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EX-10.1 - EX-10.1 - IKANOS COMMUNICATIONS, INC.d755905dex101.htm
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EX-10.1.3 - EX-10.1.3 - IKANOS COMMUNICATIONS, INC.d755905dex1013.htm
EX-10.1.2 - EX-10.1.2 - IKANOS COMMUNICATIONS, INC.d755905dex1012.htm
EX-31.2 - EX-31.2 - IKANOS COMMUNICATIONS, INC.d755905dex312.htm
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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 29, 2014

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

Commission File Number: 0-51532

 

 

IKANOS COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   73-1721486

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

47669 Fremont Boulevard

Fremont, CA 94538

(Address of principal executive office and zip code)

(510) 979-0400

(Registrant’s telephone number including area code)

 

 

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) had been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the Registrant’s Common Stock, $ 0.001 par value, was 99,283,662 as of August 4, 2014.

 

 

 


Table of Contents

IKANOS COMMUNICATIONS, INC.

FORM  10-Q

TABLE OF CONTENTS

 

         Page No.  
PART I:   FINANCIAL INFORMATION   
Item 1.   Financial Statements (unaudited)      3   
  Condensed Consolidated Balance Sheets as of June 29 2014 and December 29, 2013      3   
 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 29, 2014 and June 30, 2013

     4   
 

Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 29, 2014 and June 30, 2013

     5   
 

Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended June 29, 2014 and June 30, 2013

     6   
  Notes to Unaudited Condensed Consolidated Financial Statements      7   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      15   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      23   
Item 4.   Controls and Procedures      23   
PART II:   OTHER INFORMATION   
Item 1.   Legal Proceedings      24   
Item 1A.   Risk Factors      24   
Item 6.   Exhibits      36   
  Signatures      37   

 

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Table of Contents

PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands and unaudited)

 

     June 29,
2014
     December 29,
2013
 
Assets      

Current assets:

     

Cash and cash equivalents

   $ 18,917       $ 36,043   

Short-term investments

     1,675         3,473   

Accounts receivable

     9,393         15,892   

Inventory

     2,160         2,017   

Prepaid expenses and other current assets

     3,793         3,245   
  

 

 

    

 

 

 

Total current assets

     35,938         60,670   

Property and equipment, net

     9,761         8,612   

Intangible assets, net

     478         718   

Other assets

     1,912         1,952   
  

 

 

    

 

 

 
   $ 48,089       $ 71,952   
  

 

 

    

 

 

 
Liabilities and Stockholders’ Equity      

Current liabilities:

     

Revolving line

   $ 6,912       $ 12,000   

Accounts payable

     7,252         4,692   

Accrued liabilities

     7,433         8,232   
  

 

 

    

 

 

 

Total current liabilities

     21,597         24,924   

Long-term liabilities

     1,445         1,637   
  

 

 

    

 

 

 
     23,042         26,561   

Commitments and contingencies (Note 8)

     

Stockholders’ equity

     25,047         45,391   
  

 

 

    

 

 

 
   $ 48,089       $ 71,952   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data, and unaudited)

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Revenue

   $ 11,255      $ 19,115      $ 25,768      $ 45,267   

Cost of revenue

     5,775        9,813        13,211        22,009   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     5,480        9,302        12,557        23,258   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development

     13,408        12,599        26,084        26,117   

Selling, general and administrative

     4,105        4,866        8,926        9,638   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,513        17,465        35,010        35,755   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (12,033 )     (8,163 )     (22,453 )     (12,497 )

Interest and other income (expense), net

     (129     (442     113        (360 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (12,162 )     (8,605 )     (22,340 )     (12,857 )

Provision for income taxes

     168        68        295        232   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (12,330 )   $ (8,673 )   $ (22,635 )   $ (13,089 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share

   $ (0.12 )   $ (0.12 )   $ (0.23 )   $ (0.18 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares (basic and diluted)

     99,102        71,182        98,926        70,798   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4


Table of Contents

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands and unaudited)

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Net loss

   $ (12,330 )   $ (8,673 )   $ (22,635 )   $ (13,089 )

Other comprehensive loss, net of tax

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive loss

   $ (12,330 )   $ (8,673 )   $ (22,635 )   $ (13,089 )
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands and unaudited)

 

     Six Months Ended  
     June 29,
2014
    June 30,
2013
 

Cash flows from operating activities:

    

Net loss

   $ (22,635 )   $ (13,089 )

Adjustments to reconcile net loss to net cash used by operating activities:

    

Depreciation and amortization

     2,039        2,222   

Stock-based compensation expense

     1,912        1,724   

Amortization of intangible assets and acquired technology

     240        489   

Changes in assets and liabilities:

    

Accounts receivable

     6,499        3,657   

Inventory

     (143 )     4,085   

Prepaid expenses and other assets

     (508 )     1,987   

Accounts payable and accrued liabilities

     172        (6.519 )
  

 

 

   

 

 

 

Net cash used in operating activities

     (12,424 )     (5,444 )
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of property and equipment

     (1,787 )     (2,008 )

Purchases of investments

     (3,026     (825

Maturities and sales of investments

     4,824        2,073   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     11        (760 )
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net proceeds from issuances of common stock and exercise of stock options

     375        1,097   

Net proceeds from revolving line

     6,912        12,500   

Net repayments to revolving line

     (12,000     (10,000
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (4,713     3,597   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (17,126 )     (2,607 )

Cash and cash equivalents at beginning of period

     36,043        28,391   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 18,917      $ 25,784   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Ikanos and Summary of Significant Accounting Policies

The Company

Ikanos Communications, Inc. (“Ikanos” or the “Company”) was incorporated in the State of California in April 1999 and reincorporated in the State of Delaware in September 2005. The Company is a provider of advanced semiconductor products and software for delivering high speed broadband solutions to the digital home. The Company’s broadband multi-mode and digital subscriber line (“DSL”) processors and other semiconductor offerings power carrier infrastructure (referred to as “Access”) and customer premises equipment (referred to as “Gateway”) for network equipment manufacturers (“NEMs”) who, in turn, serve leading telecommunications service providers. The Company has developed programmable, scalable chip architectures, which form the foundation for deploying and delivering multi-play services. This flexible communications processor architecture, with wire-speed packet processing capabilities, enables high-performance end user devices capable of distributing advanced services in the home. These products support telecommunications services providers’ multi-play deployment plans to the digital home, while keeping their capital and operating expenditures low and have been deployed by service providers in Asia, Europe, and North and South America.

The accompanying consolidated financial statements of the Company have been prepared on a basis that assumes that the Company will continue as a going concern and contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.

Liquidity

The Company incurred net losses of $12.3 million and $22.6 million for the quarter and six months ended June 29, 2014, respectively, and had an accumulated deficit of $348.7 million as of June 29, 2014. The Company incurred a net loss of $30.4 million for the year ended December 29, 2013 and had an accumulated deficit of $326.1 million as of December 29, 2013.

As a result of the Company’s recurring losses from operations, the need to stay in compliance with certain debt covenants, and the need for additional financing to fund its operating and capital requirements, there is uncertainty regarding the Company’s ability to maintain liquidity sufficient to operate its business effectively, which raises substantial doubt as to the Company’s ability to continue as a going concern. If the Company is unable to raise additional capital in the short-term, it will cease to continue as a going concern. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to the Company.

The Company utilizes an existing revolving line of credit under a Loan and Security Agreement (“Loan Agreement”) with Silicon Valley Bank (“SVB”) to partially fund its operations. This facility is subject to certain affirmative, negative, and financial covenants. The August 8, 2013 amendment to the Loan Agreement changed existing financial covenants relating to minimum cash held with SVB and Earnings Before Interest Taxes, Depreciation and Amortization (“EBITDA”) measurements. On April 30, 2014, the Company sought and received an amendment to the Loan Agreement prospectively eliminating one of the covenants required to be met as of June 29, 2014, and modifying others. The Company anticipates that it will not be in compliance with certain covenants during and as of the end of the third quarter of 2014 as well as during and as of the end of the fourth quarter of 2014. Because the Company foresees challenges in complying with some of the covenants during and after the third quarter of 2014, the Company has begun comprehensive discussions with SVB to revise these covenants. There can be no assurance that the Company will be successful in revising the covenants with SVB. If the Company is not successful in revising the covenants with SVB, it will need to obtain a replacement debt facility or raise additional cash, or it will cease to continue as a going concern.

The Company filed a Registration Statement on Form S-1 on August 23, 2013, as subsequently amended (and was declared effective on November 6, 2013), under which it might offer and sell up to $35.0 million of common stock. On November 7, 2013 and November 22, 2013, Ikanos sold an aggregate of 26.4 million shares of common stock in an underwritten offering for $26.4 million. After deducting underwriting fees, legal, accounting, and other costs, the Company realized net proceeds of $24.0 million.

Beginning on January 31, 2014, the Company’s common stock began to trade below $1.00 per share on The NASDAQ Capital Market (“NASDAQ”). On March 18, 2014, the Company received notification from NASDAQ indicating that the Company was not in

 

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compliance with Nasdaq Marketplace Rule 5550(a)(2), which Rule provides that securities listed by NASDAQ must maintain a minimum closing bid price of $1.00 per share and that, based upon the closing bid price for the Company’s securities for the previous 30 consecutive business days, the Company no longer meets this requirement. NASDAQ further notified the Company that, in accordance with Nasdaq Marketplace Rule 5810(c)(3)(A), the Company will be provided 180 calendar days, or until September 15, 2014, to regain compliance by achieving a closing bid price of the Company’s securities of at least $1.00 per share for a minimum of ten consecutive business days at any time during the 180 calendar day period. However, there can be no guarantee that the Company will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the 180 calendar day period. In the event the Company does not regain compliance by September 15, 2014, NASDAQ also notified the Company that it may be eligible for a second 180 calendar day compliance period provided that the Company continues to meet the continued listing requirements of NASDAQ, with the exception of the bid price requirement, and provides written notice of the Company’s intention to cure the deficiency during the second 180 calendar day compliance period. Even if granted a second 180 calendar day compliance period, there can be no guarantee that the Company will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the second 180 calendar day compliance period.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”), the rules and regulations of the Securities and Exchange Commission (“SEC”), and accounting policies consistent with those applied in preparing the Company’s audited annual consolidated financial statements. Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with these rules and regulations. The information in this Quarterly Report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K filed with the SEC on February 28, 2014 (“Annual Report”).

