**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

----

 

**FORM 10-Q**

----

 

**x        Quarterly report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

**For the quarterlyperiod ended October 1, 2006**

**OR**

**£**        Transition report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934

**Commission FileNumber: 0-51532**

**IKANOS COMMUNICATIONS, INC.**

(Exact name of registrant as specified in its charter)

| **Delaware**                                               |   | **73-1721486**       |
|------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                           |   | (I.R.S. Employer     |
| incorporation or  organization)                            |   | Identification  No.) |
|                                                       |   |                 |
| **47669  Fremont Boulevard**                               |
| **Fremont,  California 94538**                             |
| (Address of  principal executive offices)                  |
|                                                       |
| **(510)  979-0400**                                        |
| (Registrant’s  telephone number, including area code) |

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “ExchangeAct”) during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days:                           x  Yes o  No

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large acceleratedfiler  o                   Acceleratedfiler  o                             Non-acceleratedfiler  x

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).      o    Yes  xNo

As of October 31, 2006,there were 27,626,729 shares of the Registrant’s common stock, par value $0.001, outstanding.

 

----

**IKANOSCOMMUNICATIONS, INC.**

**Table of Contents**
|               | ** ** | ** **                                                                  | ** ** | **Page No.** |
|---------------|------------|-----------------------------------------------------------------------------|------------|--------------|
| ** **    | ** ** | ** **                                                                  | ** ** | ** **   |
| **PART I.**   | ** ** | **FINANCIAL  INFORMATION**                                                  | ** ** | ** **   |
| ** **    | ** ** | ** **                                                                  | ** ** | ** **   |
| **Item  1.**  | ** ** | **Financial  Statements:**                                                  |       |         |
| ** **    | ** ** | ** **                                                                  |       |         |
|          |       | Condensed  Consolidated Balance Sheets as of                                |       |         |
|          |       | September 30,  2006 and December 31, 2005 – (unaudited)                |       | 2            |
|          |       |                                                                        |       |         |
|          |       | Condensed  Consolidated Statements of Operations for the                    |       |         |
|          |       | three and nine  months ended September 30, 2006 and 2005 – (unaudited) |       | 3            |
|          |       |                                                                        |       |         |
|          |       | Condensed  Consolidated Statements of Cash Flows for the                    |       |         |
|          |       | nine months  ended September 30, 2006 and 2005 – (unaudited)           |       | 4            |
|          |       |                                                                        |       |         |
|          |       | Notes to Condensed Consolidated Financial Statements –  (unaudited)    |       | 5            |
|          |       |                                                                        |       |         |
| **Item 2.**   |       | **Management’s Discussion and Analysis of Financial  Condition**       |       |         |
|          |       | **and Results of Operations**                                               |       | 21           |
|          |       |                                                                        |       |         |
| **Item 3.**   | ** ** | **Quantitative and Qualitative Disclosures About Market  Risk**             |       | 30           |
| ** **    | ** ** | ** **                                                                  |       |         |
| **Item 4.**   | ** ** | **Controls and Procedures**                                                 |       | 31           |
| ** **    | ** ** | ** **                                                                  |       | ** **   |
| **PART  II.** | ** ** | **OTHER  INFORMATION**                                                      |       |         |
| ** **    | ** ** | ** **                                                                  |       |         |
| **Item  1.**  | ** ** | **Legal  Proceedings**                                                      |       | 32           |
| ** **    | ** ** | ** **                                                                  |       |         |
| **Item  1A.** | ** ** | **Risk  Factors**                                                           |       | 32           |
| ** **    | ** ** | ** **                                                                  |       |         |
| **Item 2.**   | ** ** | **Unregistered Sales of Equity Securities and Use of  Proceeds**            |       | 48           |
| ** **    | ** ** | ** **                                                                  |       |         |
| **Item 6.**   | ** ** | **Exhibits**                                                                |       | 49           |
| ** **    | ** ** | ** **                                                                  |       |         |
| ** **    |       | **Signatures**                                                              |       | 50           |
| ** **    |       | ** **                                                                  |       |         |
| ** **    |       | **Exhibit  Index**                                                          |       | 51           |

 

