline in the value of our inventory, which would increase our cost of revenue, negatively affect gross margins, and create a drain on our liquidity. Our failure to accurately manage inventory against demand would adversely affect our financial results.
To remain competitive, we need to continue to reduce the cost of our semiconductor chips, which includes migrating to smaller geometrical processes, and our failure to do so may harm our business.
We negotiate pricing with our suppliers from time to time. Negotiations with respect to pricing typically depend on order volumes and, if our order volumes decrease over time, we may experience difficulties negotiating favorable pricing, negatively impacting our ability to compete.
We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometrical processes, which are measured in microns or nanometers. We have in the past, and may in the future, experience some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased product costs and expenses. Additionally, upfront expenses associated with smaller geometry process technologies such as for masks and tooling can be significantly higher than those for the processes that we currently use, and our migration to these newer process technologies can result in significantly higher research and development expenses.
Third-party claims of infringement or other claims against us could adversely affect our ability to market our products, require us to redesign our products or seek licenses from third parties, and harm our business. In addition, any litigation required to defend such claims could result in significant expenses and diversion of our resources.
Semiconductor industry companies and intellectual property holding companies often aggressively protect and pursue their intellectual property rights. From time to time, we receive, and we are likely to continue to receive in the future, notices that claim our products infringe upon other parties’ proprietary rights. We may in the future be engaged in litigation with parties who claim that we have infringed their patents or misappropriated or misused their trade secrets or who may seek to invalidate one or more of our patents, and it is possible that we would not prevail in any future lawsuits. An adverse determination in any of these types of claims could prevent us from manufacturing or selling some of our products, could increase our costs of products and could expose us to significant liability. In addition, a court could issue a preliminary or permanent injunction that would require us to withdraw or recall certain products from the market or redesign certain products offered for sale or that are under development. In addition, we may be liable for damages for past infringement and royalties for future use of the technology and we may be liable for treble damages if infringement is found to have been willful. Even if claims against us are not valid or successfully asserted, these claims could result in significant costs and a diversion of management and personnel resources to defend.
Many companies in the semiconductor business have significant patent portfolios. These companies and other parties may claim that our products infringe their proprietary rights. We may become involved in litigation as a result of allegations that we infringe the intellectual property rights of others. Any party asserting that our products infringe their proprietary rights would force us to defend ourselves, and possibly our customers, against the alleged infringement. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. We also could be forced to do one or more of the following:
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stop selling, incorporating or using our products that use the challenged intellectual property;
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obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or could require us to make significant payments with respect to past or future sales of our products;
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redesign those products that use any allegedly infringing technology, which may be costly and time-consuming; or
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refund amounts received for allegedly infringing technology or products.
Any potential dispute involving our patents or other intellectual property could also include our customers which could trigger our indemnification obligations to one or more of them and result in substantial expense to us.
In any potential dispute or claim involving our patents or other intellectual property, our customers could also become the target of litigation. Because we may indemnify our customers for intellectual property claims made against them for products incorporating our technology, any litigation could trigger technical support and
indemnification obligations in some of our agreements, which could result in substantial expenses. Any indemnity claim could adversely affect our relationships with our OEM customers and result in substantial costs to us.
We face intense competition in the semiconductor industry and the broadband communications markets, which could reduce our market share and negatively affect our revenue.
The semiconductor industry and the broadband communications markets are intensely competitive. In the VDSL or VDSL-like technology, PON and communications processing markets, we currently compete or expect to compete with, among others, Broadcom Corporation, BroadLight, Inc., Cavium Networks, Inc., Freescale Semiconductor, Inc., Lantiq Deutschland GmbH, Marvell Technology Group Ltd., MediaTek Inc., PMC-Sierra, Inc. and Realtek Semiconductor Corp.
Many of our competitors may have stronger manufacturing subcontractor relationships than us and longer operating histories, greater name recognition, larger customer bases, and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources. In addition, many of our competitors have extensive technology libraries that could enable them to incorporate broadband or communications processing technologies into a system on a chip, creating a more attractive product line than ours. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. In addition, current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Existing or new competitors may also develop alternative technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of semiconductor integration or lower cost. We cannot assure you that we will be able to compete successfully against current or new competitors, in which case we may lose market share in our existing markets and our revenue may fail to increase or may decline.
Other data transmission technologies and communications processing technologies may compete effectively with the service provider services addressed by our products, which could adversely affect our revenue and business.
Our revenue currently is dependent upon the increase in demand for service provider services that use broadband technology and integrated residential gateways. Besides xDSL and other DMT-based technologies, service providers can decide to deploy PON or fiber and there would be reduced need for our products. If more service providers decide to use FTTH deployments, it could harm our xDSL business if our products are not needed. Furthermore, residential gateways compete against a variety of different data distribution technologies, including Ethernet routers, set-top boxes provided by cable and satellite providers, wireless (WiFi and WiMax) and emerging power line and multimedia over coax alliance technologies. If any of these competing technologies proves to be more reliable, faster or less expensive than, or has any other advantages over the broadband technologies we provide, the demand for our products may decrease and our business would be harmed.
Rapidly changing standards and regulations could make our products obsolete, which would cause our revenue and operating results to suffer.
We design our products to conform to regulations established by governments and to standards set by industry standards bodies worldwide such as the ATIS, and by the ITU-T. Because our products are designed to conform to current specific industry standards, if competing standards emerge that are preferred by our customers, we would have to make significant expenditures to develop new products. If our customers adopt new or competing industry standards with which our products are not compatible, or the industry groups adopt standards or governments issue regulations with which our products are not compatible, our existing products would become less desirable to our customers, and our revenue and operating results would suffer.
If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenue or increase our cost.
Our success will depend, in part, on our ability to protect our intellectual property. We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. Our pending patent applications may not result in issued patents, and our existing and future patents may not be sufficiently broad to protect our proprietary technologies or may be held invalid or unenforceable in court. While we are not currently aware of misappropriation of our existing technology, policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where we have not applied for patent protections and, even if such protections were available, the laws may not protect our proprietary rights as fully as United States law. The patents we have obtained or licensed, or may obtain or license in the future, may not be adequate to protect our proprietary rights. Our competitors may independently develop or may have already developed technology similar to us, duplicate our products or design around any patents issued to us or our other intellectual property. In addition, we have been, and may be, required to license our patents as a result of our participation in various standards organizations. If competitors appropriate our technology and it is not adequately protected, our competitive position would be harmed, our legal costs would increase and our revenue would be harmed.
Changes in current or future laws or regulations or the imposition of new laws or regulations by federal or state agencies or foreign governments could impede the sale of our products or otherwise harm our business.
The effects of regulation on our customers or the industries in which they operate may materially and adversely impact our business. For example, India’s government is currently considering regulation that may limit or prohibit sales of certain telecommunications products manufactured in China. While the rule-making process is not final, if the rules apply to equipment containing our semiconductor products, such regulation could reduce sales of our products and have a negative effect on our operating results.
In addition, the Ministry of Internal Affairs and Communications in Japan, the Ministry of Communications and Information in Korea, various national regulatory agencies in Europe, the European Commission in the European Union, the U.S. Federal Communications Commission have broad jurisdiction over our target markets. Although the laws and regulations of these and other federal or state agencies may not be directly applicable to our products, they do apply to much of the equipment into which our products are incorporated. Governmental regulatory agencies worldwide may affect the ability of telephone companies to offer certain services to their customers or other aspects of their business, which may in turn impede sales of our products.
In addition to the laws and regulations specific to telecommunications equipment, other laws and regulations affect our business. For instance, changes in tax, employment and import/export laws and regulations, and their enforcement commonly occur in the various countries in which we operate. If changes in those laws and regulations, or in the enforcement of those laws and regulations, occur in a manner that we did not anticipate, those changes could cause us to have increased operating costs or to pay higher taxes, and thus have a negative effect on our operating results.
Failure to maintain adequate internal controls as required by Section 404 of the Sarbanes-Oxley Act (SOX) could harm our operating results, our ability to operate our business and our investors’ view of Ikanos.
If we do not maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of SOX. Effective internal controls particularly those related to revenue recognition, valuation of inventory and warranty provisions, are necessary for us to produce reliable financial reports and are important in
helping to prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly.
Our international operations subject us to risks not faced by companies without international operations.
We currently obtain substantially all of our manufacturing, assembly and testing services from suppliers and subcontractors located outside the United States, and have a significant portion of our research and development team located in India. In addition, 99% and 98% of our revenue for the fiscal year ended December 30, 2012 and January 1, 2012, respectively, were derived from sales to customers outside the United States. We have expanded our international business activities and may open other design and operational centers abroad. International operations are subject to many other inherent risks, including but not limited to:
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political, social and economic instability, including war and terrorist acts;
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exposure to different legal standards, particularly with respect to intellectual property;
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trade and travel restrictions;
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the imposition of governmental controls and restrictions or unexpected changes in regulatory requirements;
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burdens of complying with a variety of foreign laws;
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import and export license requirements and restrictions of the United States and each other country in which we operate;
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foreign technical standards;
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changes in tariffs;
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difficulties in staffing and managing international operations;
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foreign currency exposure and fluctuations in currency exchange rates;
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difficulties in collecting receivables from foreign entities or delayed revenue recognition; and
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potentially adverse tax consequences.
Because we are currently substantially dependent on our foreign sales, research and development and operations, any of the factors described above could significantly harm our ability to produce quality products in a timely and cost effective manner, and increase or maintain our foreign sales.
Fluctuations in exchange rates between and among the U.S. dollar and other currencies in which we do business, may adversely affect our operating results.
We maintain extensive operations internationally. We have offices or facilities in China, France, Germany, India, Japan, Korea and Taiwan. We incur a portion of our expenses in currencies other than the U.S. dollar, including predominantly the Indian Rupee and the Chinese Yuan. A large portion of our cash is held by our international affiliates both in U.S. dollar and local currency denominations. As a result, we may experience foreign exchange gains or losses due to the volatility of these currencies compared to the U.S. dollar. Because we report our results in U.S. dollars, the difference in exchange rates in one period compared to another directly impacts period to period comparisons of our operating results. In addition, our sales have been historically denominated in U.S. dollars. Currency exchange rates have been especially volatile in the recent past and these currency fluctuations may make it difficult for us to predict and/or provide guidance on our results. Currently, we have not implemented any strategies to mitigate risks related to the impact of fluctuations in currency exchange rates and we cannot predict future currency exchange rate changes.
Several of the facilities that manufacture our products, most of our OEM customers and the service providers they serve, and our California facility are located in regions that are subject to earthquakes and other natural disasters.
Several of our subcontractors’ facilities that manufacture, assemble and test our products and five of our wafer foundries are located in Malaysia, Singapore and Taiwan. Several large customers are located in Japan and Korea. The Asia-Pacific region has experienced significant earthquakes and other natural disasters in the past, including a recent major earthquake and tsunami in Japan, and could be subject to additional seismic activities. Any earthquake or other natural disaster in these areas could significantly disrupt these manufacturing facilities’ production capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage of wafers, in particular, and possibly in higher wafer prices, and our products in general. Our headquarters in California are also located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, it could significantly disrupt our operations.
Changes in our tax rates could affect our future results.
Our future effective tax rates could be favorably or unfavorably affected by the absolute amount and future geographic distribution of our pre-tax income, our ability to successfully shift our operating activities to foreign operations and the amount and timing of inter-company payments from our foreign operations subject to U.S. income taxes related to the transfer of certain rights and functions.
Risks Related to Our Common Stock
The market price of our common stock has been and may continue to be volatile, and holders of our common stock may not be able to resell shares at or above the price paid, or at all.