In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to a fair statement of the Company’s financial position, results of operations, and cash flows for the interim periods presented. The operating results for the three and six month periods ended June 29, 2014 are not necessarily indicative of the results that may be expected for the full fiscal year ending December 28, 2014, or for any other future period.

Use of Estimates

The preparation of the Company’s unaudited condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates, judgments, and assumptions. The Company believes that the estimates, judgments, and assumptions upon which it relies are reasonable based upon information available to it at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expenses during the periods presented. To the extent that there are material differences between these estimates and actual results, the Company’s financial statements would be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require the Company’s management’s judgment in its application. There are also areas in which the Company’s management’s judgment in selecting any available alternative would not produce a materially different result.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued accounting guidance entitled, “Revenue from Contracts with Customers,” which will replace most existing revenue recognition guidance under U.S. GAAP. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the effect that the standard will have upon our consolidated financial statements.

Summary of Significant Accounting Policies

The Company’s significant accounting policies are described in its Annual Report at Note 1 to the audited Consolidated Financial Statements for the year ended December 29, 2013. These accounting policies have not significantly changed.

 

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Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash, cash equivalents, and 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 creditworthy and, accordingly, minimal credit risk exists with respect to those deposits. As of June 29, 2014, the Company had short-term investments consisting solely of certificates of deposit. 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 small number of customers in any particular reporting period. Three customers represented 34%, 19%, and 12% of accounts receivable at June 29, 2014. Three customers represented 35%, 10%, and 10% of accounts receivable at December 29, 2013. Three customers accounted for 35%, 19%, and 18% of revenue for the three months ended June 29, 2014. Four customers accounted for 27%, 25%, 13%, and 10% of revenue for the six months ended June 29, 2014. Four customers accounted for 20%, 12%, 11%, and 11% of revenue for the three months ended June 30, 2013. Three customers accounted for 23%, 18%, and 10% of revenue for the six months ended June 30, 2013.

In the second quarter of 2014, the Company derived 18% of its revenue from Sagemcom SAS (“Sagemcom”) and 35% of its revenue from Amod Technology Co., Ltd. (“Amod”). Amod is a distributor that sells its purchases from the Company to Askey Computer Corporation (“Askey”) who is a contract manufacturer for Sagemcom. For the first six months of 2014, the Company derived 25% of its revenue from Sagemcom and 27% of its revenue from Amod. In the second quarter of 2013, the Company derived 20% of its revenue from Sagemcom and an additional 15% of its revenue from two Sagemcom contract manufacturers – 12% from Askey and 3% from Jabil Industrial do Brasil Ltda. (“Jabil”). For the first six months of 2013, the Company derived 23% of its revenue from Sagemcom and an additional 20% of its revenue from Askey (18%) and Jabil (2%).

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 due to these and other factors.

Net Loss per Share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Potentially dilutive securities have been excluded from the computation of diluted net loss per share as their inclusion is anti-dilutive. The calculation of basic and diluted net loss per share was as follows (in thousands, except per share amounts):

 

     Three Months Ended     Six Months Ended  
     June 29, 2014     June 30, 2013     June 29, 2014     June 30, 2013  

Net loss

   $ (12,330 )   $ (8,673 )   $ (22,635 )   $ (13,089 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares, basic and diluted outstanding

     99,102        71,182        98,926        70,798   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share

   $ (0.12 )   $ (0.12 )   $ (0.23 )   $ (0.18 )
  

 

 

   

 

 

   

 

 

   

 

 

 

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):

 

     Three Months Ended      Six Months Ended  
     June 29, 2014      June 30, 2013      June 29, 2014      June 30, 2013  

Anti-dilutive securities:

           

Warrants to purchase common stock*

     7,800         7,800         7,800         7,800   

Weighted average restricted stock units

     1,367         201         1,313         201   

Weighted-average options to purchase common stock

     18,385         17,061         18,494         17,126   
  

 

 

    

 

 

    

 

 

    

 

 

 
     27,552         25,062         27,607         25,127   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* The warrants are owned by the Tallwood Investors and, if not exercised, will expire on August 24, 2014

Note 2 – 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 no money market funds as of both June 29, 2014 and December 29, 2013.

 

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As of June 29, 2014 and December 29, 2013, the Company’s short-term investments consisted solely of certificates of deposit. The following is a summary of the Company’s short-term investments (in thousands):

 

     June 29, 2014  
     Cost      Gross
Unrealized Gain
     Estimated
Fair Value
 

Certificates of deposit

   $ 1,675       $ —         $ 1,675  
  

 

 

    

 

 

    

 

 

 

 

     December 29, 2013  
     Cost      Gross
Unrealized Gain
     Estimated
Fair Value
 

Certificates of deposit

   $ 3,473       $ —         $ 3,473   
  

 

 

    

 

 

    

 

 

 

There were no unrealized losses on investments aggregated by category as of June 29, 2014.

The Company’s certificates of deposit are classified as available-for-sale as of the balance sheet date. Due to their short term and relatively risk free nature, the face value of the money market funds and certificates of deposit are considered equivalent to their fair value and, therefore, there are no unrealized gains or losses.

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 June 29, 2014 and December 29, 2013 are classified within Level 2 of the fair value hierarchy. 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 held at a financial institution. 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 June 29, 2014 and December 29, 2013 was (in thousands):

 

     June 29, 2014  
     Level 1      Level 2      Level 3      Total  

Certificates of deposit

   $ —         $ 1,675      $ —         $ 1,675   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 29, 2013  
     Level 1      Level 2      Level 3      Total  

Certificates of deposit

   $ —         $ 3,473      $ —         $ 3,473   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 3 – Inventory

Inventory consisted of the following (in thousands):

 

     June 29,
2014
     December 29,
2013
 

Finished goods

   $ 1,336       $ 1,385   

Purchased parts and raw materials

     824         632   
  

 

 

    

 

 

 
   $ 2,160       $ 2,017   
  

 

 

    

 

 

 

The Company has an agreement with eSilicon Corporation (“eSilicon”) under which a majority of its day-to-day supply chain management, production test engineering, and production quality engineering functions have been transferred to 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 basis.

 

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As part of the Service Agreement, the Company initially transferred ownership of certain work-in-process and raw material inventory to eSilicon as prepayment for the future delivery of finished goods. In addition, the Company has prepaid for certain wafers purchased by eSilicon on behalf of the Company. Prepayments under the arrangement were $1.4 million at June 29, 2014, and $0.8 million at December 29, 2013. The prepayments are classified in prepaid expenses. The Company has no work-in-process inventory. As of June 29, 2014, the Company had $5.3 million of non-cancellable purchase obligations with eSilicon.

Note 4 – Property and Equipment

Property and equipment consisted of the following (in thousands):

 

     June 29,
2014
    December 29,
2013
 

Machinery and equipment

   $ 24,391      $ 23,053   

Software

     14,063        11,522   

Computer equipment

     6,128        5,927   

Furniture and fixtures

     991        988   

Leasehold improvements

     1,822        1,842   

Construction in progress

     35        1,051   
  

 

 

   

 

 

 
     47,430        44,383   

Less: Accumulated depreciation and amortization

     (37,669     (35,771
  

 

 

   

 

 

 
   $ 9,761      $ 8,612   
  

 

 

   

 

 

 

Depreciation and amortization expense for property and equipment was $1.0 million and $1.1 million for the three months ended June 29, 2014 and June 30, 2013, respectively. Depreciation and amortization expense for property and equipment was $2.0 million and $2.2 million for the six months ended June 29, 2014 and June 30, 2013, respectively.

Note 5 – Purchased Intangible Assets

The carrying value of intangible assets is as follows (in thousands):

 

     June 29, 2014  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net
Amount
     Useful
life
(Years)
 

Existing technology

   $ 14,825       $ (14,347   $ 478         3   
  

 

 

    

 

 

   

 

 

    
     December 29, 2013  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net
Amount
     Useful
life
(Years)
 

Existing technology

   $ 14,825       $ (14,107   $ 718         3   
  

 

 

    

 

 

   

 

 

    

For the three months ended June 29, 2014 and June 30, 2013, the amortization of intangible assets was $0.1 million and $0.2 million, respectively. For the six months ended June 29, 2014 and June 30, 2013, the amortization of intangible assets was $0.2 million and $0.5 million, respectively. The estimated future amortization of purchased intangible assets as of June 29, 2014 is $0.3 million for the remainder of 2014 and $0.2 million in 2015.

Note 6 – Loan and Security Agreement

On January 14, 2011, the Company entered into the Loan Agreement with SVB under which SVB agreed to make advances under a revolving line of credit 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 SVB’s prime rate or 4.00% plus 50 basis points. The Loan Agreement provides for a first priority perfected lien on, and pledge of, all of the Company’s present and future property and assets. Interest accrues at 0.50% on the average unused portion of the line of credit. 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, the first requiring a minimum quarterly EBITDA amount, the second requiring a minimum monthly Adjusted Quick Ratio (cash, cash equivalents, short-term investments, and accounts receivable divided by current liabilities, net of deferred revenue), and the third requiring a minimum monthly amount of cash held at SVB, all of which are defined in the Loan Agreement.

The Loan Agreement’s original maturity date was January 14, 2013. The Loan Agreement with SVB has been amended and modified periodically – on April 12, 2012, February 19, 2013, August 8, 2013, January 13, 2014, and April 30, 2014 – and the term has been extended to April 14, 2015.

 

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On August 8, 2013, SVB amended the Loan Agreement to change existing financial covenants to coincide with the Company’s revised operating plan. The financial covenants were amended to include the following: 1) a minimum Adjusted Quick Ratio of 1.0:1, tested on a monthly basis, 2) a minimum cash balance to be held with SVB ranging between $10.0 million and $25.0 million, tested on a monthly basis, and 3) a minimum EBITDA amount between zero and $(10.0) million, tested on a quarterly basis. Under the Loan Agreement, the Company may borrow up to $15.0 million limited by the borrowing base calculation. The borrowing base is calculated at 80% of eligible accounts receivable, as defined in the Loan Agreement. All of the Company’s cash collections are applied to the outstanding principal balance on a daily basis, but may be borrowed immediately after pay down. Interest is fixed at SVB’s prime rate plus 250 basis points, with a floor of 4.00%.

