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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 March 29, 2009
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 ¨ 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 x | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) |
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 29,242,879 as of April 28, 2009.
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IKANOS COMMUNICATIONS, INC.
FORM 10-Q
Page No. | ||||
PART I: | FINANCIAL INFORMATION | |||
Item 1. | 3 | |||
Condensed Consolidated Balance Sheets as of March 29, 2009 and December 28, 2008 | 3 | |||
4 | ||||
5 | ||||
Notes to Unaudited Condensed Consolidated Financial Statements | 6 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 12 | ||
Item 3. | 16 | |||
Item 4. | 17 | |||
PART II: | OTHER INFORMATION | |||
Item 1. | 18 | |||
Item 1A. | 18 | |||
Item 2. | 27 | |||
Item 4. | 28 | |||
Item 6. | 28 | |||
28 |
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PART I: FINANCIAL INFORMATION
Item 1. | Financial Statements |
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands and unaudited)
March 29, 2009 | December 28, 2008 | |||||
Assets | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 24,301 | $ | 27,219 | ||
Short-term investments | 35,037 | 36,120 | ||||
Accounts receivable | 12,226 | 12,360 | ||||
Inventory | 12,176 | 12,489 | ||||
Prepaid expenses and other current assets | 1,800 | 1,744 | ||||
Total current assets | 85,540 | 89,932 | ||||
Long-term investments | 1,034 | 1,034 | ||||
Property and equipment, net | 8,243 | 9,597 | ||||
Intangible assets, net | 5,194 | 6,290 | ||||
Other assets | 531 | 580 | ||||
$ | 100,542 | $ | 107,433 | |||
Liabilities and Stockholders’ Equity | ||||||
Current liabilities: | ||||||
Accounts payable | $ | 7,568 | $ | 9,237 | ||
Accrued liabilities | 8,249 | 8,680 | ||||
Total current liabilities | 15,817 | 17,917 | ||||
Commitments and contingencies (Note 8) | ||||||
Stockholders’ equity | 84,725 | 89,516 | ||||
$ | 100,542 | $ | 107,433 | |||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data, and unaudited)
Three Months Ended | ||||||||
March 29, 2009 | March 30, 2008 | |||||||
Revenue | $ | 20,734 | $ | 29,697 | ||||
Cost of revenue (1) | 12,254 | 17,633 | ||||||
Gross profit | 8,480 | 12,064 | ||||||
Operating expenses: | ||||||||
Research and development (2) | 8,863 | 11,663 | ||||||
Selling, general and administrative (3) | 5,638 | 5,870 | ||||||
Restructuring charges | 267 | — | ||||||
Total operating expenses | 14,768 | 17,533 | ||||||
Loss from operations | (6,288 | ) | (5,469 | ) | ||||
Interest income, net | 237 | 776 | ||||||
Loss before provision for income taxes | (6,051 | ) | (4,693 | ) | ||||
Provision for income taxes | 37 | 91 | ||||||
Net loss | $ | (6,088 | ) | $ | (4,784 | ) | ||
Basic and diluted net loss per share | $ | (0.21 | ) | $ | (0.16 | ) | ||
Weighted average number of shares, basic and diluted | 29,094 | 29,545 | ||||||
Includes stock-based compensation expense as follows: | ||||||||
(1) Cost of revenue | $ | 80 | $ | 119 | ||||
(2) Research and development | 732 | 1,571 | ||||||
(3) Selling, general and administrative | 702 | 1,125 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands and unaudited)
Three Months Ended | ||||||||
March 29, 2009 | March 30, 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (6,088 | ) | $ | (4,784 | ) | ||
Adjustments to reconcile net loss to net cash provided (used) by operating activities: | ||||||||
Depreciation and amortization | 1,462 | 1,561 | ||||||
Stock-based compensation expense | 1,514 | 2,815 | ||||||
Amortization of intangible assets and acquired technology | 1,096 | 1,845 | ||||||
Purchased in-process research and development | — | 310 | ||||||
Changes in assets and liabilities, net of effect of acquisitions: | ||||||||
Accounts receivable | 134 | 2,617 | ||||||
Inventory | 313 | 4,875 | ||||||
Prepaid expenses and other assets | (7 | ) | (237 | ) | ||||
Accounts payable and accrued liabilities | (2,206 | ) | (6,038 | ) | ||||
Net cash provided (used) by operating activities | (3,782 | ) | 2,964 | |||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (108 | ) | (253 | ) | ||||
Purchases of investments | (6,610 | ) | (108,167 | ) | ||||
Maturities and sales of investments | 7,582 | 111,155 | ||||||
Acquisition of product line | — | (11,918 | ) | |||||
Net cash provided (used) by investing activities | 864 | (9,183 | ) | |||||
Cash flows from financing activities: | ||||||||
Proceeds from issuances of common stock and exercise of stock options | — | 222 | ||||||
Net cash provided (used) by financing activities | — | 222 | ||||||
Net decrease in cash and cash equivalents | (2,918 | ) | (5,997 | ) | ||||
Cash and cash equivalents at beginning of period | 27,219 | 65,126 | ||||||
Cash and cash equivalents at end of period | $ | 24,301 | $ | 59,129 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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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 silicon and software for interactive triple-play broadband. The Company develops and markets end-to-end products for the last mile and the digital home, which enable carriers to offer enhanced triple play services, including voice, video and data. The Company has developed programmable, scalable chip architectures, which form the foundation for deploying and delivering triple play services. Flexible network processor architecture with wire-speed packet processing capabilities enables high-performance residential gateways for distributing advanced services in the home. These products thus support carriers’ triple play deployment plans to the digital home while keeping their capital and operating expenditures low and have been deployed by carriers in Asia, Europe and North America.
Since its inception, the Company has only been profitable in the third and fourth quarter of 2005. Prior to the third quarter of 2005, the Company incurred significant net losses and has incurred losses in the past ten quarters. The Company incurred a net loss of $6.1 million for the quarter ended March 29, 2009 and had an accumulated deficit of $189.8 million as of March 29, 2009. To achieve consistent profitability, the Company will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for its business.
The Company’s fiscal year ends on the Sunday closest to December 31. The Company’s fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year, in which case the additional week falls into the fourth quarter of that fiscal year. There will be 53 weeks in the current fiscal year 2009.
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 without audit in accordance with the rules and regulations of the Securities and Exchange Commission (the SEC). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 11, 2009.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to state fairly our financial position, results of operations and cash flows for the interim periods presented. The operating results for the three month period ended March 29, 2009 are not necessarily indicative of the results that may be expected for the year ending January 3, 2010 or for any other future period.
Use of Estimates
The preparation of the Company’s 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 there are material differences between these estimates and actual results, the Company’s financial statements would have been affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.
Summary of Significant Accounting Policies
Our significant accounting policies are described in Note 1 to our audited Consolidated Financial Statements for the fiscal year ended December 28, 2008, included in our Annual Report on Form 10-K. These accounting policies have not significantly changed with the exception of those discussed below.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash, cash equivalents, investments and accounts receivable. 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 investments are credit worthy and, accordingly, minimal credit risk exists with respect to those investments. Short-term investments include a diversified portfolio of commercial paper and government agency bonds. Long-term investments are comprised of auction rate securities. All investments are classified as available-for-sale. The Company does not hold or issue financial instruments for trading purposes.
Credit risk with respect to accounts receivable is concentrated due to the number of large orders recorded in any particular reporting period. Two customers represented 50% and 14% of accounts receivable at March 29, 2009. Three customers represented 43%, 19%, and 11% of accounts receivable at December 28, 2008. Three customers accounted for 37%, 23%, and 11% of revenue for the three months ended March 29, 2009. Five customers accounted for 21%, 20%, 19%, 18% and 12% of revenue for the period ended March 30, 2008.
Concentration of Suppliers
The Company subcontracts all of the manufacture, assembly and tests of its products to third-parties located primarily in Asia. As a result of this geographic concentration, a disruption in the manufacturing process resulting from a natural disaster or other unforeseen event could have a material adverse effect on the Company’s financial position and results of operations. Additionally, a small number of sources manufacture, assemble and test the Company’s products, with which the Company has no long-term contracts. Also, each product generally has only one foundry and one assembly and test provider. An inability to obtain these products and services in the amounts needed and on a timely basis or at commercially reasonable prices could results in delays in product introductions, interruptions in product shipments or increases in product costs, which could have a material adverse effect on the Company’s financial position and results of operations.
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Concentration of Other Risk
The semiconductor industry is characterized by rapid technological change, competitive pricing pressures and cyclical market patterns. The Company’s results of operations are affected by a wide variety of factors, including general economic conditions; economic conditions specific to the semiconductor industry; demand for the Company’s products; the timely introduction of new products; implementation of new manufacturing technologies; manufacturing capacity; the availability of materials and supplies; competition; the ability to safeguard patents and intellectual property in a rapidly evolving market; and reliance on assembly and wafer fabrication subcontractors and on independent distributors and sales representatives. As a result, the Company may experience substantial period-to-period fluctuations in future periods due to the factors mentioned above, factors described in the section titled “Item 1A. Risk Factors” or other factors.
Comprehensive Loss
Comprehensive loss is defined as the change in equity of a business during a period from transactions and other events and circumstances from non-owner sources. The components of comprehensive loss are as follows (in thousands):
Three Months Ended | ||||||||
March 29, 2009 | March 30, 2008 | |||||||
Net loss | $ | (6,088 | ) | $ | (4,784 | ) | ||
Other comprehensive loss–unrealized loss on marketable securities | (111 | ) | (284 | ) | ||||
Comprehensive loss | $ | (6,199 | ) | $ | (5,068 | ) | ||
Net Loss per Share
Under the provisions of SFAS 128, Earnings 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 if their inclusion is anti-dilutive. The calculation of basic and diluted net loss per share is as follows (in thousands, except per share amounts):
Three Months Ended | ||||||||
March 29, 2009 | March 30, 2008 | |||||||
Net loss | $ | (6,088 | ) | $ | (4,784 | ) | ||
Weighted average number of shares, basic and diluted | 29,094 | 29,545 | ||||||
Basic and diluted net loss per share | $ | (0.21 | ) | $ | (0.16 | ) | ||
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 | ||||
March 29, 2009 | March 30, 2008 | |||
Anti-dilutive securities: | ||||
Weighted average restricted stock units | 837 | 1,468 | ||
Weighted-average options to purchase common stock | 1,826 | 2,185 | ||
2,663 | 3,653 | |||
Recent Accounting Pronouncements
In September 2006, Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. (SFAS) 157, Fair Value Measurements, which defines fair value, provides a framework for measuring fair value, and expands the disclosures required for fair value measurements. SFAS 157 applies to other accounting pronouncements that require fair value measurements; it does not require any new fair value measurements. The Company was required to apply the provisions of SFAS 157 beginning in 2008. In February 2008, the FASB released a FASB Staff Position (FSP) SFAS 157-2—Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008. Beginning in the first quarter of 2009, the Company adopted SFAS 157 for all nonfinancial assets and liabilities. The adoption of SFAS 157 for nonfinancial assets and liabilities did not have a material effect on the Company’s financial statements. See Note 2. Investments and Fair Value Measurements.
In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations, which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree in a business combination. SFAS 141R also establishes principles around how goodwill acquired in a business combination or a gain from a bargain purchase should be recognized and measured, as well as provides guidelines on the disclosure requirements on the nature and financial impact of the business combination. SFAS 141R was effective for the Company beginning in 2009. The adoption of SFAS 141R did not have an effect on the Company’s consolidated statements of financial position, operations or cash flows. However, SFAS 141R will have an effect on any future acquisitions as it prohibits, among other things, the capitalization of certain acquisition related costs as an offset to goodwill and, instead, requires those costs to be expensed as incurred. The nature and magnitude of the specific effects will depend on the nature, terms and size of any future acquisitions that the Company may consummate subsequent to the effective date.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. It requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. This statement establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. SFAS 160 was effective for the Company beginning in 2009. The adoption of SFAS 160 did not have a material effect on the Company’s consolidated statements of financial position, operations or cash flows.