1

----

**PART I:****                           FINANCIAL INFORMATION**

**ITEM 1.****                             FINANCIALSTATEMENTS**

**IKANOSCOMMUNICATIONS, INC.**

### **CONDENSEDCONSOLIDATED BALANCE SHEETS**

(In thousands andunaudited)
| ** **                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **Assets**                                       | ** ** | ** **             |       |                  |       |
| Current assets:                                  |       |                   |       |                  |       |
| Cash  and cash equivalents                       |       | $                      | 52,591     |                  | $          | 91,932 |   |
| Short-term  investments                          |       | 58,879                 |       | 1,988                 |       |
| Accounts  receivable, net                        |       | 27,658                 |       | 11,015                |       |
| Inventories                                      |       | 11,884                 |       | 9,125                 |       |
| Prepaid  expenses and other current assets       |       | 3,007                  |       | 2,235                 |       |
| Total  current assets                            |       | 154,019                |       | 116,295               |       |
| Property and  equipment, net                     |       | 19,439                 |       | 8,384                 |       |
| Intangible  assets, net                          |       | 12,423                 |       | —                |       |
| Goodwill                                         |       | 4,800                  |       | —                |       |
| Other assets                                     |       | 753                    |       | 916                   |       |
| Total  assets                                    |       | $                      | 191,434    |                  | $          | 125,595 |   |
|                                             |       |                   |       |                  |       |
| **Liabilities and Stockholders’ Equity**    |       |                   |       |                  |       |
| ** **                                       |       |                   |       |                  |       |
| Current liabilities:                             |       |                   |       |                  |       |
| Accounts  payable                                |       | $                      | 17,361     |                  | $          | 8,371 |   |
| Accrued  liabilities                             |       | 17,553                 |       | 11,284                |       |
| Capital  lease obligations, current portion      |       | 874                    |       | 315                   |       |
| Notes  payable, current portion                  |       | 906                    |       | 698                   |       |
| Total  current liabilities                       |       | 36,694                 |       | 20,668                |       |
| Capital lease  obligations                       |       | 1,189                  |       | 223                   |       |
| Notes payable                                    |       | —                 |       | 728                   |       |
| Total  liabilities                               |       | 37,883                 |       | 21,619                |       |
| Commitments and  contingencies (Note 9)          |       |                   |       |                  |       |
| Stockholders’  equity:                      |       |                   |       |                  |       |
| Preferred  stock                                 |       | —                 |       | —                |       |
| Common  stock                                    |       | 28                     |       | 24                    |       |
| Additional  paid-in capital                      |       | 246,759                |       | 195,398               |       |
| Warrants                                         |       | 914                    |       | 914                   |       |
| Notes  receivable from stockholders              |       | (19                    | )          | (19                   | )          |
| Deferred  stock-based compensation               |       | (256                   | )          | (5,699                | )          |
| Accumulated  other comprehensive loss            |       | (86                    | )          | (65                   | )          |
| Accumulated  deficit                             |       | (93,789                | )          | (86,577               | )          |
| Total  stockholders’ equity                 |       | 153,551                |       | 103,976               |       |
| Total liabilities and  stockholders’ equity |       | $                      | 191,434    |                  | $          | 125,595 |   |

See accompanying notes tothese unaudited condensed consolidated financial statements.

2

----

**IKANOS COMMUNICATIONS, INC.**

### **CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

 (In thousands, except per share data, andunaudited)

 
| ** **                                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                   | ** ** | $                                | 36,670     |                            | $          | 25,010 |   | $ | 113,687 |   | $ | 56,539 | ** ** |
| Costs and operating expenses:                                             |       |                             |       |                            |       |   |   |   |   |
| Cost of revenue (1)                                                       |       | 23,051                           |       | 10,950                          |       | 66,687 |   | 26,046 |   |
| Research and development (2)                                              |       | 12,912                           |       | 7,108                           |       | 40,011 |   | 20,530 |   |
| Selling, general and administrative (3)                                   |       | 5,825                            |       | 3,958                           |       | 17,520 |   | 11,465 |   |
| Common stock offering expenses                                            |       | —                           |       | —                          |       | 954 |   | — |   |
| Total cost and operating expenses                                         |       | 41,788                           |       | 22,016                          |       | 125,172 |   | 58,041 |   |
| Operating income (loss)                                                   |       | (5,118                           | )          | 2,994                           |       | (11,485 | ) | (1,502 | ) |
| Interest income, net                                                      |       | 1,484                            |       | 77                              |       | 3,788 |   | 262 |   |
| Income (loss) before provision for income taxes                           |       | (3,634                           | )          | 3,071                           |       | (7,697 | ) | (1,240 | ) |
| Provision for (benefit from) income taxes                                 |       | (70                              | )          | —                          |       | 153 |   | — |   |
| Income (loss) before cumulative effect of change in  accounting principle |       | (3,564                           | )          | 3,071                           |       | (7,850 | ) | (1,240 | ) |
| Cumulative effect of change in accounting principle,  net of tax          |       | —                           |       | —                          |       | 638 |   | — |   |
| Net income (loss)                                                         |       | $                                | (3,564     | )                               | $          | 3,071 |   | $ | (7,212 | ) | $ | (1,240 | ) |
| Basic net income (loss) per share:                                        |       |                             |       |                            |       |   |   |   |   |
| Prior to cumulative effect of change in accounting  principle, net of tax |       | $                                | (0.13      | )                               | $          | 0.17 |   | $ | (0.30 | ) | $ | (0.44 | ) |
| Cumulative effect of change in accounting principle,  net of tax          |       | —                           |       | —                          |       | 0.03 |   | — |   |
| Net income (loss) per share                                               |       | $                                | (0.13      | )                               | $          | 0.17 |   | $ | (0.27 | ) | $ | (0.44 | ) |
| Weighted average number of shares                                         |       | 27,368                           |       | 18,074                          |       | 26,234 |   | 2,803 |   |
|                                                                      |       |                             |       |                            |       |   |   |   |   |
| Diluted net income (loss) per share:                                      |       |                             |       |                            |       |   |   |   |   |
| Prior to cumulative effect of change in accounting  principle, net of tax |       | $                                | (0.13      | )                               | $          | 0.15 |   | $ | (0.30 | ) | $ | (0.44 | ) |
| Cumulative effect of change in accounting principle,  net of tax          |       | —                           |       | —                          |       | 0.03 |   | — |   |
| Net income (loss) per share                                               |       | $                                | (0.13      | )                               | $          | 0.15 |   | $ | (0.27 | ) | $ | (0.44 | ) |
| Weighted average number of shares                                         |       | 27,368                           |       | 20,328                          |       | 26,234 |   | 2,803 |   |
|                                                                      |       |                             |       |                            |       |   |   |   |   |