On April 30, 2014, the Company sought and received an amendment to the Loan Agreement prospectively eliminating one of the covenants required to be met as of June 29, 2014, and modifying others. The Company anticipates that it will not be in compliance with certain covenants during and as of the end of the third quarter of 2014 as well as during and as of the end of the fourth quarter of 2014. Because the Company foresees challenges in complying with some of the covenants during and after the third quarter of 2014, the Company has begun comprehensive discussions with SVB to revise these covenants. The Company will need to take further actions during the second half of 2014 to generate adequate cash flows or earnings to ensure compliance with the Loan Agreement and fund its capital requirements.

As of December 29, 2013, $12.0 million was owed under the line of credit. All of the Company’s cash collections of its receivables are applied to the outstanding balance, but may be borrowed immediately after pay down. As of March 30, 2014 and June 29, 2014, $8.5 million and $6.9 million, respectively, was owed under the line of credit. As of June 29, 2014, interest on advances against the Loan Agreement was equal to 6.5% on the outstanding principal and is payable monthly. The Company may repay the advances under the Loan Agreement, in whole or in part, at any time, without premium or penalty.

Note 7 – Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

 

     June 29,
2014
     December 29,
2013
 

Accrued compensation and related benefits

   $ 2,564       $ 2,834   

Deferred rent

     829         957   

Deferred revenue

     675         391   

Accrued royalties

     717         844   

Warranty accrual

     149         238   

Other accrued liabilities

     2,499         2,968   
  

 

 

    

 

 

 
   $ 7,433       $ 8,232   
  

 

 

    

 

 

 

The following table summarizes the activity related to warranty (in thousands):

 

     Six Months Ended  
     June 29,
2014
    June 30,
2013
 

Balance, beginning of period

   $ 238      $ 272   

Provision (benefit)

     (33 )     (2 )

Usage

     (56     —     
  

 

 

   

 

 

 

Balance, end of period

   $ 149      $ 270   
  

 

 

   

 

 

 

Note 8 – 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 both the three months ended June 29, 2014 and June 30, 2013, was $0.6 million. Rent expense for both the six months ended June 29, 2014 and June 30, 2013, was $1.2 million. The terms of the facility leases provide for rental payments which increase annually at a predetermined rate. The Company recognizes rent expense on a straight-line basis over the lease period and has accrued for rent expense incurred, but not paid. Deferred rent was $0.8 million and $1.0 million at June 29, 2014 and December 29, 2013, respectively. Future minimum lease payments as of June 29, 2014, under non-cancelable leases with original terms in excess of one year, are $1.3 million for the remainder of 2014, $2.4 million in 2015, $2.0 million in 2016, $1.6 million in 2017, and $0.4 million in 2018.

Purchase Commitments

As of June 29, 2014, the Company had $5.3 million of non-cancellable inventory purchase obligations with eSilicon that are expected to be paid during the remainder of 2014.

 

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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 its contractual indemnification 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.

Litigation

From time-to-time, in the normal course of business, the Company is a party to litigation matters that have involved and may involve in the future, among other things, claims related to intellectual property infringement as well as employment-related disputes. The Company is subject to claims and litigation arising in the ordinary course of business; however, it does not believe, based on currently available facts and circumstances, that the final outcome of these matters, taken individually or as a whole, will have a material adverse effect on its consolidated results of operations or financial position. The results of litigation are inherently uncertain and material adverse outcomes are possible. The Company has not provided accruals for any legal matters in its financial statements as potential losses for such matters are not considered probable and reasonably estimable. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy any liabilities arising from the matters described above will not have a material adverse effect on the Company’s consolidated results of operations, financial position, or cash flows.

Note 9 – Significant Customer Information and Segment Reporting

FASB has established standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It has also established 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 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.

The following table summarizes revenue and percentage of revenue by geographic region, based on the country in which the customer’s headquarters is located (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 29, 2014     June 30, 2013     June 29, 2014     June 30, 2013  

Taiwan

   $ 5,246         47   $ 3,028         16   $ 9,043         35   $ 9,204         20

France

     2,376         21        3,908         20        6,886         27        10,367         23   

Japan

     2,084         19        3,285         17        5,840         23        7,910         18   

China

     218         2        904         5        544         2        2,798         6   

Germany

     111         1        2,188         11        1,313         5        3,809         8   

United States

     76         —          548         3        147         1        671         2   

Other

     1,144         10        5,254         28        1,995         7        10,508         23   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 11,255         100   $ 19,115         100   $ 25,768         100   $ 45,267         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company tracks its products within two product families: Gateway and Access. The Gateway product family includes a variety of processors and software to be incorporated into devices deployed at the customer premises. Gateway products enable service providers to offer their subscribers a variety services, including internet access, voice, over-the-top content, and security. The Access product family consists of semiconductor and software products that power the carrier infrastructure for the central office, as well as any node in a hybrid-fiber-copper network where fiber is terminated and copper is used to reach the consumer premises.

 

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Table of Contents
     Three Months Ended     Six Months Ended  
     June 29, 2014     June 30, 2013     June 29, 2014     June 30, 2013  

Gateway

   $ 8,817         78   $ 13,959         73   $ 19,122         74   $ 33,851         75

Access

     2,438         22        5,156         27        6,646         26        11,416         25   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 11,255         100   $ 19,115         100   $ 25,768         100   $ 45,267         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The distribution of long-lived assets (excluding goodwill, intangible assets and other assets) is as follows (in thousands):

 

     June 29, 2014      December 29, 2013  

United States

   $ 9,267       $ 7,856   

Asia, predominantly India

     494         756   
  

 

 

    

 

 

 
   $ 9,761       $ 8,612   
  

 

 

    

 

 

 

 

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

This Quarterly Report on Form 10-Q, particularly in the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and to future events with respect to our business and industry in general. Statement that include the words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “predict,” “potential,” or the negative of these terms, or other similar expressions, identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe these factors include, but are not limited to, the following: our ability to raise additional capital in the future; our history of losses; our utilization of a revolving credit facility; our ability to amend our credit facility; the risk that our common stock will be delisted; the volatility of our common stock; the opinions of the securities analysts that publish reports regarding our Company; our ability to develop and achieve market acceptance of new products and technologies as we transition away from maturing products; our dependence on a relatively small number of customers; the intensity of the competition we face in the semiconductor industry and the broadband communications market; general macroeconomic declines could reduce demand for our products; cyclical and unpredictable decreases in demand for our semiconductors; our ability to adequately forecast demand for our products; the length of our sales cycle; that the selling prices of our products are subject to decline over time and may do so more rapidly than we anticipate; our reliance on subcontractors to manufacture, test, and assemble our products; our dependence on and qualification of foundries to manufacture our products; changes in our product sales mix; our ability to secure production capacity; our ability to recruit and retain personnel, including our senior management team; the fluctuations in our operating results and expenses; our reliance on third-party technologies in our products; the development and future growth of the broadband digital subscriber line (DSL) and communications processing markets in general; the defense of third-party claims of infringement and the protection of our own intellectual property; currency fluctuations; undetected defects, errors, or failures in our products; the significant number of shares held by a single group of investors; rapidly changing technologies, standards, and regulations; and the effectiveness of our accounting policies and disclosure controls.

The foregoing factors should not be construed as exhaustive and should be read together with other cautionary statements included in this Quarterly Report on Form 10-Q, including under the caption “Risk Factors” in Part II, Item 1A. Moreover, we operate in a very competitive and rapidly changing environment in which new risk factors emerge from time-to-time. It is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Except as required by law, we undertake no obligation to publicly update any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations.

 

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The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1, above, and with our financial statements and notes thereto for the year ended December 29, 2013, contained in our Annual Report on Form 10-K filed on February 28, 2014.

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

Overview

We are a leading provider of advanced semiconductor products and software for delivering high speed broadband solutions to the digital home. Our broadband multi-mode and digital subscriber line (DSL) processors and other semiconductor offerings power carrier infrastructure (referred to as Access) and customer premises equipment (referred to as Gateway) for network equipment manufacturers (NEMs) supplying leading telecommunications service providers. Our products are at the core of DSL access multiplexers (DSLAMs), optical network terminals (ONTs), concentrators, modems, voice over Internet Protocol (VoIP) terminal adapters, integrated access devices (IADs), and residential gateways (RGs). Our products have been deployed by service providers globally, including in Asia, Europe, and North and South America, and are also actively being evaluated and scheduled to be evaluated by other service providers for deployment in their networks.

Our products reflect advanced designs in silicon, systems, and firmware and are programmable and highly scalable. Our expertise in the 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. We are releasing new VDSL-based solutions to the market that offer vectoring and bonding to increase speeds over existing telecom carrier copper infrastructure. These products support high speed broadband service providers’ multi-play deployment plans to the digital home, while keeping their capital and operating expenditures relatively low compared to competing frameworks. Our broadband DSL products consist of high performance Access and Gateway semiconductors. We have demonstrated: (1) an aggregate downstream and upstream rate of 300 megabits per second (Mbps) over a single pair copper line at a distance of up to 200 meters, and (2) 150 Mbps aggregate data rate up to a distance of 500 meters. Our product revenue mix over the last three years has transitioned away from ADSL in favor of VDSL, in-line with global market trends. We also offer a line of multi-mode communications processors (CPs) for RGs that support a variety of wide area network (WAN) topologies for telecom carriers, wireless carriers, and cable multiple system operators (MSOs), including Ethernet and gigabit Ethernet, passive optical network (PON), DSL, and wireless broadband. In addition to our DSL and RG processors, we recently announced inSIGHT, our new suite of Gateway-based software products. inSIGHT will offer carriers the ability to remotely monitor and diagnose line impairments and noise issues to facilitate fast and cost-effective discovery and resolution of service disruptions, thereby increasing their subscriber satisfaction rate and reducing operating costs.