In April 2008, the FASB adopted FASB Staff Position SFAS 142-3,Determination of the Useful Life of Intangible Assets, amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142,Goodwill and Other Intangible Assets. This FASB Staff Position is effective for intangible assets acquired on or after July 1, 2009. The adoption of SFAS 142-3 is not expected to have a material effect on the Company’s consolidated statements of financial position, operations or cash flows.
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In March 2009, the FASB unanimously voted for theFASB Accounting Standards Codification (the “Codification”) to be effective July 1, 2009. Other than resolving certain minor inconsistencies in current GAAP, the Codification is not supposed to change GAAP, but is intended to make it easier to find and research GAAP applicable to particular transactions or specific accounting issues. The Codification is new structure which takes accounting pronouncements and organizes them by approximately ninety accounting topics. Once approved, the Codification will be the single source of authoritative GAAP. All guidance included in the Codification will be considered authoritative at that time, even guidance that comes from what is currently deemed to be a non-authoritative section of a standard. Once the Codification becomes effective, all non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative.
In April 2009, FASB issued FSP SFAS 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP SFAS 157-4 provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157,Fair Value Measurements. The FSP relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what SFAS 157 states is the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The FSP is effective beginning with the Company’s interim reporting period ending on June 28, 2009. The Company is currently evaluating the impact of the implementation of FSP SFAS 157-4 on its consolidated financial position, results of operations and cash flows.
In April 2009, FASB issued FSP SFAS 107-1 and Accounting Principles Board Opinion (APB) 28-1,Interim Disclosures about Fair Value of Financial Instruments. FSP SFAS 107-1 and APB 28-1 enhances consistency in financial reporting by increasing the frequency of fair value disclosures. The FSP relates to fair value disclosures for any financial instruments that are not currently reflected in a company’s balance sheet at fair value. Prior to the effective date of this FSP, fair values for these assets and liabilities have only been disclosed once a year. The FSP will now require these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosure requirement under this FSP is effective for the Company’s interim reporting period ending on June 28, 2009.
In April 2009, FASB issued FSP SFAS 115-2 and SFAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments. FSP SFAS 115-2 and SFAS 124-2 provide additional guidance designed to create greater clarity and consistency in accounting and presenting impairment losses on securities. The FSP is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. The FSP is effective beginning with the Company’s interim reporting period ending on June 28, 2009. The Company is currently evaluating the impact of the implementation of FSP SFAS 115-2 and SFAS 124-2 on its consolidated financial position, results of operations and cash flows.
Note 2 – Investments and Fair Value Measurements
The following is a summary of short-term investments (in thousands):
March 29, 2009 | |||||||||||||
Cost | Gross Realized Gain/(Loss) | Gross Unrealized Gain/(Loss) | Estimated Fair Value | ||||||||||
U.S. government agencies | $ | 27,666 | $ | — | $ | 167 | $ | 27,833 | |||||
Corporate bonds and notes | 7,188 | — | 16 | 7,204 | |||||||||
Total short-term investments | $ | 34,854 | $ | — | $ | 183 | $ | 35,037 | |||||
Long-term investments - auction rate securities | $ | 7,200 | $ | (6,166 | ) | $ | — | $ | 1,034 | ||||
December 28, 2008 | |||||||||||||
Cost | Gross Realized Gain/(Loss) | Gross Unrealized Gain/(Loss) | Estimated Fair Value | ||||||||||
U.S. government agencies | $ | 25,570 | $ | — | $ | 252 | $ | 25,822 | |||||
Corporate bonds and notes | 10,258 | — | 40 | 10,298 | |||||||||
Total short-term investments | $ | 35,828 | $ | — | $ | 292 | $ | 36,120 | |||||
Long-term investments - auction rate securities | $ | 7,200 | $ | (6,166 | ) | $ | — | $ | 1,034 | ||||
Marketable securities are classified as available-for-sale as of the balance sheet date and are reported at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity, net of tax. Realized gains and losses and permanent declines in value, if any, on available-for-sale securities are reported in other income or expense as incurred. Estimated fair values were determined for each individual security in the investment portfolio. The declines in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature.
A portion of the Company’s available-for-sale U.S. government agencies and corporate bonds and notes have maturity dates greater than one year from the date of purchase. Even though the stated maturity dates of these investments may be one year or more beyond the balance sheet dates, the Company has classified these securities as short-term investments. In accordance with Accounting Research Bulletin No. 43, Chapter 3A, Working Capital- Current Assets and Current Liabilities, the Company views its available-for-sale portfolio as available for use in its current operations. Based upon historical experience in the financial markets as well as the Company’s specific experience with these investments, the Company believes there is a reasonable expectation that the investments will be realized in cash or sold during the next year.
Fair Value Measurements
SFAS 157 clarifies that fair value is an exit price, representing 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, SFAS 157 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
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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 are classified within all three levels 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, valued based on other observable inputs, include investment-grade U.S. government agencies, commercial paper and corporate bonds and notes. Level 3 types of instruments, valued based on unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions, include auction rate securities. The fair value hierarchy of our marketable securities as of March 29, 2009 is (in thousands):
Fair Value Measurements at Reporting Date Using | ||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||
Money market funds | $ | 17,341 | $ | — | $ | — | $ | 17,341 | ||||
U.S. government agencies | — | 27,833 | — | 27,833 | ||||||||
Corporate bonds and notes | — | 7,204 | — | 7,204 | ||||||||
Auction rate securities | — | — | 1,034 | 1,034 | ||||||||
$ | 17,341 | $ | 35,037 | $ | 1,034 | $ | 53,412 | |||||
There have been no changes in our Level 3 securities for the three months ended March 29, 2009.
Note 3 – Inventory
Inventory consisted of the following (in thousands):
March 29, 2009 | December 28, 2008 | |||||
Finished goods | $ | 3,750 | $ | 4,482 | ||
Work-in-process | 8,204 | 7,480 | ||||
Purchased parts and raw materials | 222 | 527 | ||||
$ | 12,176 | $ | 12,489 | |||
Note 4 – Property and Equipment
Property and equipment consisted of the following (in thousands):
March 29, 2009 | December 28, 2008 | |||||||
Machinery and equipment | $ | 18,073 | $ | 17,630 | ||||
Software | 10,675 | 10,641 | ||||||
Computer equipment | 3,792 | 3,770 | ||||||
Furniture and fixtures | 840 | 886 | ||||||
Leasehold improvements | 665 | 838 | ||||||
Not yet placed in service | 28 | 418 | ||||||
34,073 | 34,183 | |||||||
Less: Accumulated depreciation and amortization | (25,830 | ) | (24,586 | ) | ||||
$ | 8,243 | $ | 9,597 | |||||
Depreciation and amortization expense for property and equipment was $1.5 million and $1.6 million for the three months ended March 29, 2009 and March 30, 2008, respectively.
Note 5 – Intangible Assets
The carrying value of intangible assets as of March 29, 2009 is as follows (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Amount | Weighted average useful life (Years) | |||||||||
Existing technology | $ | 9,795 | $ | (7,388 | ) | $ | 2,407 | 4 | ||||
Customer relationships | 5,730 | (2,943 | ) | 2,787 | 5 | |||||||
$ | 15,525 | $ | (10,331 | ) | $ | 5,194 | ||||||
The carrying amount of intangible assets as of December 28, 2008 is as follows (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Amount | Weighted average useful life (Years) | |||||||||
Existing technology | $ | 9,795 | $ | (6,664 | ) | $ | 3,131 | 4 | ||||
Customer relationships | 5,730 | (2,571 | ) | 3,159 | 5 | |||||||
$ | 15,525 | $ | (9,235 | ) | $ | 6,290 | ||||||
For the three months ended March 29, 2009 and March 30, 2008, the amortization of intangible assets was $1.1 million and $1.8 million, respectively. The estimated future amortization of purchased intangible assets as of March 29, 2009 is $3.2 million for the remainder of 2009, $1.8 million in 2010 and $0.2 million in 2011.
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Note 6 – Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
March 29, 2009 | December 28, 2008 | |||||
Compensation and related benefits | $ | 3,010 | $ | 3,787 | ||
Professional fees | 795 | 658 | ||||
Warranty | 697 | 745 | ||||
Rebates | 444 | 918 | ||||
Royalties | 378 | 654 | ||||
Restructuring charges | 189 | 190 | ||||
Other accrued liabilities | 2,736 | 1,728 | ||||
$ | 8,249 | $ | 8,680 | |||
The following table summarizes the activity related to warranty (in thousands):
Three Months Ended | ||||||||
March 29, 2009 | March 30, 2008 | |||||||
Balance, beginning of period | $ | 745 | $ | 1,055 | ||||
Accrual for warranties during the period | 63 | 452 | ||||||
Usage during the period | (111 | ) | (335 | ) | ||||
Balance, end of period | $ | 697 | $ | 1,172 | ||||
Note 7 – Restructuring Charges
During the first quarter of 2009, the Company implemented a restructuring plan to combine design centers in India and to reduce its cost structure in North America. Restructuring charges of $0.3 million related to the termination of 23 persons, 12 of whom were located in India and 11 in the United States. The Company expects the remaining severance and benefit costs to be paid in 2009. In addition, the Company will relocate its remaining personnel and equipment from Hyderabad, India to Bangalore, India during the second quarter of 2009. The Company expects to incur relocation costs of $0.2 million to $0.3 million in 2009 related to this relocation. A summary of the restructuring activity follows (in thousands):
Severance and Benefits | Software Tools | Total | ||||||||||
Balance as of December 28, 2008 | $ | — | $ | 190 | $ | 190 | ||||||
Restructuring charges | 267 | — | 267 | |||||||||
Cash payments | (78 | ) | (190 | ) | (268 | ) | ||||||
Balance as of March 29, 2009 | $ | 189 | $ | — | $ | 189 | ||||||
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 2011. Rent expense for the three months ended March 29, 2009 and March 30, 2008 was $0.3 million and $0.3 million, respectively. The terms of the facility leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period and has accrued for rent expense incurred but not paid. Future minimum lease payments as of March 29, 2009 under non-cancelable leases with original terms in excess of one year are $1.4 million for the remainder of 2009, $0.9 million in 2010 and $0.3 million in 2011.
Purchase Commitments
In the first quarter of 2009, the Company entered into a license agreement and agreed to pay $0.8 million in the second quarter of 2009. As of March 29, 2009, the Company had $3.0 million of inventory purchase obligations with various suppliers.
Indemnities, Commitments and Guarantees
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property indemnities to the Company’s customers in connection with the sales of its products, indemnities for liabilities associated with the infringement of other parties’ technology based upon the Company’s products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the various agreements that include indemnity provisions. In addition, the Company requires its employees to sign a proprietary information and inventions agreement, which assigns the rights to its employees’ development work to the Company. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets. The Company does, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and the amount of the loss can be reasonably estimated, in accordance with SFAS 5, Accounting for Contingencies.
In addition, the Company indemnifies its officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to its certificate of incorporation, bylaws and applicable Delaware law. To date, the Company has not incurred any costs related to these indemnifications.
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Litigation
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, its directors and two former executive officers, as well as the lead underwriters for its initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint sought unspecified damages for certain alleged material misrepresentations and omissions made by the Company in connection with both its initial public offering in September 2005 and its follow-on offering in March 2006. On June 25, 2007, the Company filed a motion to dismiss the amended complaint, plaintiffs opposed the motion, and on March 10, 2008, the District Court ordered the case dismissed with prejudice. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration.
On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit. The parties have filed their respective briefs with the Second Circuit, and oral arguments are scheduled for June 18, 2009. The Company cannot predict the likely outcome of the appeal, and an adverse result in the litigation could have a material effect on its financial statements.
Additionally, from time to time, the Company is a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, the Company does not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on its results of operations, cash flows or financial position.
Note 9 – Significant Customer Information and Segment Reporting
SFAS 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The method for determining the information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance.
The Company’s chief operating decision-maker is considered to be the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. On this basis, the Company is organized and operates in a single segment: the design, development, marketing and sale of semiconductors.