The market price of our common stock has fluctuated substantially since our initial public offering and is likely to continue to be highly volatile and subject to wide fluctuations. Fluctuations have occurred and may continue to occur in response to various factors, many of which we cannot control, including:
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quarter-to-quarter variations in our operating results;
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failure to comply with NASDAQ minimum bid price, as indicated above;
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announcements of changes in our senior management;
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the gain or loss of one or more significant customers or suppliers;
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announcements of technological innovations or new products by our competitors, customers or us;
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the gain or loss of market share in any of our markets;
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general economic and political conditions and specific conditions in the semiconductor industry and broadband technology markets, including seasonality in sales of consumer products into which our products are incorporated;
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continuing international conflicts and acts of terrorism;
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changes in earnings estimates or investment recommendations by analysts;
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changes in investor perceptions;
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changes in product mix; or
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changes in expectations relating to our products, plans and strategic position or those of our competitors or customers.
The closing sale price of our common stock on the NASDAQ Global Market for the period of January 1, 2007 to December 30, 2012 ranged from a low of $0.67 to a high of $9.34. In addition, the market prices of securities of semiconductor and other technology companies have been volatile, particularly for companies like us, with low trading volumes. This volatility has significantly affected the market prices of securities of many
technology companies for reasons frequently unrelated to the operating performance of the specific companies. Accordingly, holders of our common stock may not be able to resell their shares at or above the price paid.
The pending class action litigation could cause us to incur substantial costs and divert our management’s attention and resources.
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York, or the District Court, against us, certain then current and former directors and officers, as well as the lead underwriters for our initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint sought unspecified damages for certain alleged misrepresentations and omissions made by us in connection with both our initial public offering in September 2005 and our follow-on offering in March 2006. On June 25, 2007, we filed motions to dismiss the amended complaint, and on March 10, 2008, the District Court dismissed the case with prejudice. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration. On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit, or the Court of Appeals. On September 17, 2009, the Court of Appeals affirmed the District Court’s dismissal of the amended complaint, but vacated its judgment on the motion for reconsideration and remanded the case to the District Court for further proceedings. On June 11, 2010, plaintiffs filed a motion for leave to amend the complaint in the District Court, and on November 23, 2010, the District Court denied the motion. On January 6, 2011, plaintiffs filed a notice of appeal with the Court of Appeals. On May 25, 2012, the Court of Appeals granted plaintiffs’ appeal, finding that their proposed amended complaint succeeded in stating a claim. The case was remanded to the District Court for further proceedings, and on June 19, 2012, plaintiffs filed their Third Amended Class Action Complaint. The parties held a mediation on December 6, 2012 and agreed to a tentative agreement to settle the case, subject to confirmatory discovery and the Court’s approval. However, we cannot predict the final outcome of the litigation based on a tentative agreement, and an adverse result could have a material effect on our financial statements.
Additionally, from time to time, we are a party to various legal proceedings and claims arising from the normal course of business activities. We currently believe that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on our financial position, results of operations and statement of cash flows. If an unfavorable ruling were to occur in the legal proceeding described above, there exists the possibility of a material adverse effect on our financial position, results of operations and cash flows.
If the securities analyst who currently publishes reports on Ikanos does not continue to publish research or reports about our business, or if he issues an adverse opinion regarding our common stock, the market price of our common stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. We have lost all the securities research coverage with the exception of one analyst. If this analyst issues an adverse opinion regarding our common stock, the stock price would likely decline. If the analyst ceases coverage of us or fails to regularly publish reports on us, we could lose further visibility to the financial markets, which in turn could cause the market price of our common stock or trading volume to decline.
Takeover attempts that stockholders may consider favorable may be delayed or discouraged due to our corporate charter and bylaws which contain anti-takeover provisions, Delaware law, or the Tallwood Investors.
Provisions in our certificate of incorporation may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:
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the right of our Board of Directors to elect a director to fill a vacancy created by the expansion of our Board of Directors;
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the establishment of a classified Board of Directors requiring that not all members of the board be elected at one time;
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the prohibition of cumulative voting in the election of directors which would otherwise allow less than a majority of stockholders to elect director candidates;
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the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;
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the ability of our Board of Directors to alter our bylaws without obtaining stockholder approval;
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the ability of our Board of Directors to issue, without stockholder approval, up to 1,000,000 shares of preferred stock with terms set by the Board of Directors, which rights could be senior to those of common stock;
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the required approval of holders of at least two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or amend or repeal the provisions of our certificate of incorporation regarding the election and removal of directors and the ability of stockholders to take action;
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the required approval of holders of a majority of the shares entitled to vote at an election of directors to remove directors for cause; and
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the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent.
In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our certificate of incorporation, bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would without these provisions.
Due to the significant number of shares of our common stock that the Tallwood Investors hold as discussed above, the Tallwood Investors may have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders, including a takeover attempt, and may have interests that diverge from, or even conflict with, our interests and those of our other stockholders.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2. PROPERTIES
Facilities
Our headquarters is located in Fremont, California, where we lease approximately 73,500 square feet of space under a lease agreement that expires 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 throughout the world including a 57,400 square foot research and development facility in Red Bank, New Jersey whose lease expires on March 2018. In addition, we have a 36,100 square foot research and development facility in Bangalore, India whose lease expires in October 2014.
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
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York, or the District Court, against us, certain then current and former directors and officers, as well as the lead underwriters for our initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint sought unspecified damages for certain alleged misrepresentations and omissions made by us in connection with both our initial public offering in September 2005 and our follow-on offering in March 2006. On June 25, 2007, we filed motions to dismiss the amended complaint, and on March 10, 2008, the District Court dismissed the case with prejudice. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration. On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit, or the Court of Appeals. On September 17, 2009, the Court of Appeals affirmed the District Court’s dismissal of the amended complaint, but vacated its judgment on the motion for reconsideration and remanded the case to the District Court for further proceedings. On June 11, 2010, plaintiffs filed a motion for leave to amend the complaint in the District Court, and on November 23, 2010, the District Court denied the motion. On January 6, 2011, plaintiffs filed a notice of appeal with the Court of Appeals. On May 25, 2012, the Court of Appeals granted plaintiffs’ appeal, finding that their proposed amended complaint succeeded in stating a claim. The case was remanded to the District Court for further proceedings, and on June 19, 2012, plaintiffs filed their Third Amended Class Action Complaint. The parties held a mediation on December 6, 2012 and agreed to a tentative agreement to settle the case, subject to confirmatory discovery and the Court’s approval. However, we cannot predict the final outcome of the litigation based on a tentative agreement, and an adverse result could have a material effect on our financial statements.
Additionally, from time to time, we are a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, other than as set forth above, we do not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on our results of operations, cash flows or financial position.
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 periods indicated.
As of February 12, there were approximately 337 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 30, 2012 we issued 872,315 shares of unregistered common stock in connection with an asset purchase and an acquisition during 2009 through 2010.
We claimed exemption from registration under the Securities Act for the issuance of securities in the transaction described above by virtue of Section 4(2) and/or Regulation D promulgated thereunder as a transaction not involving any public offering. The purchaser of the unregistered securities for which we relied on Regulation D and/or Section 4(2) was an accredited investor as defined under the Securities Act. We claimed such exemption on the basis that (a) the purchaser represented that he intended to acquire the securities for investment only and not with a view to the distribution thereof and that he either received adequate information about us or had access, through employment or other relationships, to such information and (b) appropriate legends were affixed to the stock certificates issued in such transactions. The recipient either received adequate information about us or had adequate access, through their relationships with us, to information about us.
We sold to the Tallwood Investors for $42.0 million (i) 24 million shares of our common stock, par value $0.001 per share (the Common Stock) and (ii) warrants to purchase up to 7.8 million shares of Common Stock (the Warrants) at $1.75 per shares. 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 is $1.75. In addition, we 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 election of a minority of the members of the Board of Directors but does not share in the economics of our company. The Common Stock, Warrants and the Voting Share collectively are referred to as the Tallwood Investment. The transaction was undertaken without an underwriter. The securities were registered on Form S-3 during January of 2010. We used the proceeds from the Tallwood Investment to fund the purchase of the BBA product line from Conexant.
Performance Graph
The performance graph below is required by the SEC and shall not be deemed to be incorporated by reference by any general statement incorporating by reference this annual report on Form 10-K into any filing under the Securities Act or the Securities Exchange Act except to the extent we specifically incorporate this information by reference and shall not otherwise be deemed soliciting material or filed under such acts.
The following graph shows a comparison of cumulative total stockholder return, calculated as of the end of each six month period on a dividend-reinvested basis, for Ikanos Communications, the NASDAQ Stock Market (U.S.) Index and the Philadelphia Semiconductor Index. The graph assumes that $100 was invested in Ikanos Communications common stock, the NASDAQ Stock Market (U.S.) Index and the Philadelphia Semiconductor Index for five years from December 29, 2006 through December 30, 2012. Note that historic stock price performance is not necessarily indicative of future stock price performance.
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 2012
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
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) Net losses for the fiscal years 2008, and 2009 include acquired company results of operations beginning on the date of acquisition.
(3) 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 are a leading provider of advanced broadband semiconductor and integrated firmware products for the digital home. Our broadband DSL, communications processors and other offerings power access infrastructure and customer premises equipment (CPE) for many of the world’s leading network equipment manufacturers and telecommunications service providers. Our products are at the core of digital subscriber line access multiplexers (DSLAMs), optical network terminals (ONTs), concentrators, modems, voice over Internet Protocol (VoIP) terminal adapters, integrated access devices (IADs) and residential gateways (RGs). Our products have been deployed by service providers in Asia, Europe and North America.
We believe that we can offer advanced products by continuing to push existing limits in silicon, systems and firmware. We have developed programmable, scalable chip architectures, which form the foundation for deploying and delivering multi-play services. Expertise in the creation and integration of digital signal processor (DSP) algorithms with advanced digital, analog and mixed signal semiconductors enables us to offer high performance, high-density and low-power asymmetric DSL (ADSL) and very-high-bit rate DSL (VDSL) products. In addition, flexible communications processor architectures with wirespeed packet processing capabilities enable high-performance end-user devices for distributing advanced services in the home. These products thus support service providers’ multi-play deployment plans to the digital home while keeping their capital and operating expenditures low.
We outsource all of our semiconductor fabrication, assembly and test functions, which allows us to focus on the design, development, sales and marketing of our products and reduces the level of our capital investment. Our direct customers consist primarily of original design manufacturers (ODMs), contract manufacturers (CMs), network equipment manufacturers (NEMs) and original equipment manufacturers (OEMs), who in turn sell our semiconductors as part of their product solutions to the service provider market. In fiscal year 2012, we expanded our outsourced model by transitioning a majority of our day-to-day supply chain management, production test engineering and production quality engineering functions (Master Services) to eSilicon Corporation (eSilicon) under a master services and supply agreement (Service Agreement) . Pursuant to the Service Agreement, we place orders for our finished goods products with eSilicon, who, in turn, contracts with wafer foundries and the assembly and test subcontractors and manages these operational functions for us on a day-to-day level. During the first half of 2012, we began to transition these Master Services to eSilicon and to establish clear lines of communications among us, eSilicon, the wafer foundries and the assembly and test subcontractors. As of the end of fiscal year 2012, we have substantially completed the transition of Master Services to eSilicon.
We incurred a net loss of $17.6 million for the year ended December 30, 2012 and had an accumulated deficit of $295.7 million as of December 30, 2012. To achieve consistent profitability, we will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for our business. While we believe that we have the cash necessary to fund our operations for the next twelve months, we may also seek additional financing as deemed appropriate to support future company needs and investments. Future capital requirements will depend upon many factors including our rate of revenue growth, our ability to develop future revenue streams, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of its products.