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. In 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 basis. During the first half of 2012, we began to transition these Master Services to eSilicon. Our semiconductor customers consist primarily of NEMs, original design manufacturers (ODMs), contract manufacturers (CMs), and original equipment manufacturers (OEMs), and include vendors such as Sagemcom SAS (Sagemcom), Askey Computer Corporation (Askey), NEC Corporation (NEC), and AVM Computersysteme Vertriebs GmbH (AVM). Our products are deployed in the networks of telecom carriers such as AT&T Inc. (AT&T), Bell Canada, Orange S.A. (formerly, France Telecom) (Orange), KDDI Corporation (KDDI), and Nippon Telegraph and Telephone Corporation (NTT).

We incurred a net loss of $12.3 million and $22.6 million, respectively, for the quarter and six months ended June 29, 2014 and had an accumulated deficit of $348.7 million as of June 29, 2014. 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.

In January 2011, we entered into a Loan and Security Agreement (Loan Agreement) with Silicon Valley Bank (SVB), which provides us with a revolving line of credit of up to $15.0 million. The Loan Agreement’s original maturity date was April 14, 2013, but the Loan Agreement has been amended and modified periodically – on April 12, 2012, February 19, 2013, August 8, 2013, January 13, 2014, and April 30, 2014 – and the term extended to April 14, 2015.

From time-to-time we have drawn down our line of credit for working capital purposes and to partially fund our operations, and subsequently we have repaid the amount. As of June 29, 2014, $6.9 million was outstanding under the Loan Agreement. Interest on advances against the line is equal to 6.5% as of June 29, 2014, and is payable monthly. All cash collections of our receivables are applied to the outstanding balance, but may be borrowed immediately after pay down. We may repay the advances under the Loan Agreement, in whole or in part, at any time, without premium or penalty.

 

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On April 30, 2014, we sought and received an amendment to the Loan Agreement prospectively eliminating one of the covenants required to be met as of June 29, 2014, and modifying others. We anticipate that we will not be in compliance with certain covenants during and as of the end of the third quarter of 2014 as well as during and as of the end of the fourth quarter of 2014. Because we foresee challenges in complying with some of the covenants during and after the third quarter of 2014, we have begun comprehensive discussions with SVB to revise these covenants. We will need to take further actions during the second half of 2014 to generate adequate cash flows or earnings to ensure compliance with the Loan Agreement and fund our capital requirements.

We filed a Registration Statement on Form S-1 on August 23, 2013 and amended it thereafter (and was declared effective on November 6, 2013) under which we might offer and sell up to $35.0 million of common stock. On November 7, 2013 and November 22, 2013, we sold an aggregate of 26.4 million shares of common stock in an underwritten offering for $26.4 million. After deducting underwriting fees, legal, accounting, and other costs, we realized net proceeds of $24.0 million.

Beginning on January 31, 2014, our common stock began to trade below $1.00 per share on The NASDAQ Capital Market (NASDAQ). On March 18, 2014, we received notification from NASDAQ indicating that we were not in compliance with Nasdaq Marketplace Rule 5550(a)(2), which Rule provides that securities listed by NASDAQ must maintain a minimum closing bid price of $1.00 per share and that, based upon the closing bid price for our securities for the previous 30 consecutive business days, we no longer meet this requirement. NASDAQ further notified us that, in accordance with Nasdaq Marketplace Rule 5810(c)(3)(A), we will be provided 180 calendar days, or until September 15, 2014, to regain compliance by achieving a closing bid price of our securities of at least $1.00 per share for a minimum of ten consecutive business days at any time during the 180 calendar day period. However, there can be no guarantee that we will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the 180 calendar day period. In the event that we do not regain compliance by September 15, 2014, NASDAQ also notified us that we may be eligible for a second 180 calendar day compliance period provided that we continue to meet the continued listing requirements of NASDAQ, with the exception of the bid price requirement, and provide written notice of the our intention to cure the deficiency during the second 180 calendar day compliance period. Even if granted a second 180 calendar day compliance period, there can be no guarantee that we will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the second 180 calendar day compliance period.

We were incorporated in April 1999 and, through December 31, 2001, we were engaged principally in research and development. We began commercial shipment of our products in the fourth quarter of 2002. Our revenue was $136.6 million in 2011, $125.9 million in 2012, and $79.7 million in 2013.

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 the limited number of products that we offer. These quarterly fluctuations can result from a variety of factors, including 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 generally 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 may also be 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. In addition to these qualifications, our operations may be adversely affected by our customers’ transition strategies from existing systems that use our products to systems that may not use our products. 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 impact future revenues. In some cases, products may become mature or uncompetitive causing customers to transition to solutions from other manufacturers, in whole or in part.

It is inherently difficult to predict: (1) if and when platforms will pass qualification; and (2) 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 OEMs and service providers do not always share all of the information available to them regarding qualification and deployment criteria. 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. To the extent that we manufacture inventory to a forecast, we may have excess inventory if the forecast differs from actual results.

We have several new products in development. We believe that our team of engineers, and our current products, technology, patents, and other intellectual property will allow us to create new products that could increase our market share and enable us to

 

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implement our digital home initiatives, our next generation VDSL development, and our future G.fast products. However, many of these new products may not offset the declines in revenue of our more mature products during the near term. Failure to generate 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.

Critical Accounting Policies and Estimates

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

The critical accounting policies, are described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the year ended December 29, 2013, and have not changed materially as of June 29, 2014.

Results of Operations

Revenue

Our revenue is derived from sales of our semiconductor products. Revenue from product sales is generally recognized upon shipment, net of sales returns, rebates, and allowances. Product sales to distributors are recognized based on contractual terms. As is typical in our industry, the selling prices of our products generally decline over time. Therefore, our ability to increase revenue is dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in greater quantities. Our ability to increase unit sales volume is primarily dependent upon our ability to increase and fulfill current customer demand and obtain new customers. The rate at which broadband infrastructure may be upgraded could be slow or new broadband programs could be delayed.

Revenue for the second quarter of 2014 declined by $7.9 million, or 41%, to $11.3 million from $19.1 for the second quarter of 2013 and $6.3 million or, 36%, from the fourth quarter of 2013. Our three largest customers accounted for approximately 72% of our revenue in the second quarter of 2014, while our three largest customers accounted for 43% of our revenue in the second quarter of 2013. Revenue for the first half of 2014 declined by $19.5 million, or 43%, to $25.8 million from $45.3 for the first half of 2013. Our three largest customers accounted for approximately 65% of our revenue in the first half of 2014 while our three largest customers accounted for 51% of our revenue in the first half of 2013. Revenue from Asia remained unchanged and accounted for 69% and 61% of our revenue for the second quarter and first six months, respectively, of 2014. Revenue from Europe declined by 50% and accounted for 27% and 36% of our revenue for the second quarter and first six months, respectively, of 2014. Sales from our next generation Gateway product chipsets (Fusiv Vx185, Vx183, Vx175, and Vx173) continues to grow as a percentage of total revenue. However, even with the introduction of these new products, we continue to be adversely affected by the decline in sales of our more mature products.

Two factors are primarily responsible for our continuing revenue decline from 2013 into 2014 and this trend may continue. First, the decline that we have seen in our more mature products, particularly in Korea and Japan, has been greater than expected and outpaced the growth in revenue of our new products. However, concurrent with this, we have seen a continuing shift in our revenue mix in favor of our new products. Revenue from new products (Vx183/185/180/175/173 and Velocity-1) reached approximately 75% and 80%, respectively, in the second quarter and the first six months of 2014 versus approximately 59% and 57%, respectively, in the second quarter and first six months of 2013. Secondly, we experienced delays in the introduction of certain new products, which pushed out the ramp of these new products in some end markets. We anticipate that customer ramps of our new products will continue to gain momentum.

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 have also entered into volume purchase agreements with certain customers who provide us with non-binding forecasts. Although certain OEM customers may provide us with rolling forecasts, our ability to predict future sales in any given period is limited and subject to change based on demand for our OEM customers’ systems and their supply chain decisions. Historically, a small number of OEM customers, the composition of which has varied over time, have accounted for a substantial portion of our revenue, and we expect that significant customer concentration will continue for the foreseeable future. However, our sales strategy is to seek out a broader customer base.

 

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

 

     Three Months Ended     Six Months Ended  
Our Direct Customer    June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Amod Technology Co., Ltd**

     35     *     27     *

Paltek Corporation

     19        11        13        10   

Sagemcom SAS

     18        20        25        23   

NEC Asia Pacific Pte. Ltd.

     *        *        10        *   

Askey Computer Corporation***

     *        12        *        18   

AVM Computer Systems

     *        11        *        *   

 

* Less than 10%
** Amod is a distributor whose purchases from Ikanos are contracted to its end customer Askey.
*** Askey is a contract manufacturer for Sagemcom.

Revenue by Country as a Percentage of Total Revenue

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Taiwan

     47     16     35     20

France

     21        20        27        23   

Japan

     19        17        23        18   

China

     2        5        2        6   

Germany

     1        11        5        8   

United States

     —          3        1        2   

Other

     10        28        7        23   

The table above reflects sales to our direct customers based on the country in which the customer’s headquarters is located. It does not necessarily reflect carrier deployment of our products as we do not sell directly to carriers. France, Taiwan, and Japan continue to be the countries to which we sell the majority of our products. Actual sales to each country declined in the second quarter and the first six months of 2014 as compared to the same periods of 2013.

Revenue by Product Family as a Percentage of Total Revenue

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Gateway

     78 %     73 %     74 %     75 %

Access

     22        27        26        25   

We track our products within two product families: Gateway and Access. The Gateway product family includes a variety of processors and software to be incorporated into devices deployed at the customer premises. Gateway products enable service providers to offer their subscribers a variety services, including internet access, voice, over-the-top content, and security, among others. The Access product family consists of semiconductor and software products that power the carrier infrastructure, as well as any node in a hybrid-fiber-copper network where fiber is terminated and copper is used to reach the consumer premises.