 

----

Includes stock-basedcompensation expense as follows:
| (1) Cost of revenue                     |   | 139   |   | 56    |   | 238   |   | 179   |   |
|-----------------------------------------|--------|-------|--------|-------|--------|-------|--------|-------|--------|
| (2) Research and  development           |   | 1,387 |   | 1,023 |   | 3,250 |   | 2,710 |   |
| (3) Selling, general and administrative |   | 1,034 |   | 1,000 |   | 2,643 |   | 3,070 |   |

 

See accompanying notes tothese unaudited condensed consolidated financial statements.

3

----

**IKANOS COMMUNICATION, INC.**

### **CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

(In thousands andunaudited)
| ** **                                                                       | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                       | ** ** | **September 30,**          | ** ** |
| ** **                                                                       | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **Cash flows from operating activities:**                                        |       |                            |       |   |   |
| Net loss                                                                         |       | $                               | (7,212     | ) | $ | (1,240 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                            |       |   |   |
| Depreciation and amortization                                                    |       | 4,273                           |       | 2,031 |   |
| Stock-based compensation expense                                                 |       | 6,131                           |       | 5,959 |   |
| Amortization of intangible assets and acquired  technology                       |       | 7,092                           |       | — |   |
| Purchased in-process research and development                                    |       | 3,512                           |       | — |   |
| Cumulative effect of change in accounting principle                              |       | (638                            | )          | — |   |
| Changes in assets and liabilities, net of effect of  acquisitions:               |       |                            |       |   |   |
| Accounts receivable                                                              |       | (16,643                         | )          | (4,148 | ) |
| Inventories                                                                      |       | 3,289                           |       | 2,648 |   |
| Prepaid expenses and other assets                                                |       | (586                            | )          | 1,052 |   |
| Accounts payable and accrued liabilities                                         |       | 14,895                          |       | 1,657 |   |
| Net cash provided by operating activities                                        |       | 14,113                          |       | 7,959 |   |
| **Cash flows from investing activities:**                                        |       |                            |       |   |   |
| Purchases of property and equipment                                              |       | (11,528                         | )          | (2,052 | ) |
| Purchases of investments                                                         |       | (83,578                         | )          | — |   |
| Maturities and sales of investments                                              |       | 26,666                          |       | — |   |
| Acquisitions, net of cash acquired                                               |       | (34,925                         | )          | — |   |
| Net cash used in investing activities                                            |       | (103,365                        | )          | (2,052 | ) |
| **Cash flows from financing activities:**                                        |       |                            |       |   |   |
| Net proceeds from public offerings                                               |       | 48,538                          |       | 67,907 |   |
| Net proceeds from issuances of common stock and  exercise of stock options       |       | 2,741                           |       | 42 |   |
| Repurchases of common stock                                                      |       | —                          |       | (25 | ) |
| Payments of obligations under capital lease                                      |       | (848                            | )          | (690 | ) |
| Collection of notes receivable                                                   |       | —                          |       | 67 |   |
| Borrowing under notes payable                                                    |       | —                          |       | 552 |   |
| Payment of notes payable                                                         |       | (520                            | )          | (461 | ) |
| Net cash provided by financing activities                                        |       | 49,911                          |       | 67,392 |   |
| Effect of foreign exchange rate changes on cash and  cash equivalents            |       | —                          |       | (16 | ) |
| Net increase (decrease) in cash and cash equivalents                             |       | (39,341                         | )          | 73,283 |   |
| Cash and cash equivalents at beginning of period                                 |       | 91,932                          |       | 25,428 |   |
| Cash and cash equivalents at end of period                                       |       | $                               | 52,591     |   | $ | 98,711 |   |
|                                                                             |       |                            |       |   |   |
| **Supplemental disclosures of non-cash investing  and financing activities:**    |       |                            |       |   |   |
| Property and equipment acquired under capital leases                             |       | $                               | 2,373      |   | $ | 255 |   |
| Conversion of  redeemable convertible preferred stock into common stock          |       | $                               | —     |   | $ | 101,633 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

4

----

 

**IKANOS COMMUNICATIONS, INC.**

### **NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited)

##### **Note 1.   Ikanosand Summary of Significant Accounting Policies**

***The******Company***

IkanosCommunications, Inc. (“Ikanos,” or the “Company”) was incorporated in theState of California in April 1999 and reincorporated in the State ofDelaware in September 2005. The Company provides highly programmablesemiconductors that enable fiber-fast broadband access over telephone companies’existing copper wires and high-speed network processing devices that areemployed in residential gateways for enhanced triple-play services. The Company’schipsets integrate analog, mixed-signal and digital signal processing functionsonto a single chipset.