We filed a shelf registration statement with the SEC on October 25, 2010 (declared effective on November 1, 2010) under which we might offer and sell up to $30.0 million of common stock and warrants. On November 11, 2010 and December 7, 2010 Ikanos sold a total of 12.8 million shares of stock in an underwritten offering for $13.5 million. After deducting underwriting fees, legal, accounting and other costs, we realized proceeds of $12.5 million. As of January 1, 2012, we have $16.5 million available for future issue under that registration statement.
In January 2011, we entered into a Loan and Security Agreement (Loan Agreement) With Silicon Valley Bank (SVB) under which SVB makes advances under a revolving line of credit (Revolving Line) of up to $15.0 million, as described below. During fiscal year 2012, we drew down on our Revolving Line for working capital purposes. As of December 30, 2012, $5.0 million was outstanding on our Revolving Line. Interest on advances against the line is equal to 4.5% as of December 30, 2012 and is payable monthly. We may prepay the advances under the Revolving Line in whole or in part at any time without premium or penalty. The Loan Agreement’s maturity date is April 14, 2013. On February 19, 2013, we amended the Revolving Line and extended the term until April 14, 2015.
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. Over the last three years, our revenue was $191.7 million in 2010, $136.6 million in 2011and $125.9 million in 2012.
Quarterly revenue fluctuations are characteristic of our industry and affect our business, especially due to the concentration of our revenue among a few customers and a few products. These quarterly fluctuations can result from a mismatch of supply and demand. Specifically, service providers purchase equipment based on planned deployment. However, service providers may deploy equipment more slowly than initially planned, while OEMs continue for a time to manufacture equipment at rates higher than the rate at which equipment is deployed. As a result, periodically and usually without significant notice, service providers will reduce orders with OEMs for new equipment, and OEMs, in turn, will reduce orders for our products, which will adversely impact the quarterly demand for our products, even when deployment rates may be increasing.
Our industry is continually transitioning to new technologies and products. Large industry transitions are unpredictable due to factors including, but not limited to, extended product trials, qualifications, and the transformation of existing platforms to new platforms. Furthermore, the environment in which we market and sell our products has become increasingly competitive and cost sensitive. Our competitors are able to provide higher degrees of integration due to their broader range of products.
Our future revenue growth depends on the successful qualification and adoption of our new product platforms at service providers and network equipment manufacturers. In addition to these qualifications, our operations may be adversely affected by our customers’ transition strategies from existing systems that use our product to systems that may not use our products. As is customary in our industry, we may elect to end-of-life certain products and, as a result, certain customers may enter into last time buy arrangements which could further impact revenues. Additionally, certain of our customers entered into last time buys of some products during 2011 and in 2012. In some cases products may become mature or uncompetitive causing customers to transition to solutions from other manufacturers or implement multi-sourcing procurement strategies in which we participate in a diminished capacity.
It is inherently difficult to predict if and when platforms will pass qualification, when service providers will begin to deploy the equipment and at what rate, because we do not control the qualification criteria or process, and the systems manufacturers and service providers do not always share all of the information available to them regarding qualification and deployment decisions. Additionally, we have limited visibility into the buying patterns of our OEMs, who, in turn, are affected by changes in the buying and roll out patterns of the service provider market. As a result of manufacturing inventory to a forecast, we may have excess inventory if the forecast differs from actual results. Our 2010 forecast was reduced significantly due to our BBA products
becoming more mature and less competitive at the desired price point in the marketplace and also due to forecast revenue for a potential customer that did not materialize. As a result, we determined that we had $16.8 million of excess inventory for certain products, and consequently wrote down the inventory during 2010.
We have several new products in development and believe our team of engineers, DSL products, technology, patents and other intellectual property will allow us to create products that could increase our market share and enable us to implement our digital home initiatives and next generation VDSL development. However, many of these new products may not offset the declines of revenue recognized on our mature products during the near term. Failure to generate new revenues from these new products, or delays in the timing of the release of these products, could have a material adverse effect on our revenues, results of operations, cash flows and financial position.
In response to declining revenue during 2010 and 2011 and continuing into 2012, we initiated a worldwide restructuring plan on January 30, 2012 to manage the Company’s operating expense to its projected revenue forecast. There was a headcount reduction of approximately16% of our employment level. The restructuring plan resulted in expenditures of $1.1 million which were recognized in and paid during 2012. Although the restructuring plan resulted in approximately $5.0 million in annual operating expense reductions, these cost savings were offset by new product tape-out expenses that were incurred throughout 2012.
On April 27, 2010, Michael Gulett resigned as our Chief Executive Officer (CEO) and President and as a member of our Board of Directors. Diosdado P. Banatao, the chairman of our Board of Directors, was appointed executive chairman and assumed the role of Interim President and Chief Executive Officer while we began our search for a new Chief Executive Officer and President. On June 14, 2010, Cory Sindelar resigned as Chief Financial Officer. Dennis Bencala was appointed Chief Financial Officer and Vice President of Finance on June 14, 2010. On June 30, 2010, Paul Hansen resigned from our Board of Directors. James Smaha, a current director, replaced Mr. Hansen on the Audit Committee of our Board of Directors and Fred Lax, also a current director, was appointed chairman of the Audit Committee. On August 3, 2010, Mr. Banatao resigned as our Interim President and Chief Executive Officer. Mr. Banatao continued to serve as chairman of our Board of Directors. On August 3, 2010, our Board of Directors appointed John Quigley, our Senior Vice President, Global Engineering, as our Chief Executive Officer and President effective August 3, 2010 and also elected him to the Board of Directors.
On January 7, 2011, R. Douglas Norby was appointed to our Board of Directors and Nominating and Governance Committee and also Chairman of our Audit Committee. On December 11, 2012, Mr. Norby resigned from the Audit Committee and was replaced as chairman of the Audit Committee by Frederick Lax, a current member of the Audit Committee. Mr. Norby continues as a member of the Board of Directors and a member of the Nominating and Corporate Governance Committee.
On June 14, 2011, John H. Quigley resigned as CEO and President and as a member of our Board of Directors, effective immediately. Diosdado P. Banatao, our executive chairman, assumed the role of Interim President and CEO while we searched for a new CEO and president. On June 11, 2012, Mr. Diosdado Banatao resigned as our interim President and Chief Executive Officer. Mr. Banatao will continue to serve as chairman of our Board of Directors. On June 11, 2012, our Board of Directors appointed Omid Tahernia as our President and Chief Executive Officer, effective on that date, and also elected him to our Board of Directors.
Critical Accounting Policies and Estimates
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 the 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
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, 4) collection is reasonably assured. Since our semiconductor products are reliant upon firmware, we defer revenue recognition until the essential firmware is delivered and upon shipment 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 when the distributor has sold through to the end customer.
As noted above, in multi-element arrangements that include combination of semiconductor products with firmware that is essential to the hardware products functionality and undelivered firmware elements, 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.
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 market 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, 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 for warranty 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.
Acquisitions
We allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as purchased in-process research and development (IPR&D) based on the estimated fair values. We use various models to determine the fair values of the assets acquired and liabilities assumed. These models include the discounted cash flow (DCF), the royalty savings method and the cost savings approach. The valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets.
Critical estimates in valuing certain of the intangible assets include, but are not limited to, future expected cash flows from customer contracts, customer lists, distribution agreements and acquired developed technologies and patents; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position as well as assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio and discount rates. We derive our discount rates from our internal rate of return based on our internal forecasts and we may adjust the discount rate giving consideration to specific risk factors of each asset. Management’s estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.
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 asset except for certain foreign tax jurisdictions. Based on our historical losses and other available objective evidence, we determined it is more likely than not that the deferred tax asset 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 asset 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 of being realized upon ultimate settlement.
Prior to the fourth quarter of 2011, the Company did not provide for Federal income tax and withholding taxes for unremitted foreign earnings of its foreign affiliates 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 the unremitted earnings of foreign subsidiaries because the Company has 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 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 based primarily 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, as empirical evidence regarding these input estimates is able to provide more directionally predictive results, we may change or refine our approach of deriving these input estimates. 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
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 when the distributor has sold through to the end customer. As is typical in our industry, the selling prices of our products generally decline over time. Therefore, our ability to increase revenue is dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in greater quantities. The continuing effects of the worldwide recession have adversely affected the businesses of service providers around the world, causing them to re-evaluate how they employ capital. Consequently, the rate at which broadband infrastructure is upgraded may slow or new broadband programs could be delayed.
Beginning in the second half of 2010, certain products neared end-of-life more rapidly than previously anticipated. Additionally, we began to move away from products with low margins. However, we were not able
to offset the declines with new product introductions. The effect of these trends resulted in lower quarterly revenue beginning in the third and fourth quarters of 2010 and continuing into 2011 and 2012. We expect this trend to continue into the first quarter of 2013 as we experience the effect of other end of life products.
Total revenue for 2012 declined by $10.7 million, or 8%, to $125.9 million in 2012 from $136.6 million in 2011. Our five largest customers account for approximately 60% of our revenue. Revenue from Asia as a percent of total revenue increased from 62% to 68% while revenue in Europe declined from 36% to 29%. Revenue from the Americas increased from 2% to 3% of total revenue. There continues to be a broad distribution of revenue across our product lines. During 2012 we began selling our next generation CPE product chipsets (Fusiv® Vx185, Vx183, Vx175 and Vx173). Even with the introduction of these other products, we continued to be adversely affected by the aging of our products as well as changes to the entire broadband industry. Revenue in the first quarter of 2012 declined from $35.4 million in the fourth quarter of 2011 to $30.8 million in the first quarter of 2012. Revenue was relatively flat during the second, third and fourth quarters improving to $32.1 million and then declining marginally to $31.4 million and rebounding slightly to $31.8 million.
There is a one to two quarter push out affecting the 2013 ramp of certain end markets and carrier product launches with respect to our OEM and telecommunication partners. As a result, we expect our fiscal first quarter 2013 revenue to be lower than our fiscal fourth quarter 2012 revenue of $31.8 million.
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 customers as we expect more service providers world-wide to begin deployments of our broadband solutions. The following direct customers accounted for more than 10% of our revenue for the years indicated. Sales made to OEMs are based on information that we receive at the time of ordering.
* Less than 10%
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 them. Geographic distribution by country remained relatively stable. Comparing 2012 to 2011 by geography, revenue improvements in Taiwan and Hong Kong were offset by declines in revenue from Japan and the Netherlands.
Comparing 2011 to 2010 by geography, while China and Hong Kong revenue declined as a percent of total revenue, Japan and Taiwan increased their share of total revenue. Although we expect revenue to China carriers to decline as those carriers switch to passive optical network (PON) technology, we are working with Chinese carriers to implement our new generation products.
Revenue by Product Family as a Percentage of Total Revenue
We divide our products into the following markets: Broadband DSL, Communications Processors and Other. Broadband DSL consists of our central office products, DSL modem-only customer premise equipment products and the DSL value of our integrated devices. Communications Processors includes our stand alone processors and the processor-only value of our integrated devices. Other includes products that do not fall into the other two product families. Although the Broadband DSL product family remained relatively stable as a percent of total revenue, the dollar revenue decline was across all products, especially in the ADSL and VDSL CPE products. Our Communications Processor product family showed strong growth as a percent of revenue primarily due to sales of our VX communications processors in Europe. The Other category relates to miscellaneous technology that we acquired from our BBA acquisition including WiFi and Ethernet among other products.
Cost and Operating Expenses
nm-not meaningful
Operating Expenses as a Percent of Total Revenue:
Cost of revenue. Our cost of revenue consists primarily of the cost of silicon wafers purchased from third-party foundries and third-party costs associated with assembling, testing and shipping of our semiconductors. Because we do not have formal, long-term pricing agreements with our outsourcing partners, our wafer costs and
services are subject to price fluctuations based on the cyclical demand for semiconductors among other factors. In addition, after we purchase wafers from foundries, we also incur yield loss related to manufacturing these wafers into usable die. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested. If our manufacturing yield decreases, our cost per unit increases. This could have a significant adverse effect on our cost of revenue. Cost of revenue also includes accruals for actual and estimated warranty obligations and write-downs of excess and obsolete inventories, payroll and related personnel costs, certain variable cost components such as gold adder, licensed third-party intellectual property, depreciation of equipment and amortization of acquisition-related intangibles.