Cost and Operating Expenses

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
     June 30,
2013
     %
Change
    June 29,
2014
     June 30,
2013
     %
Change
 

Cost of revenue

   $ 5,775       $ 9,813         (41 )%    $ 13,211       $ 22,009         (40 )% 

Research and development

     13,408         12,599         6        26,084         26,117         —     

Sales, general and administrative

     4,105         4,866         (16     8,926         9,638         (7

Cost and Operating Expenses as a Percentage of Total Revenue:

 

     Three Months Ended     Six Months Ended  
     June 29,
2014
    June 30,
2013
    June 29,
2014
    June 30,
2013
 

Cost of revenue

     51 %     51 %     51 %     49 %

Research and development

     119        66        101        58   

Sales, general and administrative

     36        25        35        21   

 

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

Cost of revenue was $5.8 million for the three months ended June 29, 2014, compared to $9.8 million for the three months ended June 30, 2013. Cost of revenue was $13.2 million for the six months ended June 29, 2014, compared to $22.0 million for the six months ended June 30, 2013. The decline in both the three and six month periods is directly related to our lower revenues. Gross margin was 49% for both the second quarter of 2014 and the second quarter of 2013. Gross margins in our Gateway product lines were slightly higher in the second quarter of 2014 as compared to 2013, but this was offset by lower margins in our Access product lines. Gross margins were 49% for the first six months of 2014 as compared to 51% for the first six months of 2013. During the first six months of 2014 the margins benefitted from the recognition of $0.5 million of software-related revenue, while during the first six months of 2013 margins benefitted from the recognition of $2.5 million of previously deferred revenue related to certain software obligations that we completed and delivered in the first quarter of 2013.

Research and development

All research and development (R&D) expenses are charged to earnings as incurred. R&D expenses generally consist of compensation and related expenses for employees (including stock-based compensation) and contractors engaged in research and development; tape-out expenses; reference board development; development testing, evaluation kits and tools; 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 collectively as tape-out expenses. These tape-out expenses may cause our R&D expenses to fluctuate because they are not incurred uniformly every quarter.

R&D expenses increased $0.8 million, or 6%, to $13.4 million for the three months ended June 29, 2014, as compared to $12.6 million for the three months ended June 30, 2013. Personnel costs were lower by $0.4 million in the second quarter of 2014 as compared to the comparable period in 2013. Consulting and contractor costs were lower by $0.6 million in the second quarter of 2014 as compared to the second quarter of 2013. Tapeout costs increased by $1.7 million in the second quarter of 2014 as compared to the second quarter of 2013, due principally to the tapeout of our Vx58x product family.

R&D expenses were $26.1 million for both the six months ended June 29, 2014 and June 30, 2013. Tapeout costs, due principally to the tapeout of our Vx58x product family, increased by $2.3 million for the six months ended June 29, 2014, versus the comparable 2013 period. Offsetting these increases were lower: personnel costs, $0.4 million; license fees, $0.5 million; consulting and contractor fees, $0.9 million; facilities, including depreciation, $0.2 million; and outside services, $0.3 million.

Our R&D personnel are located in the United States and India. At June 29, 2014, we had 186 people engaged in R&D, of which 126 were located in the United States and the remainder in India. At June 30, 2013, we had 204 people engaged in R&D, of which 138 were located in the United States and the remainder in India.

Selling, general and administrative

Selling, general and administrative (SG&A) expenses generally consist of compensation and related expenses for personnel; legal, recruiting, and auditing fees; and depreciation. SG&A expenses declined by $0.8 million, or 16%, to $4.1 million for the three months ended June 29, 2014, from $4.9 million for the three months ended June 30, 2013. Personnel costs were lower by $0.2 million; bad debt expense was lower by $0.2 million; audit and legal costs were lower by $0.2 million; and the amortization of intangibles declined by $0.1 million. For the six months ended June 29, 2014, SG&A expenses declined by $0.7 million, or 7%, to $8.9 million from $9.6 million for the six months ended June 30, 2013. Personnel costs were lower by $0.2 million; audit and legal fees were lower by $0.3 million; and the amortization of intangibles was lower by $0.2 million.

At June 29, 2014, SG&A headcount was 58 compared to 52 at June 30, 2013.

 

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Interest and other income (expense), net

Interest and other income (expense), net consists primarily of interest income earned on our short-term investments, interest expense, and foreign exchange gains and losses. For the three months ended June 29, 2014, interest and other income was a loss of $0.1 million, as compared to a loss of $0.4 million for the three months ended June 30, 2013. The losses were attributable to fluctuations in the foreign exchange rates in both the Indian rupee and the euro. For the six months ended June 29, 2014, interest and other income was a gain of $0.1 million as foreign exchange gains and interest income offset interest expense. For the six months ended June 30, 2013, foreign exchange losses of $0.5 million were only partially offset by interest income of $0.2 million.

Provision for income taxes

Income tax expense is recognized based on management’s estimate of the annual income tax rate expected for the full year. The estimated annual tax rate we use for the year ending December 29, 2014 is 41%, which has been applied to the income before taxes for the three and six month periods ended June 29, 2014. The actual tax rates for the three and six months ended June 29, 2014 were 64.7% and 39.7%, respectively. The provisions for income taxes were $0.2 million and $0.3 million, respectively, for the three and six months ended June 29, 2014. The provisions for income taxes were $0.1 million and $0.2 million, respectively for the three and six months ended June 29, 2013. The income tax expense for both 2014 and 2013 is primarily the result of income taxes in various profitable foreign jurisdictions.

Net loss

As a result of the above factors, we had a net loss of $12.3 million for the three months ended June 29, 2014, as compared to a net loss of $8.7 million for the three months ended June 30, 2013. For the six months ended June 29, 2014, we had a net loss of $22.6 million as compared to a net loss of $13.1 million for the six months ended June 30, 2013. Over the past several years, we have taken 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. As appropriate, we have restructured parts of our business due to changes in the nature of our business and the business environment in which we operate. In addition, we have reduced our unit manufacturing costs by working to achieve better wafer pricing based on a larger volume of purchases, consolidating business with vendors, and reducing other input costs.

Liquidity, Capital Resources, and Going Concern

Cash, cash equivalents, and short-term investments declined by $18.9 million to $20.6 million as of June 29, 2014, as compared to $39.5 million as of December 29, 2013. Cash and short-term investments held by foreign subsidiaries were $5.1 million and $6.5 million at June 29, 2014 and December 29, 2013, respectively.

As a result of our recurring losses from operations, our accumulated deficit, and the anticipated need to revise our covenants with SVB, we will be required to raise additional capital in the short-term to remain in compliance with certain debt covenants and to fund our on-going operating and capital requirements. Accordingly, there is uncertainty regarding our ability to maintain liquidity sufficient to operate our business effectively, which raises substantial doubt as to our ability to continue as a going concern. If we are unable to raise additional capital in the short-term, we will cease to continue as a going concern. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to us.

We have funded our operations primarily through cash generated from the sale of our products, our revolving line of credit, cash from private and public offerings of our common stock, and proceeds from the exercise of stock options. Our uses of cash include payroll and payroll-related expenses, manufacturing costs, and purchases of equipment, tools, and software, as well as operating expenses, such as tapeouts, marketing programs, travel, professional services, facilities, and other costs. Additional working capital will be needed in the short-term to fund and operate our business. In addition to our existing cash balances and our revolving line of credit, we will require additional cash resources in the short-term and believe that such funds will be available either through the issuance of additional equity or other debt. However, there can be no assurance that such additional capital will be sufficient or available, and, if available, that such capital will be offered on terms and conditions acceptable to us.

The following table summarizes our statement of cash flows for the six months ended June 29, 2014 and June 30, 2013 (in millions):

 

     2014     2013  

Statements of Cash Flows Data:

    

Cash and cash equivalents—beginning of period

   $ 36.0      $ 28.4   

Net cash used in operating activities

     (12.4     (5.4

Net cash used in investing activities

     —          (0.8 )

Net cash provided by (used in) financing activities

     (4.7     3.6   
  

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 18.9      $ 25.8   
  

 

 

   

 

 

 

 

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The Loan Agreement, entered into with SVB on January 14, 2011, has been amended periodically – on April 12, 2012, February 19, 2013, August 8, 2013, January 13, 2014, and April 30, 2014 – and the term extended to April 14, 2015.

On August 8, 2013, SVB agreed to amend the Loan Agreement and revised the existing financial covenants to include the following: 1) a minimum Adjusted Quick Ratio (as defined in the Loan Agreement) of 1.0:1, tested on a monthly basis, 2) a minimum cash balance to be held with SVB ranging between $10.0 million and $25.0 million, tested on a monthly basis, and 3) a minimum EBITDA amount between zero and $(10.0) million, tested on a quarterly basis. Under the Loan Agreement, we may borrow up to $15.0 million limited by the borrowing base calculation. The borrowing base is calculated at 80% of eligible accounts receivable, as defined in the Loan Agreement. All cash collections of our receivables are applied to the outstanding principal balance on a daily basis, but may be borrowed immediately after pay down. Interest is fixed at SVB’s prime rate plus 250 basis points, with a floor of 4.00%.

On April 30, 2014, the Company sought and received an amendment to the Loan Agreement prospectively eliminating one of the covenants required to be met as of June 29, 2014, and modifying others. We anticipate that we will not be in compliance with certain covenants during and as of the end of the third quarter of 2014 as well as during and as of the end of the fourth quarter of 2014. Because we foresee challenges in complying with some of the covenants during and after the third quarter of 2014, we have begun comprehensive discussions with SVB to revise these covenants. There can be no assurance that we will be successful in revising the covenants with SVB. If we are not successful in revising the covenants with SVB, we will need to obtain a replacement debt facility or raise additional cash, or we will cease to continue as a going concern.

Operating Activities

For the six months ended March 30, 2014, we used $12.4 million of net cash in operating activities, while incurring a net loss of $22.6 million. Included in the net loss was approximately $4.2 million in various non-cash expenses consisting of depreciation, stock-based compensation expense, and the amortization of intangible assets and acquired technology. Operating cash flows also benefited from decreases in accounts receivable of $6.5 million related to lower revenue and increases of accounts payable and accrued liabilities of $0.2 million offset by increases in inventory of $0.6 million and increases in prepaid expenses and other assets of $0.5 million.

For the six months ended June 30, 2013, we used $5.4 million of net cash in operating activities, while incurring a net loss of $13.0 million. Included in the net loss was approximately $4.4 million in various non-cash expenses consisting of depreciation, stock-based compensation expense, and the amortization of intangible assets and acquired technology. Operating cash flows also benefited from decreases in accounts receivable of $3.7 million related to lower revenue, inventory of $4.1 million as revenue has declined throughout the first six months, and prepaid expenses and other assets of $2.0 million as prepayments to eSilicon under our Service Agreement have declined. These items have been partially offset by lower accounts payable and accrued liabilities of $6.5 million due to lower revenue.