TheCompany’s fiscal year ends on the Sunday closest to December 31. TheCompany’s fiscal quarters end on the Sunday closest to the end of theapplicable calendar quarter, except in a 53-week fiscal year, in which case theadditional week falls into the fourth quarter of that fiscal year. For presentationpurposes, the financial statements and notes have been presented as ending onthe last day of the nearest calendar month.

InSeptember 2005, the Company sold 6,400,000 shares of its common stock inits initial public offering at an offering price of $12.00 per share resultingin net proceeds to the Company of $67.9 million.

OnFebruary 17, 2006, the Company acquired the Broadband Products ProductLine (which includes network processing and ADSL assets) from Analog Devices,Inc. (“ADI”), which we refer to as the NPA acquisition, for approximately$32.8 million in cash.

InMarch 2006, the Company sold 2,500,000 shares of its common stock in asecondary offering at an offering price of $20.75 per share resulting in netproceeds to the Company of $48.5 million, after deducting underwritingdiscounts and commissions and issuance costs.

OnAugust 1, 2006, the Company acquired Doradus Technologies, Inc. (“Doradus”), adeveloper of advanced signal processing products for communications and digitalTV applications, for $2.1 million in cash, including $0.1 million intransaction expenses, the assumption of liabilities of $0.1 million, theissuance of approximately 177,000 options to purchase Ikanos common stock inexchange for options to purchase Doradus common stock and approximately 178,000shares of restricted stock.

***Basis of Presentation***

The accompanyingcondensed consolidated financial statements of the Company have been preparedin conformity with accounting principles generally accepted in the UnitedStates (“GAAP”). However, certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with GAAP have beencondensed, or omitted, pursuant to the rules and regulations of the Securitiesand Exchange Commission (“SEC”). In the opinion of management, the financialstatements include all adjustments necessary, which are of a normal andrecurring nature (see Note 2. Business Combination for the adjustments otherthan normal recurring adjustments) for the fair presentation of the results ofthe interim periods presented. All of the amounts included in this reportrelated to the condensed consolidated financial statements and notes thereto asof and for the three and nine months ended September 30, 2006 and 2005 areunaudited. The interim results presented are not necessarily indicative of theresults that may be expected for any future interim period or for the yearending December 31, 2006. These financial statements should be read inconjunction with the annual audited consolidated financial statements and notesas of and for the year ended December 31, 2005, included in the Company’s Form10-K dated February 27, 2006. The year-end condensed balance sheet data wasderived from audited financial statements, but does not include all disclosuresrequired by accounting principles generally accepted in the United States ofAmerica.

Theunaudited condensed consolidated financial statements include the accounts ofIkanos and all of its subsidiaries. Intercompany transactions and balances havebeen eliminated in consolidation.

As discussed laterin Note 3, the Company adopted Statement of Financial Accounting Standards No.(“SFAS”) 123 (revised 2004), *Share-BasedPayment*(“SFAS 123(R)”), onJanuary 1, 2006 using the modified prospective transition method.Accordingly, the Company’s loss from operations for the three and nine monthsended September 30, 2006 includes approximately $2.6 million and $6.1million, respectively, in stock-based employee compensation

5

----

expense for stock optionsand its Employee Stock Purchase Plan (“ESPP”). Because the Company elected touse the modified prospective transition method, results for prior periods havenot been restated.

***Use of Estimates***

The preparation ofthe Company’s condensed consolidated financial statements in conformity withGAAP requires management to make certain estimates, judgments and assumptions.The Company believes that the estimates, judgments and assumptions upon whichit relies are reasonable based upon information available to it at the timethat these estimates, judgments and assumptions are made. These estimates,judgments and assumptions can affect the reported amounts of assets andliabilities as of the date of the financial statements as well as the reportedamounts of revenue and expenses during the periods presented. To the extentthere are material differences between these estimates and actual results, theCompany’s financial statements would have been affected. In many cases, the accountingtreatment of a particular transaction is specifically dictated by GAAP and doesnot require management’s judgment in its application. There are also areas inwhich management’s judgment in selecting any available alternative would notproduce a materially different result.