In 2012, we entered into with the Service Agreement with eSilicon under which eSilicon handles our Master Services. We started the transition during the fiscal second quarter of 2012 and have effectively completed the transition as of December 30, 2012. We expect the Service Agreement will result in decrease in our cost of revenue.
Gross margin decreased by 3% from 52% in 2011 to 49% in 2012. The reduction in margin was primarily due to the reduced sales of inventory that had been previously written off in 2010. In 2012, we sold $0.4 million of inventory previously written off versus $4.1 million in 2011. Margins were also adversely affected by a charge of $1.5 million related to a patent license agreement covering the current year and certain prior periods. These items were marginally offset by a $0.4 million reduction in the amortization of acquired intangible assets. In addition, there continues to be significant pressure on margins due to our aging product lines and lower margins related to the ramping of our new Fusiv® product chipsets discussed above.
Gross margin increased by 18% from 34% in 2010 to 52% in 2011. This increase was primarily a result of higher costs incurred during 2010 which included a $16.8 million writedown of inventory and a $1.5 million amortization of the fair market of inventory acquired in 2009 BBA product line acquisition. Adding to the higher margin were lower costs incurred in 2012 which benefited from $4.1 million in sales of previously written off inventory and lower amortization of intangibles associated with the writeoff of intangibles during 2010.
Research and development expenses. All 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.
During 2012, R&D expenses were $57.5 million, an increase of $1.7 million, or 3%, from $55.8 million in 2011. The increase in R&D expenses is primarily related to higher tape-out costs in 2012 of $2.9 million related to product development and other backend costs of $1.7 million related to other materials, supplies and services. Consulting costs increased by $1.0 million in 2012 compared to 2011 as we increased our product development spending. In addition, during 2011 we received a credit of $0.9 million related to qualified R&D expenditures made by a foreign subsidiary. We did not receive a similar credit in 2012. These cost increases were offset by a reduction in personnel costs of $5.1 million, in part, the result of our February 2012 restructuring.
During 2011, R&D expenses were $55.8 million, a decrease of $5.0 million, or 8%, from $60.8 million in 2010. The decrease in costs is primarily related to lower personnel costs of $5.0 million resulting from the decline in and the location mix of R&D personnel. Supplies, laboratory materials and services decreased by a combined total of $2.1 million while software license fees dropped by $1.0 million. These reductions were offset by higher samples costs of $0.8 million, higher consulting costs of $1.0 million as well as higher stock compensation costs of $0.6 million.
Our R&D personnel are located primarily in the United States and India. As of December 30, 2012, we had 205 engineers engaged in R&D of whom 65 were located in India, 137 were located in the United States and 3 were located in China. This compares to 247 at the end of 2011 and 272 at the end of 2010.
Selling, general and administrative expenses. 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 deprecation. For 2012, SG&A expenses were $19.1 million, a decrease of $3.2 million, or 14%, from $22.3 million in 2011. The decrease in SG&A expense is attributable to lower personnel costs of $2.9 million, attributable to lower personnel levels following the first quarter restructuring; lower related travel and entertainment costs of $0.4 million and lower building and utility costs. Partially offsetting these cost reductions were higher consulting costs of $0.5 million and higher depreciation of $1.3 million due to the write off of certain software assets.
For 2011, SG&A expenses were $22.3 million, a decrease of $4.9 million, or 18%, from $27.2 million in 2010. The decrease in SG&A expense is attributable to lower personnel costs of $2.0 million, the result of lower headcount; lower severance costs of $0.7 million; lower amortization of intangibles of $2.0 million, the result of write-offs taken in 2010; lower deferred stock-based compensation costs of $0.6 million and lower bad debt expense of $0.4 million. These reductions were only partially offset by other costs.
As of December 30, 2012 SG&A headcount was 57, which compares to 85 at the end of 2011 and 100 at the end of 2010.
Asset impairments. There have been no asset impairments during fiscal 2012 and 2011.
During 2010 and prior years, we tested goodwill for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the our single reporting unit below its carrying value. As a result of our financial guidance for the third quarter 2010 period and the announced a Company-wide restructuring to better align our overhead structure with lower expected revenues and subsequently experienced a sustained decline during the quarter ended October 3, 2010 in market capitalization, we completed an impairment analysis of our goodwill as of October 3, 2010, the end of our third quarter. As a result of this analysis, we recorded impairment charges totaling $21.4 million of which $8.6 million related to goodwill and $12.8 million related to intangibles. In order to complete the 2010 impairment, we performed the first step of the two-step impairment test and compared the fair value of the Company as a single reporting unit to its carrying value. Consistent with our approach in our annual impairment testing, in assessing the fair value of the reporting unit, we considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted stock price on the NASDAQ, the number of shares outstanding of our common stock and an estimated control premium. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. The income approach is dependent on a number of significant management assumptions including estimates of revenue and operating expenses, product penetration, growth and discount rates. Due to current market conditions and the number of significant assumptions required, we used the market approach. The market approach was lower, but both valuation approaches determined that the fair value was less than the carrying value of the net assets and, therefore, we performed step two of the impairment test.
In step two of the impairment test, we determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. We allocated the fair value of the reporting unit to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the mainline reporting unit was the price paid to acquire the reporting unit. We determined the fair value of the single reporting unit using discounted cash flows. The weighted average cost of capital used in the impairment was 25.4% with perpetual growth rate of 3%. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. Our step two analysis resulted in no implied fair value of goodwill, and therefore, we recognized an impairment charge of $8.6 million, representing a write off of the entire amount of our previously recorded goodwill.
In addition, as part of and in conjunction with the impairment test, we determined that the carrying values of certain intangible assets were less than their fair values. Accordingly, we recorded a non-cash intangible asset impairment charge of $12.8 million as of October 3, 2010. The fair value calculation that lead to the impairment of the existing technology and customer relationship intangibles of $10.3 million was determined using a discounted cash flow method. The weighted average cost of capital used in the impairment was 25.4% with no perpetual growth rate. We also impaired the remaining $2.5 million of IPR&D related to the gateway line of business under the Conexant BBA product line that was acquired in August 2009, since it was determined to have no alternative use and was therefore abandoned.
Restructuring charges. In an effort to manage our operating expense to our projected revenue forecast, on January 30, 2012 the Board of Directors approved and management initiated a corporate restructuring plan that included a reduction in force of approximately16%. Employees were notified on February 1 and 2, 2012 of their planned termination. We incurred a total net pre-tax restructuring charge of $1.1 million in 2012. This charge included expenses related to the severance for terminated employees and other exit-related costs arising from contractual and other obligations. The net restructuring charges were cash expenditures.
During 2011, we recognized a benefit of $0.1 million associated with our reversal of certain restructuring expense accruals that did not occur. As of January 1, 2012 our remaining restructuring liability consists of $0.2 million for a software tool license. We made payments of $0.2 million under the software tool license during 2012.
During 2010, we implemented a restructuring plan to better align operating costs and headcount to match the revised forecasted revenue that was lower than we had previously expected subsequent to the integration of the BBA product line. Our initial forecasts anticipated revenues from products that would offset reduced demand for pre-BBA acquisition products, but those new products revenues did not occur when initially expected. Subsequently, during the third quarter of 2010, we implemented an additional restructuring plan to decrease personnel costs due to the decrease in forecasted revenue from the previously acquired BBA product lines and the continued delays in the final development of our next generation technologies. In addition, we closed three overseas offices. Total restructuring costs for 2010 amounted to $5.8 million of which $4.7 million related to severance costs, $0.4 million to facilities and $0.7 million to software tools.
Gain on Sale of Marketable Securities
There was no gain on the sale of marketable securities in fiscal 2012.
During 2010 we had auction rate securities with a purchase face value of $5.0 million. The carrying value of the securities was $2.0 million at the end of 2010 and was comprised of a cost basis of $0.7 million and $1.3 million unrealized gain. In early 2011 we sold these securities for $2.0 million and recognized the gain of $1.3 million.
Interest Income and Other, Net
Interest income and other, net consists primarily of interest income earned on our cash, cash equivalents and short-term investments, and interest expense, especially from loans under our $15.0 million loan agreement with Silicon Valley Bank. It also includes other non-operating income and expense items such as gains and losses on foreign exchange and the sales of fixed assets.
Interest income and other, net was an expense of $0.1 million in 2012 compared to an expense of $0.4 million in 2011 and income of $0.1 million in 2010. The $0.1 million expense in 2012 resulted predominantly from foreign exchange losses of $0.3 million recognized on the Indian rupee and Euro offset by interest income of $0.1 million on our certificates of deposit . The $0.4 million net expense in 2011 reflects $0.5 million of foreign exchange losses predominantly in India and France offset slightly by interest and other income. Other income of $0.1 million in 2010 reflected interest and other income of $0.3 million offset by foreign exchange losses of $0.2 million.
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 $0.1 million as of December 30, 2012 compared to $1.1 million as of January 1, 2012. Our income tax provision primarily represents foreign taxes on certain of our international subsidaries as well as federal income taxes on unremitted earnings of foreign subsidiaries.
During the fourth quarter of 2011, based on our outlook for 2012, including lower expected year over year revenue in 2012 and the timing of our new product introductions, we provided for federal income tax and foreign withholding taxes for all the unremitted earnings of foreign subsidiaries because we have determined that those funds may no longer be permanently reinvested. During 2011 our tax provision was $1.1 million, comprised of approximately $0.6 million for tax cost associated with the change in our permanent reinvestment assertion and $0.5 million related to taxes in our non-U.S. subsidiaries. Our 2012 income tax provision of $1.0 million primarily consists of additional foreign income taxes and reserves of $0.8 million and $0.2 million of federal income tax and foreign withholding taxes on un-repatriated earnings.
We are subject to taxation in the US and various states and foreign jurisdictions. During June 2012 we were notified by the Internal Revenue Service that it intended to examine our federal tax filings for the fiscal years 2009 and 2010. In November 2012 the Internal Revenue Service informed us that the returns had been accepted as filed. 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 within the next twelve months. Our tax years starting from 2005 to 2012 remain open in various tax jurisdictions.
Net Loss
As a result of the above factors, we reported a net loss of $17.6 million in 2012 compared to net losses of $7.5 million in 2011 and $49.8 million in 2010. We have incurred net losses throughout most of our history. Over the past several years, we have taken and continue to take actions to reduce our operating expense structure such as consolidating locations, reducing capital expenditures, outsourcing our back-end physical design, reducing the number of development projects and reducing overall headcount. In addition, we are taking steps to reduce unit manufacturing costs by working to achieve better wafer pricing based on larger volume of purchases, consolidating business with vendors and reducing other input costs. Over the long term it is our expectation that these steps will result in operating income, excluding stock-based compensation and amortization of intangibles.
Liquidity and Capital Resources
Cash and cash equivalents decreased by $6.4 million to $28.4 million as of December 30, 2012 compared to $34.8 million as of January 1, 2012. We have funded our operations primarily through cash from private and public offerings of our common stock, 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 and operating expenses, such as tape outs, marketing programs, travel, professional services and facilities and other costs. We believe that there may be additional working capital requirements needed to fund and operate our business. In the near future we expect to finance our operations primarily through existing cash balances and Loan Agreement with SVB as described below. However, we may require additional cash resources during 2013 as a result of changes in our business conditions or other future development. If we should need additional funds, we believe that we will secure such funds either through our line of credit, the issuance of additional equity under our shelf registration statement or other similar activities.