The following table summarizes revenue by geographic region, based on the country in which the customer’s headquarters office is located (in thousands):
Three Months Ended | ||||||
March 29, 2009 | March 30, 2008 | |||||
Asia | $ | 9,186 | $ | 16,794 | ||
Europe | 9,707 | 11,388 | ||||
North America | 1,841 | 1,515 | ||||
$ | 20,734 | $ | 29,697 | |||
The Company divides its products into two product families: Access and Gateway. Access includes products that carriers deploy in the central office or remote terminal while Gateway includes products that are deployed into the residence. Revenue by product family is as follows (in thousands):
Three Months Ended | ||||||
March 29, 2009 | March 30, 2008 | |||||
Access | $ | 7,127 | $ | 16,345 | ||
Gateway | 13,607 | 13,352 | ||||
$ | 20,734 | $ | 29,697 | |||
The distribution of long-lived assets (excluding goodwill, intangible assets and other assets) is as follows (in thousands):
March 29, 2009 | December 28, 2008 | |||||
United States | $ | 4,578 | $ | 5,792 | ||
Asia | 3,554 | 3,678 | ||||
Other | 111 | 127 | ||||
$ | 8,243 | $ | 9,597 | |||
Note 10 – Subsequent Event
On April 21, 2009, the Company entered a definitive agreement to purchase the Broadband Access product line of Conexant Systems, Inc. for $54.0 million in cash and the assumption of certain employee and facility-related liabilities. Subject to certain conditions, including stockholder and regulatory approvals, the transaction is expected to be completed in the third quarter of 2009. Concurrent and conditional with this transaction, Tallwood Venture Capital (Tallwood) agreed to purchase 24 million shares of the Company’s common stock at $1.75 per share. Tallwood will also receive warrants to purchase an additional 7.8 million shares of common stock at $1.75. The warrants will have a term of five years. Assuming exercise of the warrants and shares outstanding at March 29, 2009, Tallwood would own 52% of the Company’s outstanding common stock post closing. However, through a stockholder agreement, Tallwood’s voting rights will be restricted initially to 35%. Tallwood’s investment in the Company may result in an “ownership change” under Section 382 of the Internal Revenue Code. An ownership change, as defined, may restrict the utilization of current tax attribute carry forwards.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in this discussion, as more fully described in Part II, Item 1.A “Risk Factors” in this quarterly report on Form 10-Q. Generally, the words “anticipate,” “expect,” “intend,” “believe” and similar expressions identify forward-looking statements. These forward-looking statements include, without limitation, our expectation that a small number of OEMs will continue to account for a substantial portion of our revenue; our existing and expected cash, cash equivalents and cash flows will be sufficient to meet our anticipated cash needs for at least the next twelve months; our belief in the effectiveness of our internal controls; our expectation that significant customer concentration in a small number of OEM customers will continue for the foreseeable future; our expectation that our foreign currency exposure will increase as our operations in India and other countries expand; and future costs and expenses and financing requirements. The forward-looking statements made in this Form 10-Q are made as of the filing date with the Securities and Exchange Commission and future events or circumstances could cause results that differ significantly from the forward-looking statements included here. Accordingly, we caution readers not to place undue reliance on these statements and, except as required by law, we assume no obligation to update any such forward-looking statements.
The following discussion and analysis should be read in conjunction with the condensed financial statements and notes thereto in Part I, Item 1 above and with our financial statements and notes thereto for the year ended December 28, 2008, contained in our Annual Report on Form 10-K filed on March 11, 2009.
Overview
We are a leading global provider of high-performance silicon and software for interactive broadband. We develop and market end-to-end products for the last mile and the digital home, which enable carriers to offer enhanced triple play services, including voice, video and data. Our products power DSLAMs, ONTs, concentrators, CPE, modems and RGs for leading OEMs. Our products have been deployed by carriers in Asia, Europe and North America. We believe that we can offer advanced products by continuing to push existing limits in silicon, systems and software. We have developed programmable, scalable chip architectures, which form the foundation for deploying and delivering triple play services. Expertise in the creation and integration of unique DSP algorithms with advanced digital, mixed signal and analog semiconductors enables us to offer high-performance, high-density and low power VDSL products. Flexible network processor architecture with wire-speed packet processing capabilities enables high-performance residential gateways for distributing advanced services in the home. These industry-leading products thus support carriers’ triple play deployment plans to the digital home while keeping their capital and operating expenditures low.
We outsource all of our semiconductor fabrication, assembly and test functions, which enable us to focus on design, development, sales and marketing of our products and reduce the level of our capital investment. Our customers consist primarily of ODMs, CMs and OEMs, who in turn sell our semiconductors as part of their solutions to carriers. We also sell to distributors, who in turn sell to ODMs, CMs and OEMs. We were incorporated in April 1999, and through December 31, 2001, we were engaged principally in research and development. We began commercial shipment of our products in the fourth quarter of 2002. Over the last three years, our revenue was $134.7 million in 2006, $107.5 million in 2007 and $106.5 million in 2008.
Quarterly revenue fluctuations are characteristic of our industry and affect our business, especially due the concentration of our revenue among a few customers. For instance, in the fourth quarter of 2006, our revenue declined by $15.7 million, or 43%, from the third quarter of 2006. In the third quarter of 2008, our revenue declined by $5.7 million, or 19% from the second quarter of 2008. These quarterly fluctuations can result from a mismatch of supply and demand. Specifically, carriers purchase equipment based on planned deployment. However, carriers 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, carriers will reduce orders with OEMs for new equipment, and OEMs in turn will reduce orders for our products, which will adversely impact the quarterly demand for our products, even when deployment rates may be increasing.
Furthermore, our future revenue growth depends upon new carriers beginning to deploy new platforms with our products, among other factors. It is inherently difficult to predict if and when platforms will pass qualification, when carriers will begin to deploy the equipment and at what rate, because we do not control the qualification criteria or process, and the systems manufacturers and carriers do not always share all of the information available to them regarding qualification and deployment decisions. For example, in 2008, a carrier began to deploy a platform including our products, but temporarily put the deployment on hold due to a regulatory constraint causing our revenue projection to be lower than originally anticipated.
In February 2008, we purchased the DSL technology and related assets from Centillium Communications, Inc. for approximately $11.9 million in cash. The team of engineers, DSL products, technology, patents and other intellectual property allow us to extend our market leadership as well as accelerate our digital home initiatives and next generation VDSL2 development.
On April 22, 2009 the Company announced the signing of a definitive agreement to purchase the Broadband Access product line of Conexant Systems, Inc. for $54.0 million in cash and the assumption of certain employee and facility-related liabilities. Subject to customary closing conditions, including stockholder and regulatory approvals, the transaction is expected to be completed in the third quarter of 2009. Concurrently, in connection with this transaction, Tallwood Venture Capital has agreed to purchase 24 million shares of the Company’s common stock at $1.75 per share. Tallwood will also receive warrants to purchase an additional 7.8 million shares of common stock at $1.75. We believe the Broadband Access product line will provide us the scale to expand our product portfolio beyond DSL and to achieve profitability.
Critical Accounting Policies and Estimates
In preparing our condensed consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our consolidated financial statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical accounting estimates with the Audit Committee of the Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue, cost of revenue, marketable securities, accounts receivable, inventories, warranty, income taxes, impairment of goodwill and related intangibles, acquisitions and stock-based compensation expense have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. 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 28, 2008, and have not changed materially as of March 29, 2009.
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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. As is typical in our industry, the selling prices of our products generally decline over time. Therefore, our ability to increase revenue is dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in greater quantities. Our ability to increase unit sales volume is dependent primarily upon our ability to increase and fulfill current customer demand and obtain new customers. We believe that the current worldwide recession has impacted the businesses of service providers around the world, causing them to re-evaluate how they employ capital. Consequently the rate at which broadband infrastructure is upgraded may slow or new broadband programs could be delayed. We further believe that the weak economy has contributed to the decline in our revenue over the past three quarters.
The effect of the economic downturn on currencies has also impacted our business. For example, the Korean won devalued greatly against the U.S. dollar in the third quarter of 2008, affecting the gross profit our OEM customers made on their products. In turn, they significantly reduced their orders to us. This situation has continued through the first quarter of 2009.
Revenue decreased by $9.0 million, or 30%, to $20.7 million in the three months ended March 29, 2009 from $29.7 million in the three months ended March 30, 2008. The majority of the decrease relates to an approximate 39% decrease in units shipped, offset by roughly a 15% increase in average sales price. The reduction reflects continuing lower revenue from Korea and Japan, offset partially by an increase in Taiwan. Revenue from Korea was down as OEMs reduced purchases due to the relative weakness of the value of the Korean Won against the U.S. dollar. Japanese revenue declines from the first quarter of 2008 as well as sequentially from the fourth quarter of 2008 reflect the worldwide economic slowdown and a slower rate of capital investment in VDSL access.
We generally sell our products to OEMs through a combination of our direct sales force and third-party sales representatives. Sales are generally made under short-term, non-cancelable purchase orders. We also have volume purchase agreements, and certain customers who provide us with non-binding forecasts. Although certain OEM customers may provide us with rolling forecasts, our ability to predict future sales in any given period is limited and subject to change based on demand for our OEM customers’ systems and their supply chain decisions. Historically, a small number of OEM customers, the composition of which has varied over time, have accounted for a substantial portion of our revenue, and we expect that significant customer concentration will continue for the foreseeable future, but it may diversify across more carrier customers as we expect more carriers world-wide to begin deployments of broadband solutions and Gateway products. The following direct customers accounted for more than 10% of our revenue for the years indicated. Sales made to OEMs are based on information that we receive at the time of ordering.
OEM Customer | Three Months Ended | |||||||
Our Direct Customer | March 29, 2009 | March 30, 2008 | ||||||
Sagem | Sagem | 37 | % | 18 | % | |||
NEC Corporation of America | NEC Corporation (Magnus) | 23 | 19 | |||||
Alcatel-Lucent and its CMs | Alcatel-Lucent | 11 | 20 | |||||
Paltek Corporation | Sumitomo Electric Industries | * | 21 | |||||
Uniquest | Dasan, Millinet and Ubiquoss | * | 12 |
* | Less than 10% |
Revenue by Region as a Percentage of Total Revenue
Three Months Ended | ||||||
March 29, 2009 | March 30, 2008 | |||||
Asia | 44 | % | 57 | % | ||
Europe | 47 | 38 | ||||
North America | 9 | 5 |
The table above reflects sales to our direct customers based on where they are headquartered. It does not necessarily reflect carrier deployment of our products as we do not sell direct to them. Revenue from Asia has decreased in absolute dollars and decreased as a percentage of total revenue for the three months ended March 29, 2009 as compared to the same period in the prior year due to the decrease in volume. Revenue from Europe increased as a percentage of total revenue for the first three months of 2009 as compared to the prior year due to the decrease in Asian revenue.
Revenue by Product Family as a Percentage of Total Revenue
Three Months Ended | ||||||
March 29, 2009 | March 30, 2008 | |||||
Access | 34 | % | 55 | % | ||
Gateway | 66 | 45 |
The change in mix is primarily attributed to decreased sales of our Access products in Japan, Korea and Europe. Gateway improvement as a percentage of sales reflects more stable European sales.
Cost and Operating Expenses
Three Months Ended | |||||||||
(in millions) | |||||||||
March 29, 2009 | March 30, 2008 | % Change | |||||||
Cost of revenue | $ | 12.3 | $ | 17.6 | (30 | ) | |||
Research and development | 8.9 | 11.7 | (24 | ) | |||||
Sales, general and administrative | 5.6 | 5.9 | (5 | ) | |||||
Restructuring charges | 0.3 | — | nm |
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Cost and Operating Expenses as a Percentage of Total Revenue:
Three Months Ended | ||||||
March 29, 2009 | March 30, 2008 | |||||
Cost of revenue | 59 | % | 59 | % | ||
Research and development | 43 | 39 | ||||
Sales, general and administrative | 27 | 20 | ||||
Restructuring charges | 1 | — |
Cost of Revenue
Our cost of revenue consists primarily of cost of silicon wafers purchased from third-party foundries and third-party costs associated with assembling, testing and shipping of our semiconductors. Because we do not have formal, long-term pricing agreements with our outsourcing partners, our wafer costs and services are subject to price fluctuations based on the cyclical demand for semiconductors among other factors. In addition, after we purchase wafers from foundries, we also incur yield loss related to manufacturing these wafers into usable die. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested. When our manufacturing yields decrease, our cost per unit increases. Such increased costs could have a significant adverse impact on our cost of revenue. In addition to yield loss due to manufacturing process issues, in one of our chipsets we have also experienced yield loss due to defects apparently related to third-party technology incorporated into that product. To date we have not experienced material warranty costs associated with this technology-related issue; however, until we resolve the problem underlying the third-party technology, we cannot predict whether the yield loss will have a material impact on our revenue or 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 decreased to $12.3 million for the three months ended March 29, 2009 as compared to $17.6 million for the three months ended March 30, 2008. The reduction in cost of revenue is directly attributable to our reduced sales volume in the first quarter of 2009. Our gross margins were 41% for the three months ended March 29, 2009 as compared to 41% for the year ago period. Higher average selling prices offset higher average product costs.