***Goodwill and Intangible Assets***

Goodwillrepresents the excess of the purchase price over the fair value of the nettangible and identifiable intangible assets acquired in a business combination.Intangible assets resulting from the acquisitions of entities accounted forusing the purchase method of accounting are estimated by management based onthe fair value of assets received. Identifiable intangible assets are comprisedof existing and core technology, order backlog, customer relationships,trademarks and other intangible assets. Identifiable intangible assets thathave finite useful lives are being amortized over their useful lives. TheCompany follows the provisions of SFAS 142,*Goodwill and Other Intangible Assets*, under which goodwill is nolonger subject to amortization. Rather, goodwill is subject to at least anannual assessment for impairment, applying a fair-value based test.

***Impairment ofLong-Lived Assets***

In accordance withSFAS 144, *Accounting for the Impairmentor Disposal of Long-Lived Assets,* the Company evaluates long-livedassets, other than goodwill, for impairment whenever events or changes incircumstances indicate that the carrying value of an asset may not berecoverable based on expected undiscounted cash flows attributable to thatasset. The amount of any impairment is measured as the difference between thecarrying value and the fair value of the impaired asset. The Company has notrecorded impairment of assets as of September 30, 2006.

***Concentration of Credit Risk***

Financialinstruments that potentially subject the Company to significant concentrationsof credit risk consist of cash, cash equivalents, short term investments andaccounts receivable. Cash, cash equivalents and short term investments are heldwith a limited number of financial institutions. Deposits held with thesefinancial institutions may exceed the amount of insurance provided on suchdeposits. Management believes that the financial institutions that hold theCompany’s investments are credit worthy and, accordingly, minimal credit riskexists with respect to those investments. Short-term investments include adiversified portfolio of commercial paper, auction rate certificates andgovernment agency bonds.  All investmentsare classified as available-for-sale. The Company does not hold or issuefinancial instruments for trading purposes.

Creditrisk with respect to accounts receivable is concentrated due to the number oflarge orders recorded in any particular reporting period. Two customersrepresented 47% and 23% of accounts receivable at September 30, 2006. Threecustomers represented 33%, 30% and 30% of accounts receivable at December 31,2005. Four customers accounted for 23%, 22%, 22% and 20% of revenue for thenine months ended September 30, 2006. Three customers accounted for 46%, 27%and 24% of revenue for the nine months ended September 30, 2005.

6

----

***Concentration of Other Risk***

Thesemiconductor industry is characterized by rapid technological change,competitive pricing pressures, and cyclical market patterns. The Company’sresults of operations are affected by a wide variety of factors, includinggeneral economic conditions; economic conditions specific to the semiconductorindustry; demand for the Company’s products; the timely introduction of newproducts; implementation of new manufacturing technologies; manufacturingcapacity; the availability of materials and supplies; competition; the abilityto safeguard patents and intellectual property in a rapidly evolving market;and reliance on assembly and wafer fabrication subcontractors and onindependent distributors and sales representatives. As a result, the Companymay experience substantial period-to-period fluctuations in future periodsdue to the factors mentioned above or other factors.

***NetIncome (Loss) Per Share***

Underthe provisions of SFAS 128, *Earningsper Share,*basic net income per share is computed using theweighted-average number of common shares outstanding during the period.Potentially dilutive securities have been excluded from the computation ofdiluted net income (loss) per share if their inclusion is antidilutive.

Thecalculation of basic and diluted net income (loss) per common share is asfollows (in thousands, except per share amounts):
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                              | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss)                                                      |       | $                                | (3,564     | )                               | $          | 3,071 |   | $ | (7,212 | ) | $ | (1,240 | ) |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares outstanding                                    |       | 27,379                           |       | 4,901                           |       | 26,245 |   | 2,923 |   |
| Redeemable  convertible preferred stock                                 |       | —                           |       | 13,293                          |       | — |   | — |   |
| Weighted average  unvested shares of common stock subject to repurchase |       | (11                              | )          | (120                            | )          | (11 | ) | (120 | ) |
| Total shares -  basic                                                   |       | 27,368                           |       | 18,074                          |       | 26,234 |   | 2,803 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Effect of  dilutive securities:                                         |       |                             |       |                            |       |   |   |   |   |
| Stock options  and warrants                                             |       | —                           |       | 2,100                           |       | — |   | — |   |
| Unvested common  shares subject to repurchase                           |       | —                           |       | 120                             |       | — |   | — |   |
| Redeemable convertible preferred participating stock  warrants          |       | —                           |       | 34                              |       | — |   | — |   |
| Total shares -  diluted                                                 |       | 27,368                           |       | 20,328                          |       | 26,234 |   | 2,803 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Basic net income  (loss) per share                                      |       | $                                | (0.13      | )                               | $          | 0.17 |   | $ | (0.27 | ) | $ | (0.44 | ) |
| Diluted net income  (loss) per share                                    |       | $                                | (0.13      | )                               | $          | 0.15 |   | $ | (0.27 | ) | $ | (0.44 | ) |

 

The following potential common shares have been excluded from thecalculation of diluted net loss per share as their effect would have beenanti-dilutive (in thousands):