Investing Activities

During the six months ended June 29, 2014, investing activities resulted in no change in cash as purchases of property and equipment were $1.8 million offset by net proceeds of $1.8 million from maturities and sales of investments. During the six months ended June 30, 2013, cash used in investing activities was $0.8 million, which was comprised of purchases of property and equipment of $2.0 million offset by net proceeds of $1.2 million from maturities and sales of investments.

We have classified our investment portfolio as “available for sale.” Our investment objectives are to preserve principal and provide liquidity, while maximizing yields without significantly increasing risk. Any excess funds are currently invested in short-term certificates of deposit and are included in short-term investments on the balance sheet. We 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 the six months ended June 29, 2014, cash used in financing activities was $4.7 million. Proceeds from share purchases under our Employee Stock Purchase Plan were $0.4 million. Net repayments under our Loan Agreement amounted to $5.1 million as we repaid $12.0 million and drew down $6.9 million. During the six months ended June 30, 2013, cash provided by financing activities was $3.6 million. Proceeds from the exercise of stock options and share purchases under our Employee Stock Purchase Plan amounted to $1.1 million. Net proceeds from the revolving line of credit under the Loan Agreement were $2.5 million as we drew down $12.5 million and repaid $10.0 million.

 

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Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued accounting guidance, “Revenue from Contracts with Customers,” which will replace most existing revenue recognition guidance under U.S. GAAP. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the effect that the standard will have upon our consolidated financial statements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

All market risk sensitive instruments were entered into for non-trading purposes. We do not use derivative financial instruments for speculative trading purposes. As of June 29, 2014, we did not hold derivative financial instruments.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and to advances from our line of credit with SVB. We do not have 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. Our investments currently consist primarily of short-term certificates of deposit and are carried at market value. Advances against our line of credit are used to help fund operations. Advances are taken when needed and repaid when such funds are no longer necessary.

As of June 29, 2014, we had cash and cash equivalents of $18.9 million. Short-term investments were $1.7 million and were invested in short-term certificates of deposit. We do not enter into investments for trading or speculative purposes. If the return on our certificates of deposit were to change by one hundred basis points, the effect would be immaterial. As of June 29, 2014, advances against the line of credit were $6.9 million. If the interest on the advances from the line of credit were to change by one hundred basis points, the effect would be immaterial.

Foreign Currency Risk

Our revenue and costs, including subcontracted manufacturing expenses, 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, predominantly the Indian rupee, and to a lesser extent the euro, the Japanese yen, the Korean won, 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 change fiscal year 2014 projected operating expenses by approximately $1.0 million.

 

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures.

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Exchange Act, that are designed 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. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can only provide reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. The design of any disclosure controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under any potential future condition. Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

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Changes in Internal Controls over Financial Reporting.

There was no change in our internal control over financial reporting during the quarter ended June 29, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

 

Item 1. Legal Proceedings

From time-to-time, in the normal course of business, we are a party to litigation matters that have involved and may involve in the future, among other things, claims related to intellectual property infringement as well as employment-related disputes. We are subject to claims and litigation arising in the ordinary course of business, however, we do not believe, based on currently available facts and circumstances, that the final outcome of these matters, taken individually or as a whole, will have a material adverse effect on our consolidated results of operations or financial position. The results of litigation are inherently uncertain and material adverse outcomes are possible. We have not provided accruals for any legal matters in our financial statements as potential losses for such matters are not considered probable and reasonably estimable. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy any liabilities arising from the matters described above will not have a material adverse effect our consolidated results of operations, financial position, or cash flows.

 

Item 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 Quarterly Report on Form 10-Q, 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, 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 Financial Condition

We will need to raise additional capital or we will cease to continue as a going concern.

We will not have cash sufficient to meet our anticipated cash needs for the foreseeable future and we will need to seek financing in the near term. These financings could include the sale of equity securities (which would result in dilution to our stockholders) or we may incur additional indebtedness (which would result in increased debt service obligations and could result in additional operating and financial covenants that would restrict our operations). There can be no assurance, however, that any such equity or debt financing will be available in amounts or on terms acceptable to us, if at all. The failure to obtain additional equity or debt financing, if needed, could have a material adverse effect on our business, liquidity, and financial condition.

We have a history of losses, and future losses or the inability to raise additional capital may adversely impact our ability to continue as a going concern.

Our consolidated financial statements have been prepared on a going concern basis that assumes we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future. The report of our independent registered public accounting firm for the year ended December 29, 2013, included in our Annual Report on Form 10-K, filed with the SEC on February 28, 2014, contains an explanatory paragraph indicating that there is substantial doubt as to our ability to continue as a going concern as a result of recurring losses from operations. 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 $348.7 million as of June 29, 2014.

We utilize a revolving credit facility to fund our operations. Should we no longer have access to the revolving line of credit, it would materially impact our business, financial condition, and liquidity.

On January 14, 2011, we entered into a Loan and Security Agreement (Loan Agreement) with Silicon Valley Bank (SVB). Under the Loan Agreement we may borrow up to $15.0 million, subject to certain limitations. From time-to-time we draw advances under the Loan Agreement and repay the advance as our receivables are collected. As of June 29, 2014, the balance under the Loan Agreement was $6.9 million. The Loan Agreement is collateralized by a first priority perfected lien on, and pledge of, all of our present and future property and assets. We were in compliance with all covenants contained in the Loan Agreement as of June 29, 2014. However, we anticipated that we may not be in compliance with a certain covenant as of the end of the second quarter of 2014, and therefore sought and received a waiver from SVB with respect to this covenant in an amendment dated April 30, 2014. We anticipate that we may not be in compliance with certain covenants during and as of the end of the third quarter of 2014, as well as during and as of the end of the fourth quarter 2014. Because we foresee challenges in complying with some of the covenants after the third quarter of 2014, we have begun comprehensive discussions with SVB to revise these covenants. We will need to take further

 

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actions during the second half of 2014 to generate adequate cash flows or earnings to ensure compliance with the Loan Agreement and to fund our capital requirements. There can be no assurance that we will be successful in obtaining further amendments to the Loan Agreement from SVB. The failure to obtain any necessary amendment could result in any advances under the Loan Agreement being repayable immediately on demand, which would have a material adverse effect on our business, liquidity, and financial condition.

Our Loan Agreement is subject to contractual and borrowing base limitations, which could adversely affect our liquidity and business.

The maximum amount we can borrow under our Loan Agreement is subject to contractual and borrowing base limitations, which could significantly and negatively impact our future access to capital required to operate our business. Borrowing base limitations are based upon eligible accounts receivable. If our accounts receivable are deemed ineligible, because, for example, they are resident outside certain geographical regions or a receivable is older than 90 days, the amount we can borrow under the revolving credit facility would be reduced. These limitations could have a material adverse impact on our liquidity and business.

Our Loan Agreement contains financial covenants that may limit our operating and strategic flexibility.

Our Loan Agreement contains financial covenants and other restrictions that limit our ability to engage in certain types of transactions. For example, these restrictions limit our ability to, or do not permit us to, incur additional debt, pay cash dividends, make other distributions or repurchase stock, engage in certain merger and acquisition activity, and make certain capital expenditures. There can be no assurance that we will be in compliance with all covenants in the future or that SVB will agree to modify the Loan Agreement, should that become necessary.

Events beyond our control could affect our ability to comply with these covenants. Failure to comply with any of these covenants or restrictions could result in a default under the Loan Agreement. If we do not cure an event of default or obtain necessary waivers within the required time periods, SVB would be permitted to accelerate the maturity of the debt under the Loan Agreement, foreclose upon our assets securing the debt, and terminate any further commitments to lend. Under these circumstances, we may not have sufficient funds or other resources to satisfy our other obligations. In addition, the limitations imposed by the Loan Agreement may significantly impair our ability to obtain other debt or equity financing.

There can be no assurance that any waivers we request will be received on a timely basis, if at all, or that any waivers obtained will extend for a sufficient period of time to avoid an acceleration event, an event of default, or other restrictions on our business. The failure to obtain any necessary waivers could have a material adverse effect on our business, liquidity, and financial condition.

Our history of losses as well as future losses or inability to raise additional capital, may adversely impact our relationships with customers and potential customers.

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 $348.7 million as of June 29, 2014. To achieve profitability, we will need to generate and sustain higher revenue and 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 we were able to attain profitability, we may not be able to sustain profitability on an on-going quarterly or annual basis. 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 and this, in turn, may adversely affect our financial results.

Risks Related to Our Common Stock

Our common stock is currently trading below $1.00. If our common stock continues to trade below $1.00, our stock could be delisted from The NASDAQ Capital Market, which action could adversely affect the market liquidity of our common stock and harm our business.

Beginning on January 31, 2014, our common stock began to trade below $1.00 per share on The NASDAQ Capital Market (“NASDAQ”). On March 18, 2014, we received notification from NASDAQ indicating that we were not in compliance with Nasdaq Marketplace Rule 5550(a)(2), which Rule provides that securities listed by NASDAQ must maintain a minimum closing bid price of $1.00 per share and that based upon the closing bid price for our securities for the previous 30 consecutive business days, we no longer meet this requirement. NASDAQ further notified the us that, in accordance with Nasdaq Marketplace Rule 5810(c)(3)(A), we will be provided 180 calendar days, or until September 15, 2014, to regain compliance by achieving a closing bid price of our securities of at least $1.00 per share for a minimum of ten consecutive business days at any time during the 180 calendar day period. However, there can be no guarantee that we will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the 180 calendar day period. In the event that we do not regain compliance by September 15, 2014, NASDAQ also notified us that we may be eligible for a second 180 calendar day compliance period provided that we continue to meet the continued listing requirements of NASDAQ, with the exception of the bid price requirement, and provide written notice of the our intention to cure the deficiency during the second 180 calendar day compliance period. Even if granted a second 180 calendar day compliance period, there can be no guarantee that we will be able to regain compliance with the continued listing requirement of Nasdaq Marketplace Rule 5550(a)(2) within the second 180 calendar day compliance period.