The following table summarizes our statement of cash flows (in millions):
Cash held by foreign subsidiaries was $3.8 million, $32.6 million and $23.2 million as of December 30, 2012, January 1, 2012 and January 2, 2011, respectively. When we entered into the Services Agreement with eSilicon, we changed the international structure that we had established in 2011. Effectively eSilicon replaced our Singapore operations activity. This change enabled us to reduce the cash held by our Singapore subsidiary and return the cash to the parent accounts.
On February 19, 2013, we extended our Revolving Line with SVB through April 14, 2015 and updated the customary affirmative, negative and financial covenants to coincide with our current operating plan. The financial covenants include the following conditions: 1) minimum adjusted quick ratio (cash, cash equivalents and short-term investments and accounts receivable divided by current liabilities, net of deferred revenue) of 1.0 to 1.0; 2) minimum cash balance held with SVB will be between $8.0 million and $10.0 million dependent on specific quarter requirements; 3) minimum EBITDA (Earnings before Interest, Tax, Depreciation and Amortization), between zero and $(9.0) million dependent on specific quarter requirements. Under the facility we may borrow up to $15.0 million dependent on a calculated borrowing base. The borrowing base is the maximum of 80% of eligible accounts receivable. Further, when we have achieved two quarters of positive EBITDA performance, availability shall be increased up to $20.0 million and 25% of eligible inventory may also be included in the borrowing base.
Based on our current operating plan, we believe that this facility will be in compliance with the quarterly covenants in the extended Revolving Line with SVB. As a result, the extended Revolving Line with SVB, subject to its revised covenants, is expected to provide the funds necessary to meet our working capital needs for the next twelve months. Given the current macroeconomic conditions, the overall competitive climate of the industry in which we operate and our current business plans, projected revenues could decline or operating costs could increase such that our results may be insufficient to enable compliance with the covenant which may require us to take other actions to generate adequate cash flows or earnings to ensure compliance with the covenants. We continue to monitor our expected future performance and have the ability and intent to take additional cost reduction actions and enact other restructuring measures, if necessary, including but not limited to, consolidating locations, reducing capital expenditures, reducing the number of development projects and reducing overall headcount to ensure sufficient profitability and liquidity. There can be no assurance that our plans will be successful in achieving our objectives or generating the additional savings and earnings contributions necessary to comply with the covenants. Should we not be successful in achieving our objectives, we may be required to renegotiate the covenants with the lenders, or refinance the debt. We may also secure funds through the issuance of additional equity under our shelf registration statement or other similar activities.
Operating Activities
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). Collections have been strong as 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 master services agreement with eSilicon, who is responsible for purchasing and assembling our products as discussed above. Prepaid expenses increased primarily due to our arrangement with eSilicon as we have been prepaying to eSilicon the cost of wafer purchases. Prepayment to eSilicon was $2.7 million as of December 30, 2012. There were no prepayments to eSilicon as of January 1, 2012.
During 2011, we generated $6.8 million in net cash from operating activities while incurring a loss of $7.5 million. Included in the net loss were non-cash charges amounting to $10.4 million that resulted from amortization of intangibles and acquired technology of $2.5 million, stock-based compensation of $3.2 million, depreciation and amortization of $4.7 million. Cash flow from reductions in accounts receivable of $5.8 million and inventory of $7.6 million were partially offset by a reductions in accounts payable and accrued liabilities of $7.0 million and increase in prepaid expense and other assets of $1.2 million. In addition, the $1.3 million gain on the sale of our auction rate securities is a reduction to cash from operation activities, but the proceeds of $2.0 million from the sale are included in cash from investing activities. The decrease in accounts receivable reflects lower fourth quarter sales ($35.4 million in 2011 versus $37.1 million in 2010) and stronger collections resulting in days sales outstanding of 47 days as of January 1, 2012 versus 59 days as of January 2, 2011. The lower inventory balance as of the end of the fourth quarter reflected our lower sales expectations for the first quarter of 2012.
During 2010, we used $7.9 million in net cash from operating activities while incurring a loss of $49.8 million. Included in the net loss were non-cash charges amounting to $35.7 million that resulted from amortization of intangibles and acquired technology of $6.5 million, stock-based compensation of $3.3 million, depreciation and amortization of $4.2 million and asset impairments of $21.4 million, and loss on property and equipment included in restructuring of $0.4 million. Cash flow from reductions in accounts receivable of $10.8 million and inventory of $18.0 million were partially offset by a reductions in accounts payable and accrued liabilities of $22.6 million. The decrease in inventory includes a net write-down of $16.8 million, the majority of which was purchased in 2010. The decrease in accounts receivable and inventory reflect a reduction in 2010 fourth quarter sales to $37.1 million versus $58.2 million in the comparable 2009 period.
Investing Activities
During 2012 cash flow used in investing activities was $9.6 million, which was comprised of by the purchases of property and equipment of $6.8 million and the net purchases of certificates of deposit of $2.8 million. During 2011 cash flow used in investing activities was $1.8 million which was comprised of gross proceeds from the sale of our remaining auction rate securities of $2.0 million, offset by the purchases of property and equipment of $3.8 million. In 2010 net investing activities provided $9.7 million primarily the result of sales and maturities of investments of $14.1 million offset by fixed asset purchases of $4.4 million.
Our short-term investments consist of certificates of deposits. Previously, when we have had investments in marketable securities, our investment portfolio has been classified as “available for sale,” and our investment objectives were to preserve principal and provide liquidity, while maximizing yields without significantly increasing risk. We would sell an investment at any time if the quality rating of the investment declined; the yield on the investment was no longer attractive or we were in need of cash. We have used cash to acquire businesses and technologies that enhance and expand our product offering, and we anticipate that we will continue to do so in the future. The nature of these transactions makes it difficult to predict the amount and timing of such cash requirements. We also anticipate that we will continue to purchase necessary property and equipment in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods depend on a number of factors, including the hiring of employees, the rate of change of computer hardware and software used in our business and our business outlook.
Financing Activities
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 (see below) were $5.0 million as we drew down a total of $10.0 million under the agreement during the fiscal third and fourth quarters and repaid $5.0 million in the fiscal fourth quarter.
During 2011 cash flow from financing activities provided $0.8 million and was comprised predominantly of purchases of our stock under our Employee Stock Purchase Plan.
During late 2010, we filed with the SEC a shelf registration statement on Form S-3 which was declared effective on November 1, 2010. Under this registration statement the Company could offer and sell from time to time in one or more public offerings up to $30.0 million of common stock and warrants or any combination thereof. In November and December 2010, we sold a total of 12.8 million shares of our common stock resulting in net proceeds of $12.6 million after deducting underwriting discount and offering expenses of $1.0 million. In addition to these proceeds, we also received $0.3 million from the issuance of common stock on the exercise of stock options and $0.9 million from the issuance of common stock under our employee stock purchase plan leading to 2010 total cash provided from financing activities of $13.7 million.
Loan and Security Agreement
On January 14, 2011, we entered into the Loan Agreement SVB under which SVB shall make advances under a Revolving Line of up to $15.0 million, subject to certain restrictions. Advances under the Loan Agreement may be used solely for working capital purposes. Borrowings, if any, under the Loan Agreement bear interest at the greater of the SVB Prime Rate or 4.00% plus 50 basis points. The Revolving Line is collateralized by a first priority perfected lien on, and pledge of, all of our present and future property and assets. The original Loan Agreement had a maturity date of January 14, 2013. Interest accrues at 0.50% on the average unused portion of the Revolving Line. The Loan Agreement contains customary negative covenants for facilities of this type that restrict among other things, our ability to sell assets, make investments and acquisitions, make capital expenditures, grant liens, pay dividends and make certain other restricted payments. The Loan Agreement has three financial covenants related to EBITDA (Earnings before Interest, Tax, Depreciation and Amortization), adjusted quick ratio and perfected cash all of which are defined in the Loan Agreement.
On April 12, 2012, we amended the Loan Agreement and, among other technical changes, extended the maturity date to April 14, 2013 and amended the financial covenants to reflect current business circumstances. Minimum required EBITDA was reduced by at least $2.0 million for each quarter and the adjusted quick ratio was increased from 1.2 to 1.3. We are in compliance with all of the financial covenants as of December 30, 2012.
On September 19, 2012, we took a $5.0 million advance against the Revolving Line for working capital purposes. The advance was repaid on November 15, 2012. On December 15, 2012, we took an additional advance of $5.0 million. Interest on advances against the line is equal to 4.5% as of December 30, 2012 and is payable monthly. We may prepay the advances under the Revolving Line in whole or in part at any time without premium or penalty.
On February 19, 2013, we extended our Revolving Line with SVB through April 14, 2015 and updated the customary affirmative, negative and financial covenants to coincide with our current operating plan. The financial covenants include the following conditions: 1) minimum adjusted quick ration of 1.0 to 1.0; 2) minimum cash balance held with SVB will be between $8.0 million and $10.0 million dependent on specific quarter requirements; 3) minimum EBITDA between zero and $(9.0) million dependent on specific quarter requirements. Under the facility we may borrow up to $15.0 million dependent on a calculated borrowing base. The borrowing base is the maximum of 80% of eligible accounts receivable. Further, when we achieve two quarters of positive EBITDA performance, availability shall be increased up to $20.0 million and 25% of eligible inventory may also be included
in the borrowing base. Loan provisions are similar to the current arrangements. Interest, depending on our Asset-Based Threshold, as defined, varies from SVB Prime plus 75 basis points (or LIBOR plus 325 basis points) to SVB Prime plus 175 basis points. The SVB and LIBOR floors are 4.0% and 1.50%, respectively.
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 30, 2012 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.
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 twelve months due to the uncertainties in the timing of tax audit outcome.
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 January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for
the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the updated guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In May 2011, FASB issued updated accounting guidance to amend existing requirements for fair value measurements and disclosures. The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value but whose fair value must be disclosed. It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities as well as instruments classified in shareholders’ equity. The guidance is effective for annual and interim periods beginning after December 15, 2011. We do not have any Level 3 financial instruments and, therefore, the implementation of this guidance has not had any impact on our consolidated financial position, results of operations or cash flows.
In June 2011, the FASB issued guidance concerning the presentation of Comprehensive Income in the financial statements. Entities will have the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate, but consecutive statements. The disclosure requirements are effective for annual and interim periods beginning after December 15, 2011 and should be retrospectively applied. The implementation of this guidance has not had any impact on our consolidated financial position, results of operations or cash flows.
There has been no accounting pronouncement issued during fiscal 2012 that is expected to affect our Company.
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. 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 30, 2012 we had investments of $2.8 million in certificates of deposit. Our cash and cash equivalents consist of cash and money market accounts.
As of December 30, 2012, we had cash and cash equivalents totaling $28.4 million including money market funds of $2.0 million. Our investments in money market funds are held for working capital purposes. We do not enter into investments for trading or speculative purposes. If the return on our cash equivalents and investments were to change by one hundred basis points, the effect would be de minimis.
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.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity, comprehensive loss and cash flows present fairly, in all material respects, the financial position of Ikanos Communications, Inc. and its subsidiaries at December 30, 2012, and January 1, 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 30, 2012, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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 Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 28, 2013
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 silicon and integrated firmware for interactive triple-play broadband. The Company develops and markets end-to-end products for the last mile and the digital home, which enable carriers to offer enhanced triple play services, including voice, video and data. The Company has developed programmable, scalable chip architectures, which form the foundation for deploying and delivering triple play services. Flexible communication processor architecture with wire-speed packet processing capabilities enables high-performance residential gateways for distributing advanced services in the home. These products thereby support telecommunications services providers’ triple play deployment plans to the digital home and have been deployed by service providers in Asia, Europe and North America.