Research and development expenses
All research and development (R&D) expenses are expensed as incurred and generally consist of compensation and associated costs of employees engaged in research and development; contractors; tape-out costs; reference board development; development testing, evaluation kits and tools; stock based compensation expenses and depreciation expense. Before releasing new products, we incur charges for mask sets, amortization of acquisition-related intangibles, prototype wafers, mask set revisions, bring-up boards and other qualification materials, which we refer to as tape-out costs. These tape-out costs cause our research and development expenses to fluctuate because they are not incurred uniformly every quarter.
R&D expenses decreased $2.8 million, or 24%, to $8.9 million for the three months ended March 29, 2009 as compared to $11.7 million for the three months ended March 30, 2008. The change was primarily attributed to a $0.8 million decrease in design and tape-out costs, a $0.8 million decrease in stock based compensation, a $0.3 million reduction in compensation costs and a $0.3 million decrease in-process research and development costs associated with our purchase of the Centillium DSL assets in the first quarter of 2008. The decrease in design and tapeout costs as compared to the prior year is the result of our decision to delay certain expenditures from the first to the second quarter of 2009.
The majority of our R&D personnel are located in the United States or India. As of March 29, 2009, we had 142 people engaged in research and development of which 70 were located in India and 63 were located in the United States. As of March 30, 2008, we had 189 people engaged in research and development of whom 97 were located in India and 82 were located in North America. In February 2008 we hired 30 people as a result of acquiring the Centillium product line. As such, their personnel costs were included in the first quarter of 2008 only after the acquisition date. Furthermore, our restructuring activities (discussed below) took place later in the first quarter of 2009.
Selling, general and administrative expenses
Selling, general and administrative (SG&A) expenses generally consist of compensation and related expenses for personnel; public company costs; legal, recruiting and auditing fees; and deprecation. SG&A expenses decreased by $0.2 million for the three months ended March 29, 2009, or 4%, to $5.6 million as compared to $5.9 million for the three months ended March 30, 2008. The decrease is primarily attributed to decreases of $0.4 million in stock based compensation, $0.1 million in amortization of acquisition related intangible assets offset by miscellaneous increases in personnel and marketing costs.
As of March 29, 2009, SG&A headcount was 81, which compares to 89 at March 30, 2008.
Restructuring
During the first quarter of 2009, we implemented a restructuring plan to close our facility in Hyderabad, India and to reduce our R&D cost structure in the United States. Restructuring charges of $0.3 million related to the termination of 23 persons, 12 of whom were located in India and 11 in the United States. In addition, the Company will relocate certain personnel and equipment from its Hyderabad facility to Bangalore during the second quarter of 2009. These additional costs may amount to about $0.2 million and will be recognized and charged to restructuring as incurred.
Interest Income, Net
Interest income, net consists primarily of interest income earned on our cash, cash equivalents and investments, which is partially offset by other non-operating expenses. Interest income, net decreased to $0.2 million for the three months ended March 29, 2009 as compared to $0.8 million for the three months ended March 30, 2008. The decrease was due to a realized loss on the sale of an investment, lower balance of cash and investments and a decrease in interest rates.
Provision for Income Taxes
Income taxes are comprised mostly of foreign income taxes and state minimum taxes. The Company maintains a full valuation allowance for its tax assets as a result of recurring losses. Tax expense was marginally higher in the first quarter of 2008 versus the first quarter of 2009.
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Net Loss
As a result of the above factors, we had a net loss of $6.1 million for the three months ended March 29, 2009 compared to a net loss of $4.8 million for the three months ended March 30, 2008.
Liquidity and Capital Resources
Year-to-date, cash and investments decreased by $4.0 million to $60.4 million as of March 29, 2009 versus $64.4 million as of December 28, 2008.
As of March 29, 2009, we have funded our operations primarily through cash from private and public offerings of our common stock, cash generated from the sale of our products and proceeds from the exercise of stock options and stock purchased under our employee stock purchase plan. Our uses of cash include payroll and payroll-related expenses, manufacturing costs, purchases of equipment, tools and software and operating expenses, such as tape outs, marketing programs, travel, professional services and facilities and related costs. We believe there will be additional working capital requirements to fund and operate our business. We expect to finance our operations primarily through operating cash flows and existing cash and investment balances.
The following table summarizes our statement of cash flows for the three months ended March 29, 2009 and March 30, 2008 (in millions):
2009 | 2008 | |||||||
Statements of Cash Flows Data: | ||||||||
Cash and cash equivalents - beginning of period | $ | 27.2 | $ | 65.1 | ||||
Net cash provided (used) by operating activities | (3.8 | ) | 3.0 | |||||
Net cash provided (used) by investing activities | 0.9 | (9.2 | ) | |||||
Net cash provided (used) by financing activities | — | 0.2 | ||||||
Cash and cash equivalents - end of period | $ | 24.3 | $ | 59.1 | ||||
Operating Activities
For the three months ended March 29, 2009, we used $3.8 million of net cash in operating activities, while incurring a net loss of $6.1 million. Included in the net loss was approximately $4.1 million in various non-cash expenses consisting of depreciation and amortization, stock based compensation expense and amortization of intangible assets and acquired technology. Operating cash flows also benefited from a decrease in accounts receivable of $0.1 million and inventory of $0.3 million. These working capital improvements were offset primarily by a $2.2 million decrease in accounts payable and accrued liabilities.
For the three months ended March 30, 2008, we generated $3.0 million in net cash from operating activities, while incurring a net loss of $4.8 million. Included in the net loss was approximately $6.5 million in various non-cash expenses and charges consisting of depreciation and amortization, stock based compensation expense, amortization of intangible assets and acquired technology and purchased in-process research and development. Operating cash flows benefited from a decrease in inventory of $4.9 million and a decrease in accounts receivable of $2.6 million. The decrease in inventory was primarily due to the timing of inventory receipts and shipments. The decrease in accounts receivable was primarily due to more linearity of sales in the quarter. These improvements in operating cash flows were also affected by a decrease in accounts payable and accrued liabilities of $6.0 million. The decrease in accounts payable and accrued liabilities was primarily due a decrease in our volume of inventory purchases at the end of the quarter as well as various other payments in the ordinary course of business.
Investing Activities
Investing activities provided $0.9 million for the three months ended March 29, 2009, primarily consisting of the net sales of short-term investments.
We used net cash in investing activities of $9.2 million for the three months ended March 30, 2008, primarily in the Centillium DSL acquisition totaling $11.9 million and various fixed assets totaling $0.3 million, offset by net sales of short-term investments totaling $3.0 million.
We have classified our investment portfolio as “available for sale,” and our investment objectives are to preserve principal and provide liquidity, while maximizing yields without significantly increasing risk. We may sell an investment at any time if the quality rating of the investment declines; the yield on the investment is no longer attractive; or we are in need of cash. We have used cash to acquire businesses and technologies that enhance and expand our product offering and, we anticipate that we will continue to do so in the future. The nature of these transactions makes it difficult to predict the amount and timing of such cash requirements. We 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.
On April 22, 2009, the Company announced the signing of a definitive agreement to purchase the Broadband Access product line of Conexant Systems, Inc. for $54.0 million in cash and the assumption of certain employee and facility-related liabilities. Subject to certain conditions, including stockholder and regulatory approvals, the transaction is expected to be completed in the third quarter of 2009.
Financing Activities
Our financing activities provided $0.2 million for the three months ended March 30, 2008 primarily resulting from the exercise of employee stock options.
We have used, and continue to intend to use, the net proceeds for working capital and general corporate purposes, which may include the acquisition of businesses, products, product rights or technologies, strategic investments or purchases of common stock. Conditioned on the closing of the Broadband Access product line purchase, Tallwood Venture Capital has agreed to purchase 24 million shares of the Company’s common stock at $1.75 per share for a total of $42 million. Tallwood will also receive warrants to purchase an additional 7.8 million shares of common stock at $1.75.
We believe that our existing cash, cash equivalents and cash flows expected to be generated from future operations, if any, will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend upon many factors including the requirements after closing of the current Ikanos business combined with the Conexant broadband access products business, our rate of revenue growth, our ability to develop future revenue streams, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. Additionally in the future, we may become party to agreements with respect to potential investments in, or acquisitions of, other complementary businesses, products or technologies, which could also require us to seek additional equity or debt financing. The sale of additional equity securities or convertible debt securities would result in additional
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dilution to our stockholders. Additional debt would result in increased interest expenses and could result in covenants that would restrict our operations. We have not made arrangements to obtain additional financing, and there is no assurance that such financing, if required, will be available in amounts or on terms acceptable to us, if at all.
Contractual Commitments and Off-Balance Sheet Arrangements
We do not use off balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off balance sheet arrangements such as special purpose entities and research and development arrangements. Accordingly, our liquidity and capital resources are not subject to off balance sheet risks from unconsolidated entities.
We lease certain office facilities, equipment and software under non-cancelable operating leases. The following table summarizes our contractual obligations as of March 29, 2009, and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in millions):
Payment due by period | |||||||||
Total | Remainder of 2009 | 2010 and Thereafter | |||||||
Operating lease payments | $ | 2.6 | $ | 1.4 | $ | 1.2 | |||
Inventory purchase obligations | 3.0 | 3.0 | — | ||||||
$ | 5.6 | $ | 4.4 | $ | 1.2 | ||||
For the purpose of this table, purchase obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors within short time horizons. In addition, we have purchase orders that represent authorizations to purchase rather than binding agreements. We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements.
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant, and we are unable to estimate the maximum potential impact of these indemnification provisions on our future consolidated results of operations.
Recent Accounting Pronouncements
Recent accounting pronouncements are detailed in Note 1 to our Condensed 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 March 29, 2009, 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. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal and meet liquidity needs, while maximizing yields and without significantly increasing risk. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer, or type of investment. Our investments consist primarily of U.S. government notes and bonds, auction rate securities and commercial paper. All investments are carried at market value.
As of March 29, 2009, we had cash, cash equivalents and investments totaling $60.4 million. These amounts were invested primarily in money market funds and short-term investments that are held for working capital purposes. We do not enter into investments for trading or speculative purposes. If the return on our cash equivalents and investments were to change by one hundred basis points, the effect would be to increase/decrease investment income by $0.2 million.
Investment Risk
Our marketable securities portfolio as of March 29, 2009 was $53.4 million and approximately 1.9% of the portfolio are auction rate securities. Auction rate securities are securities that are structured with short-term interest rate reset dates of generally less than ninety days but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to thirty-five days, investors can sell or continue to hold the securities at par. These securities are subject to fluctuations in fair value depending on the supply and demand at each auction. The portfolio includes $7.2 million (at cost) invested in auction rate securities all of which are currently associated with failed auctions and have been in a loss position for over 12 months. Based on an analysis of impairment factors, we have recorded an other-than-temporary impairment loss of approximately $6.2 million during the third quarter of 2008 related to these auction rate securities. The funds associated with the securities for which auctions have failed will not be accessible until a successful auction occurs, a buyer is found outside of the auction process or the underlying securities have matured. These investments have maturities from 2025 to 2050.
We have classified the auction rate securities as Level 3 under Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. (SFAS) 157, Fair Value Measurements. We valued the auction rate securities using a discounted cash flow model. Assumptions used in valuing each of the auction rate securities include the stated coupon rate and maturity date on the note and one unobservable input; an estimated discount rate. The discount rate is an estimate of what we believe the security must be discounted to in order to sell today. It is based on a number of factors, including the credit rating of the issuer and the insurance provider for the security.