 

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If we are again subject to delisting for any reason, including the failure to maintain the minimum closing bid price, such action would adversely affect the market price and liquidity of the trading market for our common stock and our ability to obtain financing for the continuation of our operations and could result in the loss of confidence by our investors, suppliers, and employees.

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:

 

    quarter-to-quarter variations in our operating results;

 

    failure to comply with NASDAQ minimum bid price, as indicated above;

 

    changes in our senior management;

 

    the success or failure of our new products;

 

    the gain or loss of one or more significant customers or suppliers;

 

    announcements of technological innovations or new products by our competitors, customers, or us;

 

    the gain or loss of market share in any of our markets;

 

    general economic and political conditions;

 

    specific conditions in the semiconductor industry and broadband technology markets, including seasonality in sales of consumer products into which our products are incorporated;

 

    continuing international conflicts and acts of terrorism;

 

    changes in earnings estimates or investment recommendations by analysts;

 

    changes in investor perceptions;

 

    changes in product mix; or

 

    changes in expectations relating to our products, plans, and strategic position or those of our competitors or customers.

The closing sales price of our common stock for the period of December 26, 2008 to June 29, 2014 ranged from a low of $0.40 to a high of $3.41. In addition, the market prices of securities of semiconductor and other technology companies have been volatile, particularly for companies like us, with relatively 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.

If the securities analysts who currently publish reports on us do not continue to publish research or reports about our business, or if they issue an adverse opinion regarding our common stock, the market price of our common stock 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 and our business. Currently, two analysts periodically publish reports about our Company. If either of these two analysts issue an adverse opinion regarding our common stock, the stock price would likely decline. If the analysts cease coverage of us or fail 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 in general, 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:

 

    the right of our Board of Directors to expand the size of our Board and to elect directors to fill any such vacancies;

 

    the establishment of a classified Board of Directors, which provides that not all members of the Board are elected at one time;

 

    the prohibition of cumulative voting in the election of directors which would otherwise allow less than a majority of stockholders to elect director candidates;

 

    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;

 

    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;

 

    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;

 

    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

 

    no right of stockholders to call a special meeting of stockholders or 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 be without these provisions.

Due to the significant number of shares of our common stock that the Tallwood Investors hold, as discussed below, 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.

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 our more mature products are decreasing as these products near end-of-life. Beginning in the third quarter of 2012, we began selling our next generation Gateway product Fusiv Vx185, Vx183, Vx175, and Vx173 chipsets. Further, we are currently developing a new broadband DSL Access platform that incorporates 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. Our newer products and services, including our Vx585 family, Velocity-3, and Velocity-Uni products, may be delayed, and new products may not be accepted by the market, may be accepted later than anticipated, or may be replaced by newer products more quickly 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 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, and reputation.

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 significant new 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 significant customers. Our five largest customers accounted for approximately 84% of our revenue in the second quarter of 2014 and 80% for the first six months of 2014. For the three months ended June 29, 2014, Amod Technology Inc., Ltd. (a distributor selling exclusively to Sagemcom’s OEM), Paltek Corporation, and Sagemcom SAS, represented 35%, 19%, and 18% of our revenue, respectively. For the three months ended June 30, 2013 and Sagemcom, Askey Computer Corporation (a contract manufacturer for Sagemcom), AVM Computersysteme Vertriebs GmbH, and Paltek Corporation represented 20%, 12%, 11%, and 11% of our revenue in 2013, respectively. The composition and concentration of these customers has varied in the past, and we expect that it will continue to vary in the future. Accordingly, 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.

Our lack of long-term agreements with our customers could have a material adverse effect on our business.

We typically do not have contracts with our major customers that obligate them to purchase any minimum amount of products from us. Sales to these customers are made pursuant to purchase orders, which typically can be canceled or modified up to a specified point in time, which may be after we have incurred significant costs related to the sale. If any of our key customers significantly reduced or canceled its orders, our business and operating results could be adversely affected. Because many of our semiconductor products have long product design and development cycles, it would be difficult for us to replace revenues from key customers that reduce or cancel their existing orders for these products, which may happen if they experience lower than anticipated demand for their products or cancel a program. Any of these events could have a material adverse effect on our business.

 

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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 and communications processing markets, we currently compete or expect to compete with, among others, Broadcom Corporation, Cavium, Inc., Freescale Semiconductor, Inc., Lantiq Deutschland GmbH, Marvell Technology Group Ltd., MediaTek Inc., PMC-Sierra, Inc., and Realtek Semiconductor Corp.

Many of our competitors have stronger manufacturing subcontractor relationships than we have as well as 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 than we are able to. 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 and our revenue may fail to increase or may decline.

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 design wins. We often incur significant expenditures over multiple 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 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.

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, 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 equipment rather than purchasing new equipment, canceled or delayed new deployments, 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 could result in our accumulating 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, addressing technical issues arising from development efforts, unanticipated tapeout costs, additional or unanticipated costs for manufacturing or components 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, including, implementation of a corporate restructuring plan. We last implemented a restructuring plan in 2012. Restructuring charges included expenses related to the severance for terminated employees and other exit-related costs arising from contractual and other obligations.

 

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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 continues into 2014, particularly in Europe, negatively affected consumer confidence and spending. These outcomes and behaviors may adversely affect our business and financial condition. If individual consumers decide not to install—or discontinue purchasing—broadband services in their homes, whether to save money in an uncertain economic climate or otherwise, 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.

Industry consolidation may lead to increased competition and may harm our operating results.

There has been a trend toward 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, communications 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. In the past we have 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:

 

    successfully integrate our products with our OEM customers’ products;

 

    gain market acceptance of our products and our OEM customers’ products;

 

    accurately predict market requirements and evolving industry standards;

 

    accurately define new semiconductor products;

 

    timely complete and introduce new product designs or features;

 

    timely qualify and obtain industry interoperability certification of our products and the equipment into which our products will be incorporated;

 

    ensure that our subcontractors have sufficient foundry capacity and packaging materials and achieve acceptable manufacturing yields; and

 

    shift our products to smaller geometry process technologies to achieve lower cost and higher levels of design integration.

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 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. 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 decline. 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.

 

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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 forecasted revenue and margins. For example, our Access product family generally has higher margins as compared to our Gateway product family. Furthermore, the product margins within our product families can vary based on the performance and type of deployment, as the market typically commands higher 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.

Any defects in our products could harm our reputation, customer relationships, and results of operations.

Our products may contain undetected defects, errors, or failures, which may not become apparent until the products are in the hands of our customers or our customers’ customers. The occurrence of any defects, errors, or failures discovered after we have sold the product could result in:

 

    cancellation of orders;

 

    product returns, repairs, or replacements;

 

    monetary or other accommodations to our customers;

 

    diversion of our resources;

 

    legal actions by customers or customers’ end users;

 

    increased insurance and warranty costs; and

 

    other losses to us or to customers or end users.

Any of these occurrences could also result in the loss of or delay in market acceptance of these or other products and loss of sales, which could negatively affect our business and results of operations. As our products become even more complex in the future, this risk may intensify over time and may result in increased expenses.

The semiconductor industry is highly cyclical, which may cause our operating results to fluctuate.

We operate in the highly cyclical semiconductor industry. This industry is characterized by wide fluctuations in product supply and demand. In the past, the semiconductor industry has experienced significant downturns, often in connection with, or in anticipation of, excess manufacturing capacity worldwide, maturing product cycles, and declines in general economic conditions. Even if demand for our products remains constant, a lower level of available foundry capacity could increase our costs, which would likely have an adverse impact on our results of operations.

Changes in our senior management could negatively affect our operations and relationships with our customers and employees.

We have recently experienced changes in our senior management team: the resignations of our Vice President of Program Management in April 2012 and our Vice President of Sales in March 2013 and the appointments of our new President and Chief Executive Officer in June 2012, our new Vice President of Operations in September 2012, our new Vice President of Marketing in February 2013, and our new Vice President of Sales in May 2013. 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 our senior management team as well as 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 our 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.

 

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Further, the changes in senior management as well as the multiple restructurings and reductions in force that we have recently experienced, have had, and may continue to have, a negative effect on employee morale and the ability to attract and retain qualified personnel.

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 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 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 a 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.

Our service agreement with eSilicon Corporation (eSilicon) limits our ownership and control of raw materials and work-in-process. Should eSilicon default on its contractual commitments to us or fail to timely deliver furnished goods, it would negatively impact our revenue and reputation.

In 2012, we entered into an agreement with eSilicon (the Service Agreement) under which eSilicon handles a majority of our day-to-day supply chain management, production test engineering, and production quality engineering functions. Pursuant to the Service Agreement, we place orders for our finished goods with eSilicon, who, in turn, contracts with wafer foundries and assembly and test subcontractors, and manages these operational functions for us on a day-to-day basis. eSilicon owns the raw materials and work-in-process until such time as the products are delivered to us as finished goods. Should eSilicon default on its contractual obligation to deliver finished goods to us in a timely manner, or at all, we may be required to restart the wafer production process with a total cycle time of approximately one calendar quarter. As a result, we may be required to incur additional costs and we would experience delays in delivering products to our customers, which would result in decreased revenue, have a negative effect on operating results, and harm our reputation.

We are a fabless semiconductor company and failure to secure and maintain sufficient capacity with eSilicon 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 are therefore dependent on and currently use multiple third-party wafer foundries and other subcontractors, located primarily in Israel, Malaysia, the Philippines, and Taiwan, to manufacture, assemble, and test all of our semiconductor devices. While we work with multiple suppliers, generally each individual product is made by one foundry and processed at a single 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 in a timely manner. In past periods of high demand in the semiconductor market, we have experienced delays in obtaining sufficient capacity to meet our demand and as a result were unable to deliver all of the products to our customers on a timely basis. In addition, we have experienced similar delays due to technical and quality control problems. We are dependent on eSilicon and, in turn, its suppliers to deliver our products on time.

If we and/or eSilicon were to need to qualify a new facility to meet a need for additional capacity, or if a foundry or subcontractor ceased working with eSilicon, as has happened in the past, or if production is disrupted (including an event where eSilicon ceases its business operations), 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 that we 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 will continue to 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 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, as well as our operating results would suffer.