The accompanying consolidated financial statements of the Company have been prepared on a basis which assumes that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.
The Company incurred a net loss of $17.6 million for the year ended December 30, 2012 and had an accumulated deficit of $295.7 million as of December 30, 2012. 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. Although existing cash, cash equivalents, and investments, including the Company’s $15.0 million line of credit (of which $10.0 million is unused) are expected to be sufficient to meet anticipated cash needs for at least the next twelve months, the Company may also seek additional financing as deemed appropriate to support future Company needs and investments. Future capital requirements will depend upon many factors including its rate of revenue growth, its ability to develop future revenue streams, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of its products.
During fiscal 2012, the price of the Company’s common stock fell below the $1.00 NASDAQ market listing requirement. Since that time the price of the Company’s common stock has traded above $1.00 for more than 10 consecutive trading days and is, therefore, not currently subject to delisting. If the price were to fall below the requirement in the future for a specified period of time, the Company would again be subject to delisting and thereby could lose its eligibility for quotation on the NASDAQ Stock Market. Given this and other market conditions, there can be no assurance that, should the Company need additional funds, sufficient debt or equity financing will be available at all or, if available, that such financing will be at terms and conditions acceptable to the Company.
Further, the Company is reliant upon an existing revolving line of credit (Revolving Line) with Silicon Valley Bank (SVB) to help fund its operations. This facility is subject to certain affirmative, negative and financial covenants. On February 19, 2013 these covenants were revised to reflect the Company’s current operating plan. Based on its current operating plan, the Company believes that it will be in compliance with the quarterly covenants under the extended Revolving Line with SVB. As a result, the extended Revolving Line with SVB, subject to its revised covenants, is expected to provide the funds necessary to meet our working capital needs for the next twelve months. Given the current macroeconomic conditions, the overall competitive climate of the industry the Company operates in and its current business plans, projected revenues could decline or operating costs could increase such that its results may be insufficient to enable compliance with the covenants which may require the Company to take other actions to generate adequate cash flows or earnings to ensure
compliance with the covenants. The Company continues to monitor its expected future performance and has the ability and intent to take additional cost reduction actions and enact other restructuring measures, if necessary, including, but not limited to, consolidating locations, reducing capital expenditures, reducing the number of development projects and reducing overall headcount to ensure sufficient profitability and liquidity. There can be no assurance that the Company’s plans will be successful in achieving its objectives or generating the additional savings and earnings contributions necessary to comply with the covenants. Should the Company not be successful in achieving its objectives, the Company may be required to renegotiate the covenants with the lenders, or refinance the debt. The Company may also secure funds through the issuance of additional equity under our shelf registration statement or other similar activities.
The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
The Company’s fiscal year ends on the Sunday closest to December 31. 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 2012.
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.
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 for example relating to bad debt expense impairments. 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 incentives agreements, and other factors known at the time. Additional reductions to revenue would result if actual product returns or pricing adjustments exceed our 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, or 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 vendor specific evidence 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) vendor-specific objective evidence of fair value, or VSOE, (ii) third-party evidence of selling price (“TPE”), 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 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 30, 2012 the Company’s short-term investments consisted solely of certificates of deposit. In prior years marketable securities have included commercial paper, corporate bonds, government securities and auction rate securities. Marketable securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Realized gains or losses on the sale of marketable securities are determined using the specific-identification method. For all investments in debt and equity securities, unrealized losses are evaluated to determine if they are other than temporary. For investments in equity securities, unrealized losses that are considered to be other than temporary are considered impairment losses and recognized as a component of interest income and other, net, in the statements of operations. For investments in debt securities, if the fair value of a debt security is less than its amortized cost basis, the Company assesses whether the impairment is other than temporary. An impairment is considered other than temporary if (i) the Company has the intent to sell the security, (ii) it is more likely than not that the Company will be required to sell the security before recovery of its entire amortized cost basis, or (iii) the Company does not expect to recover the entire amortized cost of the security. If impairment is considered other than temporary based on conditions (i) and (ii), the entire difference between the amortized cost and the fair value of the security is recognized in earnings. If an impairment is considered other than temporary based on condition (iii), the amount representing credit losses, defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security, will be recognized in earnings and the amount relating to all other factors will be recognized in other comprehensive income. The Company evaluates both qualitative and quantitative factors such as duration and severity of the unrealized loss, credit ratings, prepayment 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
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
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:
Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. Intangible assets resulting from the acquisitions 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. Identifiable intangible assets that have finite useful lives are being amortized over their useful lives. In accordance with authoritative guidance, goodwill is not amortized. Rather, goodwill is subject to at least an annual assessment for impairment (more frequently if certain indicators are present) by applying a fair-value based test. In the event that management determines that the value of goodwill has become impaired, the Company will incur an accounting charge for the amount of impairment during the period in which the determination is made. As of December 30, 2012, the Company has no goodwill due to the economic events that occurred during the third quarter of 2010. At that time the Company performed an assessment for impairment of intangibles and goodwill and wrote down goodwill and intangibles by $8.6 million and $12.8 million, respectively. Goodwill was fully written off while intangibles were written down to $6.7 million. See Note 2 - Operating Asset Impairments.
Impairment of Long-Lived Assets
The Company evaluates long-lived assets, other than goodwill, 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 fiscal 2012 and 2011. See Note 2 - Operating Asset Impairments.
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, in prior years, 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 30, 2012 the Company’s short-term investments consisted solely of certificates of deposit. As noted above, in prior years marketable securities have included commercial paper, corporate bonds, government securities and auction rate securities. 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. Two customers represented 22% and 20% of accounts receivable at December 30, 2012. Three customers represented 33%, 18% and 18% of accounts receivable at January 1, 2012. Three customers represented 19%, 13% and 12% of revenue for the year ended December 30, 2012. Two customers represented 20% and 10% of revenue for the year ended January 1, 2012.Two customers represented 18% and 15% of revenue for the year ended January 2, 2011.
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; and reliance on assembly and wafer fabrication subcontractors and 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 January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the updated guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In May 2011, the Financial Accounting Standards Board (FASB) issued updated accounting guidance to amend existing requirements for fair value measurements and disclosures. The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value but whose fair value must be disclosed. It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities as well as instruments classified in shareholders’ equity. The guidance is effective for annual and interim periods beginning after December 15, 2011. The Company does not have any Level 3 financial instruments and, therefore, the implementation of this guidance did not have any impact on the Company’s consolidated financial position, results of operations or cash flows.
In June 2011, the FASB issued guidance concerning the presentation of Comprehensive Income in the financial statements. Entities will have the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate, but consecutive statements. The disclosure requirements are effective for annual and interim periods beginning after December 15, 2011 and should be retrospectively applied. The implementation of this guidance has not had any impact on the Company’s consolidated financial position, results of operations or cash flows.
There has been no accounting pronouncement issued during fiscal 2012 that is expected to affect the Company.
Note 2-Operating Asset Impairments
For the quarter ended October 3, 2010, the Company recorded impairment charges totaling $21.4 million of which $8.6 million related to goodwill and $12.8 million related to other intangible assets.
The Company tests goodwill for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company’s single reporting unit below its carrying value. The Company issued financial guidance for the third quarter 2010 period and announced a company-wide restructuring to better align the Company’s overhead structure with lower expected revenues and subsequently experienced a sustained decline during the quarter ended October 3, 2010 in market capitalization. Based on these indicators of potential impairment, the Company completed an impairment analysis of its goodwill as of October 3, 2010.
The Company performed the first step of the two-step impairment test and compared the fair value of the Company as a single reporting unit to its carrying value. Consistent with the Company’s approach in its annual impairment testing, in assessing the fair value of the reporting unit, the Company considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted stock price on the NASDAQ, the number of shares outstanding for the Company’s common stock and an estimated control premium. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. The income approach is dependent on a number of significant management assumptions including estimates of revenue and operating expenses, product penetration, growth and discount rates. Due to current market conditions and the number of significant assumptions required, the Company used the market approach. The market approach was lower, but both valuation approaches determined that the fair value was less than the carrying value of the net assets and, therefore, the Company performed step two of the impairment test.
In step two of the impairment test, the Company determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. The Company allocated the fair value of the reporting unit to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the mainline reporting unit was the price paid to acquire the reporting unit. The Company determined fair value of the single reporting unit using discounted cash flows. The weighted average cost of capital used in the impairment was 25.4% with perpetual growth rate of 3%. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s step two analysis resulted in no implied fair value of goodwill, and therefore, the Company recognized an impairment charge of $8.6 million, representing a write off of the entire amount of the Company’s previously recorded goodwill.
In addition, as part of and in conjunction with the impairment test, the Company determined that the carrying values of certain intangible assets were less than their fair values. Accordingly, the Company recorded a non-cash intangible asset impairment charge of $12.8 million as of October 3, 2010. The fair value calculation that leads to the impairment of the existing technology and customer relationship intangibles of $10.3 million was determined using a discounted cash flow method. The weighted average cost of capital used in the
impairment was 25.4% with no perpetual growth rate. The Company also impaired the remaining $2.5 million of IPR&D related to the gateway line of business under the Conexant BBA product line that was acquired in August 2009, since it was determined to have no alternative use and was therefore abandoned.
Information regarding the nonrecurring fair value measurements completed during the quarter ended October 3, 2010 was (in thousands):
* Note 2 - See Investments and Fair Value Measurements for explanation of Levels 1, 2, and 3.
When the Company acquired the Conexant BBA product line in August 2009, it assigned a value of $4.9 million to IPR&D. IPR&D comprised effectively two projects that were in process as of the acquisition date. The two projects were next generation VDSL solutions, one for the access line of business and the other for the gateway line. After reviewing the two projects, it was determined that further development of the access project was not necessary for product development, had no alternative use and was abandoned. Accordingly, the Company recorded an operating asset impairment charge of $2.5 million for the year ended January 3, 2010.
No additional impairments were recorded during the fiscal years ended December 30, 2012 and January 1, 2012.
The changes in the carrying value of goodwill were as follows (in thousands):
Note 3-Cash and Cash Equivalents, 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 money market funds of $2.0 million and $12.0 million as of December 30, 2012 and January 1, 2012, respectively. The investments in money market funds are included in cash equivalents based on their original maturity.
As of December 30, 2012, the Company’s short-term investments consisted solely of certificates of deposit. As of January 1, 2012, the Company had no short-term investments or marketable securities. During the first quarter of 2011, the Company sold its auction rate securities for $2.0 million and recognized a gain of $1.3 million. The Company invested the $2.0 million of proceeds in money market funds. Money market funds are considered cash equivalents and are included in cash and cash equivalents on the balance sheet.
The following is a summary of the Company’s investments as of December 30, 2012 (in thousands):
There were no unrealized losses on investments aggregated by category as of December 30, 2012.
Marketable securities have been classified as available-for-sale as of the balance sheet date and have been reported at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity, net of tax. Realized gains and losses and other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income or expense as incurred. Estimated fair values were determined for each individual security in the investment portfolio. The declines in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature.
As of January 2, 2011, the Company had an investment portfolio consisting of auction rate securities. The Company found a market outside the auction process for its auction rate securities. The auction rate securities had a book value of $0.7 million and face value of $5.0 million. The Company reviewed the marketability of its auction rate securities and received a quoted price of $2.0 million. Accordingly, as of January 2, 2011 the Company reclassified the securities from other assets to short-term investments on the balance sheet and assigned a fair market value of $2.0 million. The Company recorded the $1.3 million difference between its book value of $0.7 million and the market value of $2.0 million as accumulated other comprehensive income on the Balance Sheet. As discussed above, on January 31, 2011 the auction rate securities were sold for $2.0 million. The Company recognized $1.3 million as a gain on sale of marketable securities in the first quarter of 2011.