Foreign Currency Risk
Our revenue and cost, including subcontractor 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, including the Euro, the Japanese yen, Korean won, Indian rupee, Singapore dollar 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.
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Item 4. | Controls and Procedures |
Evaluation of disclosure controls and procedures.
As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as required by Rules 13a-15(b) or 15d-15(b) of the Securities Exchange Act of 1934, as amended. Based on their evaluation, our certifying officers concluded that these disclosure controls and procedures were effective.
We believe that a system of internal controls, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and can be affected by limitations inherent in all internal controls systems including the realities that human judgment in decision-making can be faulty, that persons responsible for establishing controls need to consider their relative costs and benefits, that breakdowns can occur because of human failures such as simple error or mistake, and that controls can be circumvented by collusion of two or more people. Accordingly, we believe that our system of internal controls, while effective, can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. There was no change in our internal control over financial reporting during the quarter ended March 29, 2009 that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II: OTHER INFORMATION
Item 1. | Legal Proceedings |
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, its directors and two former executive officers, as well as the lead underwriters for its initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint sought unspecified damages for certain alleged material misrepresentations and omissions made by the Company in connection with both its initial public offering in September 2005 and its follow-on offering in March 2006. On June 25, 2007, the Company filed a motion to dismiss the amended complaint, plaintiffs opposed the motion, and on March 10, 2008, the District Court ordered the case dismissed with prejudice. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration.
On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit. The parties have filed their respective briefs with the Second Circuit, and oral arguments are scheduled for June 18, 2009. The Company cannot predict the likely outcome of the appeal, and an adverse result in the litigation could have a material effect on its financial statements.
Additionally, from time to time, the Company is a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, the Company does not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on its results of operations, cash flows or financial position.
Item 1A. | Risk Factors |
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this annual report on Form 10-K, and in our other filings with the SEC, before deciding whether to invest in shares of our common stock. Additional risks and uncertainties not presently known to us may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on us, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock will likely decline and you may lose all or part of your investment.
Risks Related to Our Business
Our quarterly operating results, including revenue and expense levels, have fluctuated significantly over time and are likely to continue to do so, principally due to the nature of telecommunication service providers’ capital spending cycles, the design win process as well as other factors. As a result, we may fail to meet or exceed our forecasts or the expectations of securities analysts or investors, which could cause our stock price to decline.
The telecommunications semiconductor industry is highly cyclical and subject to rapid change and, from time to time, has experienced significant downturns. As was widely reported in the first half of this decade, the telecommunications industry experienced, and may again experience, a pronounced downturn. These downturns are characterized by decreases in product demand and excess inventories held by our customers, OEMs, and their customers, the telecommunications service providers (also called “service providers”). To respond to these downturns, many service providers slow their capital expenditures, cancel or delay new developments, reduce their workforces and inventories and take a cautious approach to acquiring new equipment and technologies from OEMs, usually with very little notice.
Quarterly fluctuations in revenue are characteristic of our industry. And given the concentration of our revenue among a few significant customers and given their buying patterns, we have experienced, and are likely to experience again, significant quarterly fluctuations of revenue. In the first quarter of 2005 and fourth quarter of 2006, we experienced quarter-over-quarter revenue declines of 33% and 43%, respectively, over the prior quarters. After three quarters of relatively flat revenue results, our revenue for the third quarter of 2008 declined by $5.7 million, or 19%, compared to the second quarter of 2008.
We win supply relationships by working with OEMs and service providers to have our semiconductors designed into systems that will be deployed by service providers over multiples quarters. At any given time, as is currently the case, we are competing for one or more of these design wins. If we are not successful in obtaining these design wins, our revenue results would be negatively affected. Even when we are designed into OEMs’ equipment, service provider deployments can be affected by various factors, including but not limited to demand for DSL-based broadband services, government regulatory actions and competitors’ efforts to protect or gain market share. We are aware of such deployment delays currently occurring with a service provider in Japan.
The semiconductor industry also periodically experiences increased demand and production capacity constraints, which may affect our ability to ship products. Accordingly, our operating results may vary significantly as a result of the general conditions in the semiconductor or broadband communications industry, which could cause our stock price to decline.
In addition, our expenses are also subject to quarterly fluctuations resulting from factors including the costs related to new product releases. If our operating results do not meet the expectations of securities analysts or investors for any quarter or other reporting period, the market price of our common stock may decline. Fluctuations in our operating results may be due to a number of factors, including, but not limited to, changes in the mix of products we develop, acquire and sell as well as those identified throughout this Risk Factors section. As a result, you should not rely on quarter to quarter comparisons of our operating results as an indicator of future performance.
The current worldwide financial situation could dampen demand for services based upon our products.
Our business is not directly tied to the reported causes of the current downturn in the financial markets. However we believe that consumer-targeted broadband services, which are deployed using our technology, are part of most households’ discretionary spending. If individual consumers decide not to install—or decide to discontinue purchasing—broadband services in their homes in order to save money an in uncertain economic situation, 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.
Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments.
As part of our business strategy, we seek to acquire businesses and product lines that are complementary to our current business. These acquisitions, including the acquisition of Conexant Systems’ broadband access product line, which we entered on April 21, 2009, are accompanied by the risks commonly encountered in an acquisition of a business, which may include, among other things:
• | the failure of the acquisition to result in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, costs savings, operating efficiencies and other synergies; |
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• | the difficulty and cost of integrating the acquired business, including costs and delays in implementing common systems and procedures and costs and delays caused by communication difficulties or geographic distances between the two companies’ sites; |
• | the assumption of certain liabilities, including the risk of litigation associated with intellectual property assets; |
• | the potential impairment of acquired assets; |
• | the initial dependence upon unfamiliar supply or distribution partners; |
• | the diversion of management’s attention from other business concerns; |
• | the impairment of relationships with customers or suppliers of the acquired business or our customers or suppliers; |
• | the potential loss of key employees of the acquired company; |
• | the potential incompatibility of business cultures. |
These factors could have a material adverse effect on our business, results of operations or financial condition. In addition to the risks commonly encountered in the acquisition of a business as described above, we may also experience risks relating to the challenges and costs of closing a transaction.
Acquisitions, strategic alliances, joint ventures or investments may impair our capital and equity resources, divert our management’s attention or otherwise negatively impact our operating results.
We intend to continue to pursue acquisitions, strategic alliances and other transactions that we believe may allow us to complement our growth strategy, increase market share in our current markets and expand into adjacent markets, broaden our technology and intellectual property and strengthen our relationships with service providers and OEMs. Any future acquisition, partnership, joint venture or investment may require that we pay significant cash, issue stock, thereby diluting existing stockholders, or incur debt, if such debt is available on terms acceptable to our board of directors. Acquisitions, partnerships or joint ventures may also require significant managerial attention, which may divert our focus. These capital, equity and managerial commitments may impair the operation of our business.
We have a history of losses, and future losses may cause the market price of our common stock to decline. We may not be able to reduce our expenses or generate sufficient revenue in the future to achieve or sustain profitability.
Since our inception, we have only been profitable on a GAAP basis in the third and fourth quarter of 2005. Prior to the third quarter of 2005, we incurred significant net losses, and we incurred losses in the past ten quarters. Beginning in 2006, accounting rules required us to report stock-based compensation as an expense, which has comprised a substantial portion of our quarterly and annual losses, as reported on a GAAP basis. We incurred a net loss of $6.1 million for the quarter ended March 29, 2009 and have an accumulated deficit of $189.8 million as of March 29, 2009. To achieve profitability again, we will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for our business. Because many of our expenses are fixed in the short term, or are incurred in advance of anticipated sales, we may not be able to continue to hold down our costs and expenses in a timely manner to offset any lower-than-forecasted revenue shortfall as we experienced in the fourth quarter of 2006. We may not be able to achieve profitability again and, even if we were able to attain profitability again, we may not be able to sustain profitability on a quarterly or an annual basis in the future.
The general tightening of the credit market could potentially limit our access to financial resources.
If the company continues to operate at a loss and the cash on our balance sheet continues to decline, there is a possibility we could have to seek out and evaluate alternative sources of financing in order to fund operations. Historically we have not had to use debt financing to operate the business. If that situation were to change, we believe it would be very difficult to borrow funds on terms favorable to us, if at all, due to the extremely limited availability of credit in the current economic environment. The unavailability of credit along with limits on other financing alternatives could thus negatively impact our business. Even if we were able to secure debt financing, the terms could be unfavorable to us, and we may be subject to various restrictive covenants, which could limit our ability to operate our business.
Our success is dependent upon achieving design wins into commercially successful OEM and ODM systems.
Our products are generally incorporated into our OEM and ODM customers’ systems at the design stage. As a result, we rely on OEMs to select our products to be designed into their systems, which we refer to as a “design win.” We often incur significant expenditures over multiple fiscal quarters in attempting to obtain a design win without any assurance that an OEM will select our product for design into its own system. Additionally, in some instances, we are dependent on third parties to obtain or provide information that we need to achieve a design win. Some of these third parties may not supply this information to us on a timely basis, if at all. Furthermore, even if an OEM designs one of our products into its system offering, we cannot be assured that its equipment will be commercially successful or that we will receive any orders and, accordingly, revenue as a result of that design win. Our OEM customers are typically not obligated to purchase our products and can choose at any time to stop using them if their own systems are not commercially successful, if they decide to pursue other systems strategies, or for any other reason. If we are unable to achieve design wins or if our OEM customers’ systems incorporating our products are not commercially successful, our revenue would suffer.
If demand for our semiconductor products declines or does not grow, we will be unable to increase or sustain our revenue; and our operating results will be harmed.
We currently expect the semiconductor products we have already announced to account for substantially all of our revenue for the foreseeable future. If we are unable to develop new products or to successfully integrate acquired products and technology to meet our customers’ demand in a timely manner, if demand for our semiconductors declines or fails to grow, or if the DSL, GPON or network processor markets do not materialize as expected, it would harm our business. In addition to being affected by global macroeconomic factors, the markets for our products are characterized by frequent introduction of new semiconductors, short product life cycles and significant price competition. If we or our OEM customers are unable to manage product transitions in a timely and cost-effective manner, our revenue would suffer. In addition, frequent technology changes and introduction of next generation products may result in inventory obsolescence, which would increase our cost of revenue and adversely affect our operating performance.
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The average selling prices and gross margins of certain 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 competitive pressures, including lowering average selling prices in order to increase market share. We have lowered our prices significantly at times to gain or maintain market share, and we expect that we will reduce prices again in the future. Offering reduced prices to one customer could likely impact our average selling prices to all customers. In addition, we have not been able to reduce our costs of goods sold as rapidly as our prices have declined. Our financial results 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, by reducing our manufacturing costs or by developing new or enhanced products that command higher prices or better gross margins on a timely basis.
Our products typically have lengthy sales cycles, which may cause our operating results to fluctuate and result in volatility in the price of our common stock. An OEM customer or a service provider may decide to cancel, delay or change its product plans, which could cause us to lose or delay anticipated sales.
After we have delivered a product to an OEM customer, the OEM will usually test and evaluate our product with its service provider customer prior to the OEM completing the design of its own equipment that will incorporate our product. Our OEM customers and the service providers may take several months to test, evaluate and adopt our product and several additional months to begin volume production of equipment that incorporates our product. This entire process can take from six months to over a year to complete. Due to this lengthy sales cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring these expenditures and investments. Even if an OEM customer selects our product to incorporate into its equipment, we have no assurances that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increases the risk that an OEM customer or service provider will decide to cancel or change its product plans. From time to time, we have experienced changes and cancellations in the purchase plans of our OEM customers. A cancellation or change in plans by an OEM customer or service provider could cause us to not achieve anticipated revenue and result in volatility of the price of our common stock. In addition, our anticipated sales could be lost or substantially reduced if a significant OEM customer or service provider reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products.
Our product sales mix is subject to frequent and unexpected changes, which may impact our revenue and margin.