 

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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 eSilicon have a guaranteed level of production capacity from any of our foundries or subcontractors’ facilities that we depend upon to produce our 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 eSilicon 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 eSilicon, or directly with foundries or other subcontractors, that could be costly and negatively affect our operating results, including minimum order quantities over extended periods, and payment of premiums to secure necessary lead-times.

We may not be able to make 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 a 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 experienced in the past, and may experience in the future, 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 that we have incorporated into our products. If defects are discovered after our products have shipped, we have experienced, and could continue to experience, warranty and consequential damage 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 from 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 some 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 allocate resources to manufacturing products that we may not be able to sell. As a result, as we experienced in the past, 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 reduce our liquidity. Similarly, if our forecast underestimates customer demand, we may forego revenue opportunities, lose market share, and damage customer relationships. Our failure to accurately manage inventory against demand would adversely affect our financial results.

To remain competitive, we may need to migrate to smaller geometrical processes and our failure to do so may harm our business.

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 has resulted in reduced manufacturing yields, delays in product deliveries, and increased product costs and expenses. Additionally, upfront expenses associated with smaller geometrical 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 that we are required to defend regarding such claims could result in significant expenses and diversion of our resources.

Other companies in the semiconductor industry 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’ intellectual property rights. We may in the future be engaged in litigation with parties who claim that we have infringed their intellectual property rights or who may seek to invalidate one or more of our patents, and it is possible that we would not prevail in any such lawsuit. 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

 

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liability. In addition, a court could issue a preliminary or permanent injunction that could require us to stop selling certain products in that 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 nevertheless result in significant costs and a diversion of management and personnel resources to defend.

Many companies in the semiconductor industry 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 could 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 could also be forced to do one or more of the following:

 

    stop selling, incorporating, or using our products that utilize the challenged intellectual property;

 

    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 at all, or we could be required us to make significant payments with respect to past or future sales of our products;

 

    redesign those products that use any allegedly infringing technology, which may be costly and time-consuming; or

 

    refund to our customers 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 a third party’s patents or other intellectual property, our customers could also become the target of litigation. We are aware of certain instances in which third parties have recently notified our customers that their products (incorporating our technology) may infringe on the third parties’ technology. We expect that our customers may receive similar notices in the future. Because we have entered into agreements whereby we have agreed to indemnify our customers for intellectual property claims made against them for products incorporating our technology, any litigation could trigger indemnification obligations. Any indemnity claim could adversely affect our relationships with our customers and result in substantial expense to us.

Other data transmission technologies and communications processing technologies may compete effectively with the services enabled by our products, which could adversely affect our revenue and business.

Our revenue currently is dependent upon the increase in demand for services that use broadband technology and integrated residential gateways. Besides xDSL and other discrete multi-tone (DMT)-based technologies, service providers can decide to deploy passive optical network or fiber and there would be reduced need for our products. If more service providers decide to extend fiber all the way to the home, commonly referred to as fiber to the home (FTTH) deployment, it could harm our xDSL business. 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, less expensive, 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 Alliance for Telecommunications Industry Solutions (ATIS) and the International Telecommunication Union Telecommunication Standard (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, industry groups adopt new standards, or governments issue new 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 agreements, and licensing arrangements to establish and protect our proprietary rights. From time-to-time we file new patent applications. These 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 determined to be invalid or unenforceable. While we are not currently aware of any misappropriation of our existing technology, policing

 

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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 unauthorized use in foreign countries where we have not applied for patent protection and, even if such protection was 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 decrease.

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 and the industries in which they operate may materially and adversely impact our business. For example, various governments around the world have considered, and it is anticipated that others may consider, regulations that would limit or prohibit sales of certain telecommunications products manufactured in China. If these 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, and the U.S. Federal Communications Commission have broad jurisdiction over our target markets. Although the laws and regulations of these and other government 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 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 us.

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.

We are exposed to legal, business, political, and economic risks associated with our international operations.

We currently obtain substantially all of our manufacturing, assembly, and testing services from suppliers and subcontractors located outside of the United States, and have a significant portion of our research and development team located in India. In addition, 97%, 99%, 99%, and 99% of our revenue for the years ended 2013 and 2012 and for the six months ended June 29, 2014 and June 30, 2013, 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:

 

    political, social, and economic instability, including war and terrorist acts;

 

    exposure to different legal standards, particularly with respect to intellectual property;

 

    trade and travel restrictions;

 

    the imposition of governmental controls and restrictions or unexpected changes in regulatory requirements;

 

    burdens of complying with a variety of foreign laws;

 

    import and export license requirements and restrictions of the United States and each other country in which we operate;

 

    foreign technical standards;

 

    changes in tariffs;

 

    difficulties in staffing and managing international operations;

 

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    foreign currency exposure and fluctuations in currency exchange rates;

 

    difficulties in collecting receivables from foreign entities or delayed revenue recognition; and

 

    potentially adverse tax consequences.

Because we are currently almost wholly dependent on our foreign sales, as well as our research and development facilities located off-shore and operations in foreign jurisdictions, any of the factors described above could significantly harm our ability to produce quality products in a timely and cost effective manner, as well as our ability to increase or maintain our foreign sales.

Fluctuations in exchange rates 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 headquarters 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 most of our wafer foundries, are located in Malaysia, the Philippines, and Taiwan. Several of our large customers are located in Japan and Korea. The Asia-Pacific region has experienced significant earthquakes and other natural disasters in the past and will be subject to seismic activities in the future. 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 increased production costs in general. Natural disasters could also adversely affect our customers and their demand for our products. Our headquarters in California is 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 jurisdictions, and the amount and timing of intercompany payments from our foreign operations that are subject to U.S. income taxes. In addition, our subsidiary in India is currently being audited by the tax authorities in that country. Should the audit or any subsequent appeals result in a decision adverse to us, such decision could not only result in assessments for prior periods, but also an increased tax rate in future periods.

New regulations related to “conflict minerals” may force us to incur additional expenses, may make our supply chain more complex, and may result in damage to our reputation with customers.

On August 22, 2012, under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC adopted new requirements for companies that use certain minerals and metals, known as “conflict minerals,” in their products, whether or not these products are manufactured by third parties. These requirements will require companies to diligence, disclose, and report whether or not such minerals originate from the Democratic Republic of the Congo and adjoining countries. We believe some or all of these minerals are used in the manufacture of our products. The implementation of these new requirements could adversely affect the sourcing, availability, and pricing of such minerals. In addition, we will incur additional costs to comply with the disclosure requirements, including costs related to determining the source of any of the relevant minerals and metals used in our products. Since our supply chain is complex, we may not be able to sufficiently verify the origins for these minerals and metals used in our products through the due diligence procedures that we implement, which may harm our reputation, could increase our costs, and could adversely affect our manufacturing operations. In such event, we may also face difficulties in satisfying customers who require that all of the components of our products be certified as conflict mineral free.

 

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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 from 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 2010 and purchased an additional 5.6 million shares of our common stock. Tallwood Partners, LLC, a Delaware limited liability company, and an entity related to the Tallwood Investors, participated in our 2013 public offering and purchased an additional 2.0 million shares of our common stock. The common stock collectively owned by Tallwood Investors and Tallwood Partners, LLC (collectively referred to as the Tallwood Entities) represented approximately 32% of the outstanding shares of our common stock (excluding the exercise of warrants) as of June 29, 2014. Assuming the full exercise of the warrants, the common stock owned by the Tallwood Entities would represent approximately 37% of the outstanding shares of our common stock as of June 29, 2014. In 2009, we 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 us in subsequent equity offerings. Given their ownership interest in us, the Tallwood Entities may have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders. The Tallwood Entities 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 (and entities related to the Tallwood Investors, such as Tallwood Partners, LLC) hold at least 35% of our outstanding common stock, including the warrants. In the event that the Tallwood Entities hold less than 35% of our common stock, the number of directors the Tallwood Entities can appoint to our Board of Directors becomes proportional to the Tallwood Entities’ ownership position in us at such time. As a result, the directors elected to our Board of Directors by the Tallwood Entities 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 Entities.

We are unable to predict the potential effects of the Tallwood Entities’ 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, if we file a registration statement it must permit the resale of such securities into the public market. Any such resale would increase the number of shares of our common stock available for public trading. Sales by the Tallwood Entities 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.

 

Item 6. Exhibits

 

Exhibit

Number

  

Description

    3.1    Restated Certificate of Incorporation, as amended on June 3, 2014.
  10.1*    2014 Stock Incentive Plan.
  10.1.1    Form of Notice of Stock Unit Award under the 2014 Stock Incentive Plan.
  10.1.2    Form of Notice of Stock Option Grant under the 2014 Stock Incentive Plan.
  10.1.3    Form of Notice of Grant of Stock Appreciation Right (SAR) under the 2014 Stock Incentive Plan.
  10.1.4    Form of Notice of Stock Option Grant for non-employee directors under the 2014 Stock Incentive Plan.
  31.1    Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

* Indicates a management contract or compensatory plan or arrangement.

 

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SIGNATURES

Pursuant to the requirements 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.

 

    IKANOS COMMUNICATIONS, INC.
Dated: August 8, 2014     By:  

        /s/ Omid Tahernia

              Omid Tahernia
              President, Chief Executive Officer and Director
              (Principal Executive Officer)
Dated: August 8, 2014     By:  

        /s/ Dennis Bencala

              Dennis Bencala
              Chief Financial Officer and Vice President of Finance
              (Principal Financial and Accounting Officer)

 

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IKANOS COMMUNICATIONS, INC.

EXHIBITS TO FORM 10-Q QUARTERLY REPORT

For the Quarter Ended June 29, 2014

 

Exhibit

Number

  

Description

    3.1    Restated Certificate of Incorporation, as amended on June 3, 2014.
  10.1*    2014 Stock Incentive Plan.
  10.1.1    Form of Notice of Stock Unit Award under the 2014 Stock Incentive Plan.
  10.1.2    Form of Notice of Stock Option Grant under the 2014 Stock Incentive Plan.
  10.1.3    Form of Notice of Grant of Stock Appreciation Right (SAR) under the 2014 Stock Incentive Plan.
  10.1.4    Form of Notice of Stock Option Grant for non-employee directors under the 2014 Stock Incentive Plan.
  31.1    Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

* Indicates a management contract or compensatory plan or arrangement.

 

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