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 30, 2012 and January 1, 2012 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 marketable securities as of September 30, 2012 and January 1, 2012 was (in thousands):
There were no Level 3 securities during 2012 or 2011.
Note 4-Allowance for Doubtful Accounts
The following table summarizes the activity related to the allowance for doubtful accounts (in thousands):
Note 5-Inventory
Inventory consisted of the following (in thousands):
During 2012, the Company transitioned a majority of its 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, the Company places orders for its finished goods products with eSilicon, who, in turn, contracts with wafer foundries and the assembly and test subcontractors and manages these operational functions for Ikanos on a day-to-day level. During the first half of 2012, the Company began the transition of these Master Services to eSilicon and establishing clear lines of communications among the Company, eSilicon, the wafer foundries and
the assembly and test subcontractors. As of the end of fiscal year 2012, the Company has completed the transition of Master Services to eSilicon.
As part of its Services Agreement, the Company has transferred ownership of certain work-in-process and raw material inventory to the service provider as prepayment for the future delivery of finished goods inventory. In addition, the Company has prepaid for certain wafers purchased by the service provider on behalf of the Company. Prepayments under the arrangement are currently $2.7 million at December 30, 2012 and none at January 1, 2012. The prepayments are classified in prepaid expenses and other current assets.
Note 6-Property and Equipment
Property and equipment consisted of the following (in thousands):
Depreciation expense for property and equipment was $5.3 million, $4.7 million and $4.2 million for the years ended December 30, 2012, January 1, 2012 and January 2, 2011, respectively.
Note 7-Purchased Intangible Assets
The carrying amount of intangible assets is as follows (in thousands):
* Technical feasibility of IPR&D had not been reached as of January 1, 2012.
The Company determined that technical feasibility of its in-process research and development (IPR&D) was achieved during the fiscal third quarter of 2012. Effective July 2, 2012, the IPR&D carrying amount of
$1.4 million was transferred to and included in the category Existing technology and is being amortized over three years. The Company had no additional IPR&D as of December 30, 2012.
The amortization of technology is charged to cost of revenue and the amortization of customer relationships is charged to selling, general and administrative. For the years ended December 30, 2012, January 1, 2012 and January 2, 2011, the amortization of intangible assets was $2.1 million, $2.5 million and $6.5 million, respectively. During the years ended December 30, 2012 and January 1, 2012 there was no intangible asset impairment charge. During the year ended January 2, 2011 there was an intangible asset impairment charge of $12.8 million. The estimated future amortization of purchased intangible assets as of December 30, 2012 is $0.8 million in 2013, $0.5 million in 2014 and $0.2 million in 2015.
Note 8-Loan and Security Agreement
On January 14, 2011, the Company entered into a Loan and Security Agreement (Loan Agreement) with Silicon Valley Bank (SVB) under which SVB shall make advances under a revolving line of credit (Revolving Line) of up to $15.0 million, subject to certain restrictions. Advances under the Loan Agreement may be used solely for working capital purposes. Borrowings, if any, under the Loan Agreement bear interest at the greater of the SVB Prime Rate or 4.00% plus 50 basis points. The Revolving Line is collateralized by a first priority perfected lien on, and pledge of, all of the Company’s present and future property and assets. The original Loan Agreement had a maturity date of January 14, 2013. Interest accrues at 0.50% on the average unused portion of the Revolving Line. The Loan Agreement contains customary negative covenants for facilities of this type that restrict among other things, the Company’s ability to sell assets, make investments and acquisitions, make capital expenditures, grant liens, pay dividends and make certain other restricted payments. The Loan Agreement has three financial covenants related to EBITDA (Earnings before Interest, Tax, Depreciation and Amortization), adjusted quick ratio (cash, cash equivalents and short-term investments and accounts receivable divided by current liabilities, net of deferred revenue) and cash held by SVB all of which as defined in the Loan Agreement.
On April 12, 2012, the Loan Agreement was amended and, among other technical changes, extended the maturity date to April 14, 2013 and amended the financial covenants to reflect current business circumstances. Minimum required EBITDA was reduced by at least $2.0 million for each quarter and the adjusted quick ratio was increased from 1.2 to 1.3. The Company is in compliance with all of the financial covenants as of December 30, 2012.
On September 19, 2012, the Company took a $5.0 million advance against the Revolving Line for working capital purposes. The advance was repaid on November 15, 2012. On December 15, 2012, the Company took an additional advance of $5.0 million. Interest on advances against the line is equal to 4.5% as of December 30, 2012 and is payable monthly. The Company may prepay the advances under the Revolving Line in whole or in part at any time without premium or penalty.
On February 19, 2013, the Company amended the Loan Agreement. See Note 17-Subsequent Event.
Note 9-Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
The following table summarizes the activity related to the warranty accrual (in thousands):
Note 10-Restructuring Charges
In an effort to align the Company’s operating expenses to its projected revenue forecast, on January 30, 2012 the Board of Directors approved and management initiated a corporate restructuring plan that included a reduction in force of approximately 15%. Employees were notified on February 1 and 2, 2012 of their planned terminations.
During the first quarter of 2010, the Company implemented a plan to restructure its work force and reduce its cost structure after its acquisition of the BBA product line. Subsequently, during the third quarter of 2010, the Company implemented a restructuring plan in order to better align its operating expenses with its revised revenue forecast and to reallocate sufficient engineering resources to the continued development of its broadband technology and products. In addition, the Company closed three overseas offices. Total restructuring costs for 2010 amounted to $5.8 million of which $4.7 million related to severance costs, $0.4 million to facilities and $0.7 million to software tools.
As of December 30, 2012, the Company has completed its restructuring activities.
A summary of the Company’s restructuring activities is as follows (in thousands):
* Non-cash adjustments relate to stock-based compensation expense and fixed asset dispositions.
Note 11-Tallwood Investment
During 2009, in order to facilitate the BBA acquisition, the Company negotiated a $42.0 million cash investment by Tallwood III, L.P. Tallwood III Annex, L.P. and certain of their affiliates (collectively, the Tallwood Investors) pursuant to which the Company sold to the Tallwood Investors (i) 24.0 million shares of Ikanos common stock, par value $0.001 per share (the Common Stock), and (ii) warrants to purchase up to 7.8 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 $1.75. 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 election of a minority of the members of the Board of Directors but does not share in the economics of Ikanos. The 24.0 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.
Assuming the exercise of the Warrants and the shares outstanding as of January 3, 2010, the Tallwood Investors would own 51% of the Company’s outstanding common stock post-closing. However, through the Stockholder Agreement between the Company and the Tallwood Investors dated April 21, 2009, the Tallwood Investors have agreed (a) to vote for all non-Tallwood directors in the same proportion as other stockholders of the Company; (b) that to the extent they hold shares in excess of 35% of the total outstanding common stock, they will vote the excess shares in the same proportion as shares voted by non-Tallwood stockholders; and (c) for certain
matters requiring a separate vote of the stockholders who control the single Series A Preferred share issued to the Tallwood Investors, they will delegate their proxy to vote those shares to the non-Tallwood directors.
In November 2010 Tallwood participated in the Company’s stock issuance (see Note 12 below) and purchased an additional 5.6 million shares. Assuming the exercise of the Warrants and the shares outstanding as of December 30, 2012, the Tallwood Investors would own 48% of the Company’s outstanding common stock. Subsequent to this purchase, the voting restrictions discussed in the prior paragraph still remain in effect.
Note 12-Equity Plans and Related Equity Activity
Common Stock Issuance
On October 25, 2010, the Company filed with the SEC a shelf registration statement on Form S-3 which was declared effective on November 1, 2010. Under this registration statement the Company may offer and sell from time to time in one or more public offerings up to $30.0 million of common stock and warrants or any combination thereof. In November and December 2010, the Company sold a total of 12.8 million shares of our common stock resulting in net proceeds of $12.5 million after deducting underwriting discount and offering expenses of $1.0 million.
Common Stock Reserved
As of December 30, 2012, the Company has reserved 26.1 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 (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 terminate ten years after the date of grant. Upon completion of the Company’s initial public offering, the 1999 Plan was terminated and no shares are available for future issuance under the 1999 Plan. As of December 31, 2012, the Company had thirty-two thousand options outstanding under the 1999 Plan.
2004 Equity Incentive Plan
In September 2005, the Company adopted the 2004 Equity Incentive Plan (2004 Plan) upon the closing of its initial public offering. The 2004 Plan allows 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. 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. Awards of restricted stock units generally vest over a four year period.
The 2004 Plan provides for the automatic grant of non-statutory stock options to our non-employee directors. Each non-employee director appointed to the board will receive an initial option to purchase 45,000 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 as to 1/12th of the shares each quarter thereafter, subject to the director’s continuing to serve as a director on each vesting date. In addition, non-employee directors will receive a subsequent option to purchase shares on the date of each annual meeting of our stockholders at the following rate: 10,000 shares for Board members with one year of service; 15,000 shares for Board members with two
years of service; 20,000 shares for board members with three years of service; and 25,000 shares for board members with four or more years of service. These subsequent 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. 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 our common stock on the date of grant.
On December 11, 2012, the 2004 Plan was amended and restated to provide for the granting of restricted stock to each non-employee member of the Board of Directors. Under the terms of the Non-Employee Director Restricted Stock Agreement, each non- employee received 9,000 shares of restricted stock fully vested on the date of grant, December 11, 2012. Each recipient was bound under the terms of the agreement not to sell and shares of stock at a time when applicable laws, Company policies or any agreement between the Company and its underwriters prohibit a sale.
The 2004 Plan provides for an annual increase to the shares authorized under the plan on the first day of the Company’s fiscal year beginning in 2006, equal to the least of (i) 4.4% of the Company’s outstanding shares of common stock on such date, (ii) 3.0 million shares or (iii) an amount determined by the Board of the Directors. The shares may be authorized, but unissued or reacquired common stock. In addition, in August 2009, our stockholders approved an amendment and restatement of the 2004 Plan and increased the number of shares reserved for issuance under the 2004 Plan by 5.5 million shares in connection with the BBA acquisition. In June 2011 the Stockholders approved an amendment and restatement of the 2004 Plan and increased the number of shares reserved under the Plan by 4.0 million shares to have a sufficient number of shares available to provide employees, consultants and directors with equity awards. As of December 30, 2012, the Company had 17.1 million options and awards outstanding and 6.3 million options and awards available for future grant under the 2004 plan.
2004 Employee Stock Purchase Plan
In September 2005, the Company adopted the 2004 Employee Stock Purchase Plan (ESPP), upon the closing of its initial public offering. As of December 30, 2012, the Company had 2.5 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 Ikanos or any participating subsidiary for at least 20 hours per week. The Company’s 2004 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. On the first day of the Company’s fiscal year starting in 2005 and ending in 2014, the number of authorized shares under the ESPP will be increased by the lesser of (i) 2.5% of the Company’s outstanding shares of common stock on such date, (ii) 1.5 million shares or (iii) an amount determined by the Board of the Directors.
Doradus 2004 Amended and Restated Stock Option Plan
In August 2006, in connection with Doradus acquisition, the Company assumed Doradus’ 2004 Amended and Restated Stock Option Plan (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 30, 2012, the Company has reserved no shares of its common stock for options outstanding and approximately 0.1 million shares for future issuance. 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.
Stock Option Agreement for Omid Tahernia
In June 2012, the Company adopted a stand-alone Stock Option Agreement for Omid Tahernia, under which 2,100,000 shares of the Company’s common stock have been reserved for issuance to the Company’s CEO,
Omid Tahernia, in connection with 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 (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 (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 $0.89 (the fair market value on the grant date); and has a seven year term.
With respect to 1,500,000 shares subject to the Option (Time-Based Option Shares), 25% of such Shares shall vest twelve months from the June 11, 2012 (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 1,500,000 Shares shall have completely vested on the four year anniversary of the Vesting Commencement Date, unless that date falls on a non-business date, in which case the next business date shall apply.