Our product margins vary widely by product. As a result, a change in the sales mix of our products could have an impact on the forecasted revenue and margins for the quarter. Our modem only products within the Gateway product family generally have lower margins as compared to our Access product family. Furthermore, the product margins within our Access product line can vary based on the type and performance of deployment being used as customers typically pay higher selling prices for higher performance. While we make estimates of what we believe the product mix will be in a given quarter, actual results can be materially different than our estimates.
Because we depend on a few significant customers for a substantial portion of our revenue, the loss of any of our key customers, our inability to continue to sell existing and new products to our key customers in significant quantities or our failure to attract new significant customers could adversely impact our revenue and harm our business.
We derive a substantial portion of our revenue from sales to a relatively small number of customers. As a result, the loss of any significant customer or a decline in business with any significant customer would materially and adversely affect our financial condition and results of operations. The following customers accounted for more than 10% of our revenue for any one of the periods indicated. We have indicated the OEM customer based on information that we receive at the time of ordering.
Our Direct Customer | OEM Customer | Year Ended December 30, 2007 | Year Ended December 28, 2008 | Three Months Ended March 29, 2009 | |||||||
Sagem | Sagem | 20 | 21 | 37 | |||||||
NEC Corporation | NEC Corporation | 29 | % | 25 | % | 23 | % | ||||
Alcatel-Lucent and its CMs(a) | Alcatel-Lucent | * | 11 | 11 | |||||||
Paltek Corporation | Sumitomo Electric Industries | * | 23 | * | |||||||
Altima Corporation | Sumitomo Electric Industries | 12 | * | * | |||||||
Uniquest | Dasan, Millinet and Ubiquoss | 11 | * | * |
* | Less than 10% |
(a) | Alcatel and Lucent Technologies, subsequent to their 2007 merger, accounted for a combined 10% of our revenue in 2007. |
A small group of OEM customers historically has accounted for a substantial portion of our revenue; the composition of this group has varied, and we expect will continue to vary, over time. Further, we expect that this small group of customers will continue to account for a substantial portion of our revenue for the foreseeable future. Accordingly, our future operating results will continue to depend on the success of our largest OEM customers and on our ability to sell existing and new products to these customers in significant quantities. Demand for our semiconductor products is based on service provider demand for our OEM customers’ systems products. Accordingly, a reduction in growth of service provider deployment of product that use our semiconductors would adversely affect our product sales and business.
In addition, our relationships with some of our larger OEM customers may also deter other potential customers who compete with these customers from buying our products. To attract new customers or retain existing OEM customers, we have offered and may continue to offer certain customers favorable prices on our products. If these prices are lower than the prices paid by other existing OEM customers, we may have to offer the same lower prices to certain of these customers. In that event, our average selling prices would decline. The loss of a key customer, a reduction in sales to any major customer, or our inability to attract new significant customers in the absence of any offsetting sales would harm our business.
We have historically derived a substantial amount of our revenue from Japan and Korea, and a majority of our network processing revenue comes from a single customer in France. If we fail to further diversify the geographic sources and customer base of our revenue in the future, our operating results could be harmed.
A substantial portion of our revenue is derived from sales into Japan, Korea and France; and our revenue has been heavily dependent on market growth in these countries. As a result, our sales are subject to economic downturns, decrease in demand and overall negative market conditions in a very few number of specific economies. For instance, a slowdown in growth of fiber extension over copper and broadband over copper subscribers in Asia has caused our revenue in that market to decline, and may prevent that revenue stream from returning to historical levels. While part of our strategy is to continue to diversify the geographic sources and customer base of our revenue, our failure to successfully penetrate markets other than those served by our existing customers, and diversify our customer base could harm our business and operating results.
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In the past year, we have experienced a turnover in several senior management positions, and we may be unable to attract, retain and motivate key senior management and technical personnel, which could harm our development of technology and ability to be competitive.
In April 2008, we hired a General Manager and in July 2008, we hired a Vice President of Corporate Marketing. Our Chief Executive Officer, Michael Gulett, who has been a member of our board of directors for five years, assumed his current role with the company in July 2008. We also recently hired a new Vice President of Software Engineering. Further, as required, we seek out highly-qualified candidates to fill positions throughout our business. We will continue to examine ways to improve the Company’s processes, productivity and results.
Our future success depends to a significant extent upon the continued service of our senior executives and key technical personnel as well as the integration of new senior executives. We do not have employment agreements with any of these executives or any other key employees that govern the length of their service. Changes in the services of senior management or technical personnel could impact our customer relationships, employee morale, our ability to operate in compliance with existing internal controls and regulations and harm our business.
Furthermore, our future success depends on our ability to continue to attract, retain and motivate other senior management and qualified technical personnel, particularly software engineers, digital circuit designers, mixed-signal circuit designers and systems and algorithms engineers. Competition for these employees is intense. Restricted stock units and stock options generally comprise a significant portion of our compensation packages for all employees, and as long as the price of our common stock remains depressed it may make it more difficult for us to attract and retain key employees, which could harm our ability to provide technologically competitive products. Additionally, a reduction in staff could negatively affect employee morale. We have periodically reduced our staff in response to business conditions. Workforce reductions and job reassignments could negatively affect employee morale and make it difficult to motivate and retain the remaining employees and contractors, which would affect our ability to deliver our products in a timely fashion and otherwise negatively affect our business.
Because of the rapid technological development in our industry and the intense competition we face, our products tend to become outmoded or obsolete in a relatively short period of time, which requires us to provide frequent updates and/or replacements to existing products. If we do not successfully manage the transition process to next generation semiconductor products, our operating results may be harmed.
Our industry is characterized by rapid technological innovation and intense competition. Accordingly, our success depends in part on our ability to develop next generation semiconductor products in a timely and cost-effective manner. The development of new semiconductor products is expensive, complex and time consuming. If we do not rapidly develop our next generation semiconductor products ahead of our competitors, we may lose both existing and potential customers to our competitors. Further, if a competitor develops a new, less expensive product using a different technological approach to delivering broadband services over existing networks, our products would no longer be competitive. Conversely, even if we are successful in rapidly developing new semiconductor products ahead of our competitors and we 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. If any of the foregoing were to occur, then our operating results would be harmed.
We rely on third-party technologies for the development of our products; and our inability to use such technologies in the future would harm our ability to remain competitive.
We rely on third parties for technologies that are integrated into some of our products, including our 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. For instance, we have experienced on-going issues with the intellectual property acquired from one of our vendors for one of our products. We have worked with the vendor as well as with customers who purchase this product to identify process and design improvements that will ultimately resolve these issues. While we have not experienced material warranty costs in any period as a result of the issues related to this intellectual property, there can be no assurance that we will not in the future experience material damages from this or other licensed intellectual property. Failure to use the technologies we have purchased could also result in unfavorable impairment costs. In addition, if we are unable to successfully license technology from third parties to develop future products, we may not be able to develop such products in a timely manner or at all.
We are a fabless semiconductor company and may rely on one wafer foundry and one assembly and test subcontractor to manufacture, package and test each of our products, and our failure to secure and maintain sufficient capacity with these subcontractors, or if a subcontractor ceases operations, such developments could impair our relationships with customers and decrease sales, which would negatively impact our market share and operating results.
We are a fabless semiconductor company in that we do not own or operate a fabrication or manufacturing facility. Currently, seven wafer foundries and three outside factory subcontractors, located in Austria, China, Israel, Korea, Malaysia, Singapore, Taiwan, and the United States manufacture, assemble and test all of our semiconductor devices in current production. While we work with multiple suppliers, only one foundry and one assembly and test subcontractor may be used for a single product. Accordingly, we are greatly dependent on a limited number of suppliers to deliver quality products on time.
In past periods of high demand in the semiconductor market, we have experienced delays in meeting our capacity demand and as a result were unable to deliver products to our customers on a timely basis. In addition, we have experienced similar delays due to technical and quality control problems. Furthermore, our costs for manufacturing services or components have increased from time to time without significant notice.
In the fall of 2008, we received notice that one of our subcontractors would close a fabrication facility where two of our products are made, unless a third party buys the facility and keeps it open. It now appears that the fabrication facility may cease manufacturing products for us later this year. Accordingly, we are making arrangements for our subcontractor to build an adequate supply of the two products fabricated at this facility sufficient to meet our anticipated demand until we have identified alternative fabrication facilities. One of our remaining options is to have the two products fabricated at a different facility owned by the same subcontractor. If we are unable to pursue that option, we will have to identify an alternative subcontractor to fabricate the two products. Transitioning to either the new location operated by the same subcontractor or an alternative manufacturer may be more expensive, may result in additional costs associated with obtaining customer requalification or may not be available at all.
In the future, if any of these events occur, or if the facilities of any of our subcontractors suffer any damage, power outages, financial difficulties or any other disruption due to natural disasters, terrorist acts or otherwise, we may be unable to meet our customer demand on a timely basis, or at all; and we may be required to incur additional costs and may need to successfully qualify an alternative facility in order to not disrupt our business. We typically require several months or more to qualify a new facility or process before we can begin shipping products. If we cannot accomplish this qualification 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. If we are unable to secure sufficient capacity at our subcontractors’ existing facilities, or in the event of a closure or significant delay at any of these facilities, our relationships with our customers would be harmed and our market share and operating results would suffer as a result. In addition, we do not have formal pricing agreements with our subcontractors regarding the pricing for the products and services that they provide us. If their pricing for the products and services they provide increases and we are unable to pass along such increases to our OEM customers, our operating results would be adversely affected.
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In the event 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, our use of seven independent wafer foundries to manufacture all of our semiconductor products exposes us to risks of delay, increased costs and customer dissatisfaction in the event that any of these foundries were unable to provide us with our semiconductor requirements. Particularly during times when semiconductor manufacturing capacity is limited, we may seek to qualify additional wafer foundries to meet our requirements. In order to bring these new foundries on-line, our customers may need to qualify product from the new facility, which could take several months or more. Once qualified, these new foundries would then require an additional number of months to actually begin producing semiconductors to meet our needs, by which time the temporary requirement for additional capacity may have passed or the opportunities we previously identified may have been lost to our competitors. Furthermore, even if these new foundries offer better pricing than our existing manufacturers, if they prove to be less reliable than our existing manufacturers, we would not achieve some or all of our anticipated cost reductions.
When demand for manufacturing capacity is high, we may take various actions to try to secure sufficient capacity, which may be costly and negatively impact our operating results.
The ability of each of our subcontractors’ manufacturing facilities to provide us with semiconductors is limited by its available capacity and existing obligations. Although we have purchase order commitments to supply specified levels of products to our OEM customers, we do not have a guaranteed level of production capacity from any of our subcontractors’ facilities that we depend on 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 our subcontractors may not be able to meet our requirements in a timely manner. For example, in the second half of 2005 and in the first half of 2006, general market conditions in the semiconductor industry resulted in a significant increase in demand at these facilities. The demand for some of our OEM customers’ products increased significantly, and we were asked to produce significantly higher quantities than in the past and to deliver on short notice. In addition, our subcontractors have also allocated capacity to the production of other companies’ products and reduced deliveries to us on short notice. It is possible that our subcontractors’ other customers that are larger and better financed than we are, or that have long-term agreements with our subcontractors, may have induced our subcontractors to reallocate capacity to them. If this reallocation were to occur again, it would impair our ability to deliver products on a timely basis.
In addition, due to the weak global economy, some of our subcontractors have been laying off employees and/or shortening work schedules. These reductions in labor and factory operations could result in capacity constraints that impair our ability to obtain finished products in time to meet customer demand.
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 subcontractors that could be costly and harm our operating results, including:
• | option payments or other prepayments to a subcontractor; |
• | nonrefundable deposits with or loans to subcontractors in exchange for capacity commitments; |
• | contracts that commit us to purchase specified quantities of components over extended periods; |
• | purchase of testing equipment for specific use at our subcontractors’ facilities; |
• | issuance of our equity securities to a subcontractor; and |
• | other contractual relationships with subcontractors. |
We may not be able to make any such arrangements in a timely fashion or at all, and any arrangements may be costly, reduce our financial flexibility and not be on terms favorable to us. Moreover, if we are able to secure facility capacity, we may be obligated to use all of that capacity or incur penalties. These penalties and obligations may be expensive and require significant capital and could harm our business.