7

----

** **

|                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                              | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Anti-dilutive  securities:                              |       |                             |       |                            |       |   |   |   |   |
| Weighted-average redeemable convertible preferred stock |       | —                           |       | —                          |       | — |   | 14,639 |   |
| Warrants to purchase common stock                       |       | 6                                |       | —                          |       | 6 |   | 43 |   |
| Weighted-average restricted stock units                 |       | 615                              |       | —                          |       | 146 |   | — |   |
| Options to purchase common stock                        |       | 1,313                            |       | —                          |       | 399 |   | 1,937 |   |
|                                                    |       | 1,934                            |       | —                          |       | 551 |   | 16,619 |   |

 

**Note2.   BusinessCombinations**

**DoradusAcquisition**

OnAugust 1, 2006, the Company acquired Doradus, a developer of advanced signalprocessing products for communications and digital TV applications, for $2.1million in cash, including $0.1 million in transaction expenses, and theassumption of liabilities of $0.1 million, options to purchase approximately 177,000shares of Ikanos common stock and approximately 178,000 shares of restrictedstock.  The agreement provides foradditional consideration of up to $0.5 million in cash based on the achievementof certain revenue milestones. The results of Doradus’ operations have beenincluded in the condensed consolidated financial statements since theacquisition date.

Theacquisition was accounted for as a purchase business combination. The fairvalue of the assets acquired, including identified intangible assets andin-process research and development expense (“IPR&D”), was determined to be$5.8 million, which exceeded the purchase price by $3.6 million. The fair valuein excess of the purchase price was allocated ratably to the identifiedintangible assets and IPR&D.  Theallocation of the purchase price for this acquisition is as follows (inthousands):
| Net tangible assets  acquired                  |   | $     | 23     |   |
|------------------------------------------------|--------|-------|--------|--------|
| Developed technology                           |   | 1,545 |   |
| Customer relationships                         |   | 70    |   |
| Purchased in-process  research and development |   | 612   |   |
| Liabilities assumed                            |   | (92   | )      |
| Total purchase  price                          |   | $     | 2,158  |   |

 

The fairvalue of the restricted stock issued and the intrinsic value of the unvestedoptions assumed is being recognized as compensation expense over the respectivefuture service periods. Pro forma results of operations have not beenpresented, because the historical results of operations of Doradus are notmaterial to the consolidated results of operations of the Company.

Thedeveloped technology comprised products that have reached technologicalfeasibility and were valued utilizing a discounted cash flow (“DCF”)model. This intangible assetis being amortized on a straight-line basis over three years.

Customer relationshipsrelate to the ability to sell products to existing customers and have beenestimated using a DCF model. This asset is being amortized on a straight-linebasis over one year.

Of the total purchaseprice, $0.6 million was allocated to IPR&D and was expensed in the quarterended September 30, 2006. Projects that qualify as IPR&D represent thosethat have not yet reached technological feasibility and which have noalternative future use.

**NPA Acquisition**

OnFebruary 17, 2006, the Company completed the NPA acquisition for $32.8million in cash, including transaction costs of $1.8 million. Theacquisition has been accounted for as a purchase business combination. Theresults of operations from the assets acquired in the NPA acquisition have beenincluded in the Company’s condensed consolidated statement of operations fromthe date of the acquisition.

8

----

Underthe purchase method of accounting, the total estimated purchase price as shownin the table has been allocated to the net tangible and intangible assetsacquired based on their estimated fair values as of the date of theacquisition. The allocation of the purchase price for this acquisition, as ofthe date of the acquisition, is as follows (in thousands):

| Tangible assets acquired                       |   | $      | 7,475  |   |
|------------------------------------------------|--------|--------|--------|--------|
| Liability for  severance payment assumed       |   | (308   | )      |
| Goodwill                                       |   | 4,800  |   |
| Amortizable  acquired intangible assets:       |   |   |   |
| Existing technology                            |   | 4,600  |   |
| Patents/core technology                        |   | 2,000  |   |
| Trademarks                                     |   | 1,000  |   |
| Customer relationships                         |   | 3,000  |   |
| Order backlog                                  |   | 1,200  |   |
| Non-competition agreement                      |   | 100    |   |
| Transition services                            |   | 1,000  |   |
| Favorable supply arrangement                   |   | 5,000  |   |
| Total acquired intangible assets               |   | 17,900 |   |
| Purchased  in-process research and development |   | 2,900  |   |
| Total purchase  price                          |   | $      | 32,767 |   |

 

The amount of thetotal purchase price allocated to the tangible assets acquired of$7.5 million was assigned based on the fair values as of the date ofacquisition. The identified intangible assets acquired were assigned fairvalues in accordance with the guidelines established in SFAS 141*, Business Combinations,*Financial Accounting Standards BoardInterpretations No. (“FIN”) 4,*Applicability of FASB Statement No. 2to Business Combinations Accounted for by the Purchase Method*, and other relevant guidance. TheCompany believes that these identified intangible assets have no residualvalue. The purchase price allocated to purchased in-process research and development(“IPR&D”) and to identifiable purchased intangible assets was determined bya third-party appraisal.