With respect to the remaining 600,000 shares subject to the Option (“Performance-Based Option Shares”), (i) 300,000 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 $2.50; and (ii) the remaining 300,000 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 $3.50. 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.
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 as defined in the Offer Letter.
Stock-Based Compensation
Stock-based compensation expense related to all stock-based compensation awards was $2.9 million, $3.2 million, and $3.4 million for the years ended December 30, 2012, January 1, 2012 and January 2, 2011, respectively.
As of December 30, 2012, there was $9.5 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 the years ended December 30, 2012, January 1, 2012, and January 2, 2011 was $0.46, $0.64, and $0.85, respectively. The total intrinsic value of options exercised during the years ended December 30, 2012, January 1, 2012 and January 3, 2010 was insignificant.
The following table summarizes information about stock options as of December 30, 2012 (in thousands, except per share):
Restricted Stock Units
A summary of our restricted stock unit activity is presented below (in thousands):
The weighted average grant date fair value per restricted stock units granted was $1.39 and $2.54 during the years ended December 30, 2012 and January 2, 2011, respectively. There were no grants in the year ended January 1, 2012. The total fair values of restricted stock units that vested were $0.1 million, $0.1 million and $0.9 million for the years ended December 30, 2012, January 1, 2012 and January 2, 2011, respectively. The restricted stock units have one to four years vesting terms and are scheduled to vest through 2014. Tax related withholdings of restricted stock units totaled $1.1 million during the year ended January 3, 2010. The tax related withholdings of restricted stock units were zero for the year ended December 30, 2012 and insignificant for the years ended December 30, 2012 and January 1, 2012.
Restricted Stock
A summary of restricted stock activity is presented below (in thousands):
The total fair value of restricted stock that vested was $0.3 million, $0.4 million and $0.3 million during the years ended December 30, 2012, January 1, 2012 and January 2, 2011, respectively. The restricted stock has three years vesting terms and is scheduled to vest through 2013.
Disclosures Pertaining to All Stock-Based Award Plans
Cash received from option exercises and ESPP contributions under all share-based payment arrangements was $0.6 million, $0.8 million and $1.2 million for the years ended December 30, 2012, January 1, 2012 and January 2, 2011, 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 the years ended December 30, 2012, January 1, 2012, and January 2, 2011.
Note 13-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 14-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 the years ended December 30, 2012, January 1, 2012 and January 2, 2011 was $2.6 million, $2.4 million, and $2.9 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 30 under non-cancelable leases with original terms in excess of one year are $2.6 million in 2013; $2.3 million in 2014; $2.0 million in 2015: $1.6 million in 2016 and $1.7 million in 2017 and thereafter.
Purchase Commitments
As of December 30, 2012, the Company had $2.7 million of inventory purchase obligations with various suppliers that are expected to be paid during the first quarter of fiscal year 2013.
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
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York (District Court), against the Company, certain then current and former directors and officers, as well as the lead underwriters for its initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint sought unspecified damages for certain alleged misrepresentations and omissions made by the Company in connection with both its initial public offering in September 2005 and its follow-on offering in March 2006. On June 25, 2007, the Company filed motions to dismiss the amended complaint, and on March 10, 2008, the District Court dismissed the case with prejudice. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration. On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit (Court of Appeals). On September 17, 2009, the Court of Appeals affirmed the District Court’s dismissal of the amended complaint, but vacated its judgment on the motion for reconsideration and remanded the case to the District Court for further proceedings. On June 11, 2010, plaintiffs filed a motion for leave to amend the complaint in the District Court, and on November 23, 2010, the District Court denied the motion. On January 6, 2011, plaintiffs filed a notice of appeal with the Court of Appeals. On May 25, 2012, the Court of Appeals granted plaintiffs’ appeal, finding that their proposed amended complaint succeeded in stating a claim. The case was remanded to the District Court for further proceedings, and on June 19, 2012, plaintiffs filed their Third Amended Class Action Complaint. The parties held a mediation on December 6, 2012 and agreed to a tentative agreement to settle the case, subject to confirmatory discovery and the Court’s approval. However, the Company cannot predict the final outcome of the litigation based on the tentative agreement, and an adverse result could have a material effect on its financial statements.
Additionally, from time to time, the Company is a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, the Company does not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on its financial position, results of operations or cash flows.
Note 15-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 (benefit from) income taxes computed by applying the US federal tax rate to income (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 our deferred tax assets are as follows (in thousands):
Realization of deferred tax assets is dependent upon future taxable earnings, the timing and amount of which are uncertain. Due to cumulative losses in earlier years and continued significant amount of loss in most recent year, management believes that it is more likely than not that the majority of its deferred tax assets will not be realizable in future periods. The valuation allowance for deferred tax assets increased by $10.0 million as of December 30, 2012 versus a decrease of $0.6 million as of January 1, 2012. The increase is mainly due to operating losses generated in the current period. The deferred tax assets, valuation allowance and deferred tax liabilities as at December 30, 2012, includes an adjustment of approximately $1.6 million, $3.9 million and $2.3 million, respectively, related to prior periods. This adjustment has no material impact on the reported net deferred tax assets or liabilities. Additionally, the reconciliation of unrecognized tax benefits for the fiscal year ended December 30, 2012, includes approximately $4.0 million related to unrecognized tax benefits that should have been disclosed in the prior years. This adjustment has no impact on the reported net deferred tax assets or liabilities. Management believes that the impact of these errors is not material to any prior years’ financial statements and the impact of correcting these errors in the current year is not material to the full year fiscal 2012 financial statements.
As of December 30, 2012, the Company had net operating loss carryforwards for federal and state of California tax purposes of $12.9 million and $12.3 million respectively. The net operating loss carryforwards will begin to expire beginning in 2030 for federal and 2031 for California, if not utilized. The Company has research and development tax credits of approximately $2.1 million and $1.1 million for federal and California 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 30, 2012, the Company has federal and state capital loss carryforwards for income tax purpose were approximately $3.6 million and $3.6 million, respectively. If not utilized, both the Federal and California capital loss carryforwards will begin to expire in 2014.
On January 2, 2013, the “American Tax Payer Relief Act of 2012” was signed into law. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 and before January 1, 2014. As a result, the Company expects to record a deferred tax asset of approximately $0.9 million that will be fully offset by a valuation allowance in the first quarter of 2013. This will not have an impact on the income tax provision.
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 carryforwards will only be recorded to equity when they reduce cash taxes payable. The cumulative amounts as of December 30, 2012 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 NOL carryforwards 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 $0.1 million as of and for the fiscal year ended December 30, 2012.
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 United States 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 benefit related to our 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.
During June 2012 the Company was notified by the Internal Revenue Service that it intended to examine the Company’s federal tax filings for the fiscal years 2009 and 2010. In November 2012 the Internal Revenue Service informed the Company that the returns had been accepted as filed. The Company is currently undergoing an income tax audit in India. Otherwise there are no ongoing examinations by income taxing authorities at this time. The Company does not expect any material adjustment to our reserves within the next twelve months. The Company’s tax years starting from 2005 to 2012 remain open in various tax jurisdictions.
Note 16-Significant Customer Information and Segment Reporting
The 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 divides its products into three product families: Broadband DSL, Communications Processors and Other. Broadband DSL consists of the Company’s central office products, DSL modem-only customer premise equipment products and the DSL value of the Company’s integrated devices. Communications Processors includes the Company’s stand-alone processors and the processor-only value of the Company’s integrated devices. Other includes products that do not fall into the other two product families. Revenue by product family is as follows (in thousands):
The distribution of long-lived assets (excluding goodwill, intangible assets and other assets) was as follows (in thousands):
Note 17-Subsequent Event
On February 19, 2013, the Company extended its Revolving Line with SVB through April 14, 2015 and updated the customary affirmative, negative and financial covenants to coincide with its current operating plan. The financial covenants include the following conditions: 1) minimum adjusted quick ratio of 1.0 to 1.0; 2) minimum cash balance held with SVB will be between $8.0 million and $10.0 million dependent on specific quarter requirements; 3) minimum EBITDA between zero and $(9.0) million dependent on specific quarter requirements. Under the facility the Company may borrow up to $15.0 million dependent on a calculated borrowing base. The borrowing base is the maximum of 80% of eligible accounts receivable. Further, when the Company achieves two quarters of positive EBITDA performance, availability shall be increased up to $20.0 million and 25% of eligible inventory may also be included in the borrowing base. Loan provisions are similar to the current arrangements. Interest, depending on the Company’s Asset-Based Threshold, as defined, varies from SVB Prime plus 75 basis points (or LIBOR plus 325 basis points) to SVB Prime plus 175 basis points. The SVB and LIBOR floors are 4.0% and 1.50%, respectively.
Quarterly Financial Information SUPPLEMENTARY FINANCIAL DATA
Quarterly Financial Information (Unaudited)
(In thousands)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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 30, 2012. 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. Based on our assessment using those criteria, we concluded that, as of December 30, 2012, our internal control over financial reporting is effective.
The Company’s independent registered public accounting firm, PricewaterhouseCoopers 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 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
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 2013 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 or Chief Financial Officer and other officers providing financial information, will be disclosed on our website at www.ikanos.com or in a report on Form 8-K filed with the SEC.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information included under the following captions in our Proxy Statement is incorporated herein by reference: Compensation Discussion and Analysis, Summary Compensation Table, Grants of Plan-Based Awards in 2012, Outstanding Equity Awards at 2012 Fiscal Year End, Option Exercises and Stock Vested in 2012, Nonqualified Deferred Compensation, 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 30, 2012 with respect to common stock that may be issued upon the exercise of equity awards under our Amended and Restated 1999 Stock Option Plan (1999 Plan), Amended and Restated 2004 Equity Incentive Plan (2004 Plan), 2004 Employee Stock Purchase Plan (2004 ESPP) and the Doradus Technologies, Inc. 2004 Amended and Restated Stock Option Plan (Doradus Plan).
(1) Includes: (i) shares of common stock issuable upon the exercise of outstanding options grants (subject to vesting) for 17,139,339 shares (ii) shares of common stock issuable upon the vesting of restricted stock units for 23,413 shares.
(2) No further equity awards may be granted under the 1999 Plan, which terminated at the time our initial public offering in September 2005.
(3) The 2004 Plan provides for an annual increase to the shares authorized under the plan on the first day of our fiscal year beginning in 2006, equal to the least of (i) 4.4% of our outstanding shares common stock on such date, (ii) 3.0 million shares, or (iii) an amount determined by the Board of the Directors.
The 2004 ESPP provides for an annual increase of the shares authorized under the plan on the first day of our fiscal year starting in 2005 and ending in 2014, the number of authorized shares under the ESPP will be increased by the lesser of (i) 2.5 % of our outstanding shares of common stock on such date, (ii) 1.5 million shares, or (iii) an amount determined by the Board of the Directors.
(4) Includes 6,288,342 shares available for future issuance under the 2004 Plan and 2,544,110 shares available for future issuance under the 2004 ESPP.
(5) Shares available for future issuance under the Doradus Plan.
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 will have a term of ten 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:
* Indicates a management contract or compensatory plan or arrangement.
** Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised that, pursuant to Rule 406T, these interactive data files are deemed not filed and otherwise are not subject to liability.
TRADEMARKS
Ikanos Communications, Ikanos, the Ikanos logo, the “Bandwidth without boundaries” tagline, Fusiv, Ikanos NodeScale, Ikanos SmartCPE and Ikanos Velocity are among the trademarks or registered trademarks of Ikanos Communications.
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 George Portugal, 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 purposes 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.
** Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised that, pursuant to Rule 406T, these interactive data files are deemed not filed and otherwise are not subject to liability.