If our subcontractors’ manufacturing facilities do not achieve satisfactory quality or yields, our relationships with our customers and our reputation will be harmed, our revenue, gross margin and operating results could decline.
Defects in our products may not be always detected by the testing process performed by our subcontractors or by our own staff. Those defects can result from a variety of causes, including but not limited to manufacturing problems or intellectual property licensed from third parties. If defects are discovered after we have shipped our products, we have and could continue to experience warranty and consequential damages claims from our customers.
In January 2007, a significant customer notified us that they were experiencing a high defect rate on a certain product that was manufactured and shipped in the last month of 2006. In February 2007, we entered into a settlement agreement releasing us of all liabilities associated with this claim in exchange for a payment and providing replacement parts. The settlement was recorded as an offset to revenue and as accrued rebates within accrued liabilities in the fourth quarter of 2006. Such claims as this one or others may have a significant adverse impact on our revenue and operating results.
We incorporate third party intellectual property into our products. That intellectual property consists of elements of the semiconductor, such as the processor core, standard external interfaces, as well as applications that run on our products. From time to time, our customers have discovered errors or defects arising from these third party intellectual property designs. We and our contract manufacturers attempt to catch these defects in the testing process, but are not always successful. If we are unable to deliver quality products, our reputation would be harmed, which could result in the loss of, future orders and business with our customers. 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.
The fabrication of semiconductors is a complex and technically demanding process. Minor deviations in the manufacturing process can cause substantial decreases in yields; and in some cases, cause production to be stopped or suspended. We have experienced difficulties in achieving acceptable yields on some of our products, particularly with new products, which frequently involve newer manufacturing processes and smaller geometry features than previous generations. Maintaining high numbers of shippable die per wafer is critical to our operating results, as decreased yields can result in higher per unit cost, shipment delays and increased expenses associated with resolving yield problems. Although we work closely with our subcontractors to minimize the likelihood of reduced manufacturing yields, their facilities have from time to time experienced lower than anticipated manufacturing yields that have resulted in our inability to meet our customer demand. We have been experiencing manufacturing defect rates for one of our products that are higher than the rates we experience with our other products. As noted above, we believe that the issues observed in this product are related to a particular third party technology; however, there may be other causes for these defects. We have been actively working with the vendor and with our customers to reduce the defect rate for this product. If we are unable to resolve these issues, our revenues could be materially reduced and our warranty-related costs could be materially higher than currently anticipated.
It is common for yields in semiconductor fabrication facilities to decrease in times of high demand or due to poor workmanship or operational problems at these facilities. When these events occur, especially simultaneously, as happens from time to time, we may be unable to supply our customers’ demand. Many of these problems are difficult to detect at an early stage of the manufacturing process and, regardless of when the problems are detected, they may be time consuming and expensive to correct. In addition, because we purchase wafers, our exposure to low wafer yields from our subcontractors’ wafer foundries are increased. Poor yields
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from the wafer foundries or defects, integration issues or other performance problems in our products could cause us significant customer relations and business reputation problems, or force us to sell our products at lower gross margins and therefore harm our financial results. Conversely, unexpected yield improvements could result in us holding excess inventory that would also increase our product cost and negatively impact our profitability.
We base orders for inventory on our forecasts of our OEM customers’ demand and if our forecasts are inaccurate, our financial condition and liquidity would suffer.
We place orders with our suppliers based on our forecasts of our OEM customers’ demand. Our forecasts are based on multiple assumptions, each of which may introduce errors into our estimates. In the past, when the demand for our OEM customers’ products increased significantly, we were not able to meet demand on a timely basis, and we expended a significant amount of time working with our customers to allocate limited supply and maintain positive customer relations. If we underestimate customer demand, we may forego revenue opportunities, lose market share and damage our customer relationships. Conversely, if we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell. As a result, we would have excess or obsolete inventory, resulting in a decline in the value of our inventory, which would increase our cost of revenue and create a drain on our liquidity. Our failure to accurately manage inventory against demand would adversely affect our financial results.
To remain competitive, we need to continue to reduce the cost of our semiconductor chips, which includes migrating to smaller geometrical process, 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 designed our products to be manufactured in 0.8 micron, 0.25 micron, 0.18 micron, 0.13 micron, 0.09 micron (or 90 nanometer) and 0.065 micron (or 65 nanometer) geometrical processes. We may migrate some of our current products to smaller geometrical process technologies, and over time, we are likely to migrate to even smaller geometries. The smaller geometry generally reduces our production and packaging costs, which may enable us to be competitive in our pricing. The transition to smaller geometries requires us to work with our subcontractors to modify the manufacturing processes for our products, to develop new and more complex quality assurance tests and to redesign some products. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased product costs and expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes, all of which could harm our relationships with our customers, and our failure to do so would impact our ability to provide competitive prices to our customers, which would have a negative impact on our sales. Additionally, upfront expenses associated with smaller geometry process technologies such as for masks and tooling can be significantly higher than those for the processes that we currently use, and our migration to these newer process technologies can result in significantly higher research and development expenses.
The complexity of our products could result in unforeseen delays or expenses and in undetected defects or bugs, which could damage our reputation with current or prospective customers and adversely affect the market acceptance of new products.
Highly complex products such as those that we offer frequently contain defects (commonly referred to as “bugs”), particularly when they are first introduced or as new versions are released. In the past, we have experienced, and may in the future experience, defects or bugs in our products. These defects or bugs may originate in third party intellectual property incorporated into our products as well as in technology or software designed by Ikanos’ engineers. If any of our products contains defects or bugs, or have reliability, quality or compatibility problems, our reputation may be damaged; and our OEM customers may be reluctant to buy our products, which could harm our ability to retain existing customers and attract new customers. In addition, these defects or bugs could interrupt or delay sales or shipment of our products to our customers.
Third-party claims of infringement or other claims against us could adversely affect our ability to market our products, require us to redesign our products or seek licenses from third parties, and harm our business. In addition, any litigation required to defend such claims could result in significant expenses and diversion of our resources.
Companies in the semiconductor industry often aggressively protect and pursue their intellectual property rights. From time to time, we receive, and are likely to continue to receive in the future, notices that claim our products infringe upon other parties’ proprietary rights. While we do not believe that we are currently infringing on the proprietary rights of third parties, we may in the future be engaged in litigation with parties who claim that we have infringed their patents or misappropriated or misused their trade secrets or who may seek to invalidate one or more of our patents, and it is possible that we would not prevail in any future lawsuits. An adverse determination in any of these types of claims could prevent us from manufacturing or selling some of our products could increase our costs of products and could expose us to significant liability. Any of these claims could harm our business. For example, in a patent or trade secret action, a court could issue a preliminary or permanent injunction that would require us to withdraw or recall certain products from the market or redesign certain products offered for sale or that are under development. In addition, we may be liable for damages for past infringement and royalties for future use of the technology and we may be liable for treble damages if infringement is found to have been willful. Even if claims against us are not valid or successfully asserted, these claims could result in significant costs and a diversion of management and personnel resources to defend.
Any potential dispute involving our patents or other intellectual property could also include our manufacturing subcontractors and OEM customers and/or service providers using our products, which could trigger our indemnification obligations to one or more of them and result in substantial expense to us.
In any potential dispute involving our patents or other intellectual property, our manufacturing subcontractors and OEM customers could also become the target of litigation. Because we often indemnify our customers for intellectual property claims made against them for products incorporating our technology, any litigation could trigger technical support and indemnification obligations in some of our license agreements, which could result in substantial expenses such as increased legal expenses, damages for past infringement or royalties for future use. From time to time, we receive notices that customers have received potential infringement notices from third parties. While we have not incurred any indemnification expenses as a result of notices received to date, any future indemnity claim could adversely affect our relationships with our OEM customers and result in substantial costs to us.
We face intense competition in the semiconductor industry and the broadband communications markets, which could reduce our market share and negatively impact our revenue.
The semiconductor industry and the broadband communications markets are intensely competitive. In the VDSL or VDSL-like technology, PON and network processing markets, we currently compete or expect to compete with, among others, Aware, Inc., Broadcom Corporation, Broadlight, Cavium Networks, Conexant Systems, Inc., Freescale Semiconductor, Inc., Infineon Technologies A.G., Intel Corporation, Marvell Technology Group Ltd., PMC-Sierra, Inc., Realtek Semiconductor Corp, Teknovus, Thomson S.A. and TrendChip Technologies Corp. We expect competition to continue to increase. Competition has resulted and may continue to result in declining average selling prices for our products and market share.
We consider other companies that have access to DMT technology as potential competitors in the future, and we also may face competition from newly established competitors, suppliers of products based on new or emerging technologies and customers who choose to develop their own semiconductors. To remain competitive, we need to provide products that are designed to meet our customers’ needs. Our products must:
• | achieve optimal product performance; |
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• | comply with industry standards; |
• | be cost-effective for our customers’ use in their systems; |
• | meet functional specifications; |
• | be introduced timely to the market; and |
• | be supported by a high-level of customer service and support. |
Many of our competitors operate their own fabrication facilities or have stronger manufacturing subcontractor relationships than we have. In addition, many of our competitors have extensive technology libraries that could enable them to incorporate broadband or network processing technologies into a more attractive product line than ours. Many of them also have longer operating histories, greater name recognition, larger customer bases, and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. In addition, current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Existing or new competitors may also develop alternative technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of semiconductor integration or lower cost. We cannot assure you that we will be able to compete successfully against current or new competitors, in which case we may lose market share in our existing markets and our revenue may fail to increase or may decline.
Other data transmission technologies and network processing technologies may compete effectively with the service provider services addressed by our products, which could adversely affect our revenue and business.
Our revenue currently is dependent upon the increase in demand for service provider services that use DSL broadband technology and integrated residential gateways. Besides VDSL and other DMT-based technologies, service providers can decide to deploy PON or fiber. In this case, fiber is used to connect directly to the residence instead of using the existing copper phone line. As such, if a service provider decides to deploy fiber-to-the-home, our VDSL products are not required. For example, a major service provider in Korea announced its intention to use more fiber-to-the-home deployments in the future. Such deployments of fiber may be in lieu of VDSL products. If more service providers decide to use FTTH deployments, it could harm our 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 or less expensive than, or has any other advantages over the broadband technologies we provide, the demand for our products may decrease and our business would be harmed.
If we are unable to develop, introduce or to achieve market acceptance of our new semiconductor products, our operating results would be adversely affected.
Our future success depends on our ability to develop new semiconductor products and transition to new products, introduce these products in a cost-effective and timely manner and convince OEMs to select our products for design into their new systems. Our historical quarterly results have been, and we expect that our future results will continue to be, dependent on the introduction of a relatively small number of new products and the timely completion and delivery of those products to customers. The development of new semiconductor products is complex, and from time to time we have experienced delays in completing the development and introduction of new products. We have in the past invested substantial resources in 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 certain technologies acquired in acquisitions into our product lines; |
• | 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; |
• | shift our products to smaller geometry process technologies to achieve lower cost and higher levels of design integration; and |
• | gain market acceptance of our products and our OEM customers’ products. |
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.
Our efforts to identify technologies and develop products designed to deliver broadband services inside the home may not ultimately be successful; if this is the case, our current long-term strategy would not result in the growth in our revenue we intend to generate, and we could experience a material negative effect on our business and equity value.
We have focused our long-term technology strategy on identifying technologies that would be used to deliver services such as high-definition television over various broadband wireline and wireless media within the home. This so-called “Digital Home” has received attention from leaders in semiconductors and systems. For instance, an industry organization named the “Home Grid Forum” was formed recently by Intel, Texas Instruments, Infineon and Panasonic in order to define the industry standards applicable to Digital Home technologies. We and several other smaller companies also are founding participants. If we are unable to develop products that comply with the standards set by the Home Grid Forum or other industry organizations, and our investments in Digital Home technologies do not result in any commercially viable products, we would not realize revenue growth based upon such technologies, and our business and equity value could suffer as a result.