***Amortizable Acquired Intangible Assets and Goodwill***

*ExistingTechnology:* The existing technology comprises products thathave reached technological feasibility and includes the Eagle and Fusivproducts. The Company valued the existing technology utilizing a DCF model,which uses forecasts of future revenue and expense related to the intangibleasset. The Company utilized a discount rate of 20% for existing technology andis amortizing the intangible assets on a straight-line basis over theirestimated useful life of three to four years.

*Patents/CoreTechnology:* The patents/core technology represents aseries of awarded patents, filed patent applications, and corearchitectures that are used in the products and form a major part ofthe architecture of both current and planned future releases. The Companyvalued patents/core technology using the royalty savings method, which representsthe benefit of owning this intangible asset rather than paying royalties forits use. The Company utilized a royalty rate of 2% and a discount rate of 26%for the patents/core technology and is amortizing this intangible asset on astraight-line basis over its estimated useful life of four years.

*Trademarks:*The trademark assets were determined using the royalty savings method, whichrepresents the benefit of owning an intangible asset rather than payingroyalties for its use. The Company utilized a royalty rate of 0.5% and adiscount rate of 22% for the trademark and is amortizing this intangible asseton a straight-line basis over its estimated useful life of three to five years.

*CustomerRelationships:* The customer relationships asset relates to theability to sell existing and future versions of products to existing customersand has been estimated using the income method. The Company valued customerrelationships utilizing a DCF model and a discount rate of 22% and isamortizing this intangible asset on a straight-line basis over its estimateduseful life of five years.

9

----

*OrderBacklog:* The order backlog asset represents the value of thesales and marketing costs required to establish the order backlog and wasvalued using the cost savings approach. The order backlog was fully amortizedas of the end of the second quarter of 2006 as the orders were delivered andbilled.

*Non-competitionAgreement:* The Company valued the non-competition agreementwith ADI by estimating the effect on our future revenue and cash flows if anon-compete were not in place, thereby allowing ADI to re-enter the market andcompete with us. The Company utilized a discount rate of 22% for thenon-compete agreement and is amortizing this intangible asset on astraight-line basis over the three -year term of the agreement.

 *Transition Services*: The transition services assetrepresents the $1.0 million of transition services that the Company is entitledto receive from ADI with no obligation to pay and is expected to be fullyutilized over nine to twelve months.

*FavorableSupply Agreement:* The favorable supply arrangement representsa $5.0 million credit for future purchases from a supplier which is beingamortized in proportion to the value of related purchases from that supplier,and is expected to be utilized over nine to twelve months.

*PurchasedIn-process Research and Development*: Of the total purchaseprice, $2.9 million has been allocated to IPR&D, and was expensed inthe quarter ended March 31, 2006, in accordance with FIN 4. Projectsthat qualify as IPR&D represent those that have not yet reachedtechnological feasibility and which have no alternative future use.Technological feasibility is established when an enterprise has completed allplanning, designing, coding, and testing activities that are necessary toestablish that a product can be produced to meet its design specificationsincluding functions, features, and technical performance requirements. Thevalue of IPR&D was determined by considering the importance of each projectto our overall development plan, estimating costs to develop the purchasedIPR&D into commercially viable products, estimating the resulting net cashflows from the projects when completed and discounting the net cash flows totheir present value based on the percentage of completion of the IPR&Dprojects. The Company utilized the DCF model to value the IPR&D usingdiscount rates ranging from 28% to 35%, depending on the estimated useful lifeof the technology.

*Goodwill:*****Goodwillrepresents the excess of the purchase price over the fair value of the nettangible and intangible assets acquired. In accordance with SFAS 142 goodwillresulting from business combinations will not be amortized but instead will betested for impairment at least annually (more frequently if certain indicatorsare present). In the event that management determines that the value ofgoodwill has become impaired, the combined company will incur an accountingcharge for the amount of impairment during the fiscal quarter in which thedetermination is made. The Company anticipates that none of the $4.8 millionof the goodwill recorded in connection with the NPA acquisition will be deductiblefor income tax purposes.

***Pro forma Financial Information***

The followingunaudited pro forma financial information presents the combined results ofoperations of Ikanos and the stand alone business of the network processing andADSL assets as if the NPA acquisition had occurred as of the beginning offiscal 2005, after giving effect to certain adjustments, including amortizationof intangibles. The IPR&D charge of $2.9 million is not reflected in theinformation below. The unaudited pro forma financial information does notnecessarily reflect the results of operations that would have occurred had thecombined businesses constituted a single entity during such periods, and is notnecessarily indicative of results which may be obtained in the future (inthousands, except per share amounts):

|                                                                 | ** ** | **Year Ended**   | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **December 31,** | ** ** |
| ** **                                                      | ** ** | **2005**              | ** ** |
|                                                            |       |                  |       |
| Pro forma  adjusted total revenue                               |       | $                     | 138,311    |   |
| Pro forma  adjusted net loss                                    |       | $                     | (12,324    | ) |
| Pro forma  adjusted net loss per share – basic and diluted |       | $                     | (0.65      | ) |
| Pro forma  weighted-average basic and diluted shares            |       | 19,002                |       |

 

10

----

**Note 3. Stock-Based Compensation Expense**

The Company has in effectthree stock option plans under which incentive and non-qualified stock optionshave been granted to employees and directors. Options granted under these plans generally have a ten year term andvest over a four year period. As of September 30, 2006, the Company had1,276,118 authorized options and awards outstanding and 329,879 options andawards available for future grant under its stock option plans.