Our products include a significant amount of firmware. If we are unable to deliver the firmware in a timely manner, we may have to delay revenue recognition at the end of a quarter, which could lead to significant unplanned fluctuations in our quarterly revenue. As a result, we may fail to meet or exceed our forecasts or the expectations of securities analysts or investors, which could cause our stock price to decline.
In connection with new product introductions in a given market, we release production quality code to our OEM customers. This firmware is required for our products to function as intended. If the production-ready firmware is not released in a timely manner, we may have to defer all revenue related to the semiconductors that we may have already shipped during the quarter, and therefore, cause us to miss our revenue guidance. In addition, a customer may demand a specific future software feature as part of its order. As such, we may have to delay recognition on some or all of our revenue related to that customer’s order until the future software feature is delivered. Such delays or deferrals in revenue recognition could lead to significant fluctuations in our quarterly revenue and operating results and cause us to fail to meet or exceed our quarterly revenue guidance.
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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 Committee T1E1.4 (now known as NIPP-NAI) of the ATIS (accredited by ANSI), and worldwide by both the IEEE and the ITU-T. Because our products are designed to conform to current specific industry standards, if competing standards emerge that are preferred by our customers, we would have to make significant expenditures to develop new products. If our customers adopt new or competing industry standards with which our products are not compatible, or the industry groups adopt standards or governments issue regulations with which our products are not compatible, our existing products would become less desirable to our customers, and our revenue and operating results would suffer.
If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenue or increase our cost.
Our success will depend, in part, on our ability to protect our intellectual property. We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. Our pending patent applications may not result in issued patents, and our existing and future patents may not be sufficiently broad to protect our proprietary technologies or may be held invalid or unenforceable in court. While we are not currently aware of misappropriation of our existing technology, policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where we have not applied for patent protections and, even if such protections were available, the laws may not protect our proprietary rights as fully as United States law. The patents we have obtained or licensed, or may obtain or license in the future, may not be adequate to protect our proprietary rights. Our competitors may independently develop or may have already developed technology similar to ours, 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 we are not adequately protected, our competitive position would be harmed, our legal costs would increase and our revenue would be harmed.
Changes in current or future laws or regulations or the imposition of new laws or regulations by federal or state agencies or foreign governments could impede the sale of our products or otherwise harm our business.
The effects of regulation on our customers or the industries in which they operate may materially and adversely impact our business. For example, the Ministry of Internal Affairs and Communications in Japan, the Ministry of Communications and Information in Korea, various national regulatory agencies in Europe, as well as the European Commission in the European Union, along with the U.S. Federal Communications Commission have broad jurisdiction over our target markets. Although the laws and regulations of these and other federal or state agencies may not be directly applicable to our products, they do apply to much of the equipment into which our products are incorporated. Governmental regulatory agencies worldwide may affect the ability of telephone companies to offer certain services to their customers or other aspects of their business, which may in turn impede sales of our products.
In addition to the laws and regulations specific to telecommunications equipment, other laws and regulations affect our business. For instance, changes in tax, employment and import/export laws and regulations, and changes their enforcement, commonly occur in the various countries in which we operate. If changes in those law and regulations, or in the enforcement of those laws and regulations, occur in a manner 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.
Compliance with the requirements imposed by Section 404 of the Sarbanes-Oxley Act 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, as standards are modified, supplemented or amended from time to time, 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 Sarbanes-Oxley. There is a risk that neither we, nor our independent registered public accounting firm, will be able to conclude that our internal control over financial reporting is effective as required by Section 404 of Sarbanes-Oxley. In addition, during the course of our testing we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by Sarbanes-Oxley for compliance with the requirements of Section 404. 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 to helping 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 stock could drop significantly.
We are highly dependent on manufacturing, development and sales activities outside of the United States; and as our international manufacturing, development and sales operations expand, we will be increasingly exposed to various 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 the United States, and have a significant portion of our research and development team located India and France. In addition, 91% of our revenue for the quarter ended March 29, 2009 and 92% of our revenue for the year ended December 28, 2008 was 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 substantially dependent on our foreign sales, research and development and operations, any of the factors described above could significantly harm our ability to produce quality products in a timely and cost effective manner, and increase or maintain our foreign sales.
Fluctuations in exchange rates between and among the Euro, the Indian rupee, the Japanese yen, the Korean won, the Singapore dollar and the U.S. dollar, and, as well as other currencies in which we do business, may adversely affect our operating results.
We maintain extensive operations internationally. We have offices in Bangalore, India and other offices in France, Japan, Korea, Singapore and Taiwan. We incur a portion of our expenses in currencies other than the U.S. dollar, including the Euro, the Indian rupee, the Korean won, the Japanese yen, Singapore dollar and the Taiwanese dollar. 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. As a result of an increase in the U.S. dollar relative to the Korean won, our customers in Korea have significantly reduced their orders; a similar increase in the U.S. dollar occurs relative to other currencies in the countries where our customers operate could materially affect our other Asian and European customers’ demand for our products, thereby forcing them to reduce their orders, which would adversely affect our business. Furthermore, currency exchange rates have been especially volatile in the recent past and these currency fluctuations may make it difficult for us to predict and/or provide guidance on our results. Currently, we have not implemented any strategies to mitigate risks related to the impact of fluctuations in currency exchange rates and we cannot predict future currency exchange rate changes.
Several of the facilities that manufacture our products, most of our OEM customers and the service providers they serve, and our California facility are located in regions that are subject to earthquakes and other natural disasters.
Several of our subcontractors’ facilities that manufacture, assemble and test our products, and four of our subcontractor’s wafer foundries, are located in Malaysia, Singapore and Taiwan. Our customers are currently primarily located in Japan and Korea. The Asia-Pacific region has experienced significant earthquakes and other natural disasters in the past and could be subject to additional seismic activities. Any earthquake or other natural disaster in these areas could significantly disrupt these manufacturing facilities’ production capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of wafers in particular, and possibly in higher wafer prices, and our products in general. Our headquarters in California are also located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, it could significantly disrupt our operations.
Our investments in marketable securities may experience further decline in value, which would require us to recognize a charge and adversely affect our operating results.
Our marketable securities portfolio, which totals $ 53.4 million at March 29, 2009, includes auction rate securities of $1.0 million ($7.2 million at cost). Auction rate securities are securities that are structured with short-term interest rate reset dates of generally less than ninety days, but with contractual maturities that can be well in excess of ten years. At the end of each interest reset period, which occurs every seven to thirty-five days, investors can sell or continue to hold the securities at par. In the third quarter of 2007, certain auction rate securities with a cost value of $7.2 million failed auction and did not sell. We recorded an other-than-temporary impairment of approximately $6.2 million during the three months ended September 28, 2008 related to these auction rate securities. Although we believe that $1.0 million is the current fair value of these securities, there is a risk that the value of the securities may decline in value further, which would result in additional loss being recognized in our statement of 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 our foreign operations and the amount and timing of inter-company payments from our foreign operations subject to U.S. income taxes related to the transfer of certain rights and functions.
Risks Related to Our Common Stock
Our stock price has been and may continue to be volatile, and you may not be able to resell shares of our common stock at or above the price you 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:
• | the market’s reaction to the investment by Tallwood Venture Capital announced on April 22, 2009 |
• | quarter-to-quarter variations in our operating results; |
• | announcements of changes in our senior management; |
• | 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 and 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 |
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• | changes in expectations relating to our products, plans and strategic position or those of our competitors or customers. |
The closing sale price of our common stock on the NASDAQ Global Market for the period of December 31, 2006 to March 29, 2009 ranged from a low of $1.02 to a high of $9.34.
In addition, the market prices of securities of semiconductor and other technology companies have been volatile, particularly companies, like ours, with low trading volumes. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. Accordingly, you may not be able to resell your shares of common stock at or above the price you paid.
The pending class action litigation could cause us to incur substantial costs and divert our management’s attention and resources.
In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, our directors and two former executive officers, as well as the lead underwriters for our initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint alleges certain material misrepresentations and omissions by us in connection with our initial public offering in September 2005 and the follow-on offering in March 2006 concerning our business and prospects, and seeks unspecified damages. On June 25, 2007, we filed motions to dismiss the amended complaint; plaintiffs opposed our motions, and a hearing on our motions was heard on January 16, 2008. The Court dismissed the case with prejudice on March 10, 2008. On March 25, 2008, plaintiffs filed a motion for reconsideration, and on June 12, 2008, the District Court denied the motion for reconsideration. On October 15, 2008, plaintiffs appealed the District Court’s dismissal of the amended complaint and denial of its motion for reconsideration to the United States Court of Appeals for the Second Circuit. The parties have filed their respective briefs with the Second Circuit and are awaiting notification from the court as to whether oral argument will be allowed. The Company cannot predict the likely outcome of the appeal. If we are not successful in our defense of the lawsuits, we could be forced to make significant payments to class members and their lawyers, and such payments could have a material adverse effect on our business, financial condition, cash flows and results of operations, if not covered by our insurance service providers. Even if such claims are not successful, the litigation could result in substantial expenses and the diversion of management’s attention, which could have an adverse effect on our business.
If securities or industry analysts do not continue to publish research or reports about our business, or if they issue an adverse opinion regarding our stock, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us issue an adverse opinion regarding our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
Substantial future sales of our common stock in the public market could cause our stock price to fall.
As of April 28, 2009, we had approximately 29.2 million shares of common stock outstanding. Of these shares, 6.4 million were sold in our initial public offering in September 2005 and an additional 2.5 million were sold in a follow-on public offering in March 2006. All of these shares are freely tradable under federal and state securities laws without further registration under the Securities Act, except that any shares held by our “affiliates” (as that term is defined under Rule 144 of the Securities Act) may be sold only in compliance with the limitations under Rule 144. The remaining outstanding shares are “restricted securities” and generally are available for sale in the public market at various times upon qualification for exemption pursuant to Rules 144 and/or 701 of the Securities Act.
In the future, we intend to issue additional shares to our employees, directors or consultants, and may issue shares in connection with corporate acquisitions, as well as in follow-on offerings to raise additional capital. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales could reduce the market price of our common stock.
Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
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 the Board of Directors to elect a director to fill a vacancy created by the expansion of the Board of Directors; |
• | the establishment of a classified Board of Directors requiring that not all members of the board be 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; |
• | the ability of the Board of Directors to alter our bylaws without obtaining stockholder approval; |
• | the ability of the Board of Directors to issue, without stockholder approval, up to 5,000,000 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 |
• | the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent. |
We are also subject to provisions of the Delaware General Corporation Law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for three years after the point in time that such stockholder acquired shares constituting 15% or more of our shares, unless the holder’s acquisition of our stock was approved in advance by our board of directors
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
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Item 4. | Submission of Matters to a Vote of Security Holders |
No stockholder votes took place during the first quarter of 2009.
Item 6. | Exhibits |
An Exhibit Index has been attached as part of this Quarterly Report on Form 10-Q and is incorporated herein by reference.
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: May 6, 2009 | By: | /s/Michael Gulett | ||||||
Michael Gulett | ||||||||
President and Chief Executive Officer | ||||||||
(Principal Executive Officer) | ||||||||
Dated: May 6, 2009 | By: | /s/Cory J. Sindelar | ||||||
Cory J. Sindelar | ||||||||
Vice President and Chief Financial Officer | ||||||||
(Principal Financial and Accounting Officer) |
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IKANOS COMMUNICATIONS, INC.
EXHIBITS TO FORM 10-Q QUARTERLY REPORT
For the Quarter Ended March 29, 2009
Exhibit Number | Description | |
10.1 | 2009 Sales Compensation Plan for the Vice President of Worldwide Sales. Incorporated by reference to the Registrant’s Form 8-K filed with the SEC on March 12, 2009 (File No. 000-51532). | |
10.2 | Summary of Registrant’s 2009 Executive Bonus Program. Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the SEC on April 27, 2009 (File No. 000-51532). | |
10.3 | Amended and restated 2004 Equity Incentive Plan. Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the SEC on March 11, 2009 (File No. 000-51532). | |
10.4 | Entry into an Asset Purchase Agreement, Securities Purchase Agreement and Stockholder Agreement. Incorporated by reference to the Registrant’s Current Repot on Form 8-K filed with the SEC on April 24, 2009 (File No. 000-51532). | |
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. |
* | Filed Herewith. |
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