TheCompany also has an ESPP for all eligible employees that qualifies underSection 423 of the Internal Revenue Code and provides for consecutive,overlapping 24-month offering periods. Each offering period includes four6-month purchase periods.  As ofSeptember 30, 2006, the Company had 919,231 authorized shares available forgrant under the ESPP.

OnAugust 1, 2006, in connection with Doradus acquisition, the Company assumedDoradus’ 2004 Amended and Restated Stock Option Plan (the “Doradus Plan”). Each unvested option to acquire shares of Doradus common stock outstandingunder the Doradus Plan immediately prior to the closing date was converted intothe right to acquire 0.079365 shares of Ikanos common stock.  The Companyhas reserved 177,246 shares of Ikanos common stock for options outstanding asof the closing date and 103,346 shares for future issuance.

TheDoradus plan allows for issuance to directors, employees and consultants. Options granted under the Doradus Plan may be incentive stockoptions or non statutory stock options.  Incentive stock optionsmay only be granted to new employees.  Options to purchase shares ofthe Company’s common stock are granted at a price equal to the fair marketvalue of the stock at the date of grant, as determined by the board ofdirectors.  Options generally vest at a rate of 25% on the firstanniversary of the grant date and 1/12th per quarter thereafter.Generally, options terminate ten years after the date of grant.  Should anemployee subsequently leave, the Company has the right to repurchase the sharesthat had not vested at the departure date.

***Changes in Accounting Principle***

OnJanuary 1, 2006, the Company adopted SFAS 123(R), which is a revision ofSFAS 123, *Accounting for Stock-BasedCompensation*. SFAS 123(R) supersedes Accounting Principles Bulletin(“APB”) No. 25, *Accounting for StockIssued to Employees,* and amends SFAS 95, *Statement of Cash Flows.* SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in theincome statement based on their fair values. Pro forma disclosure is no longeran alternative to financial statement recognition. The Company elected to usethe modified prospective transition method as permitted by SFAS 123(R) andtherefore has not restated its financial results for prior periods. Under thistransition method, the post adoption share-based payment includes compensationexpense for all stock-based compensation awards granted prior to, but not yetvested as of January 1, 2006, based on the grant date fair value estimatedin accordance with the original provisions of SFAS 123. For these awards, theCompany has continued to recognize compensation expense using the accelerated amortizationmethod. The fair value of all share-based payment transactions grantedsubsequent to January 1, 2006 will be based on the grant date fair valueestimated in accordance with the provisions of SFAS  123(R). The Company recognizes compensationexpense for post adoption share-based awards on a straight-line basis over therequisite service period of the award.

Priorto the adoption of SFAS 123(R), the intrinsic value of unvested commonstock options issued prior to the initial public offering was recorded asunearned stock-based compensation as of December 31, 2005. Upon theadoption of SFAS 123(R) in January 2006, the unearned stock-basedcompensation balance of approximately $4.5 million was reclassified toadditional-paid-in-capital. The deferred-stock based compensation as ofSeptember 30, 2006 represented the unamortized stock-based compensation whichwas derived from awards granted prior to the Company’s initial Form S-1registration statement filed with the SEC on June 25, 2004. These awards werevalued under the minimum value method and are being amortized over theremaining vesting period.

11

----

Theadoption of SFAS 123(R) also resulted in a cumulative benefit from accountingchange of $0.6 million net of tax, which reflects the net cumulative impact of estimatingfuture forfeitures in the determination of period expense, rather thanrecording forfeitures when they occur as previously permitted.

***Summary of Assumptions***

The fair value ofeach option award is estimated on the date of grant using the Black-Scholesoption pricing model that uses the assumptions noted in the following table.

|                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Option Grants:                      |       |                             |       |                            |       |   |   |   |   |
| Expected volatility                 |       | 63                               | %          | 90                              | %          | 63 | % | 90 | % |
| Expected dividends                  |       | —                           |       | —                          |       | — |   | — |   |
| Expected term of options (in years) |       | 4.8                              |       | 4.0                             |       | 4.8 |   | 4.0 |   |
| Risk-free interest rate             |       | 4.8                              | %          | 4.0                             | %          | 4.9 | % | 4.0 | % |
| ESPP:                               |       |                             |       |                            |       |   |   |   |   |
| Expected volatility                 |       | 64                               | %          | n/a                             |       | 64 | % | n/a |   |
| Expected dividends                  |       | —                           |       | n/a                             |       | — |   | n/a |   |
| Expected term of ESPP (in years)    |       | 1.25                             |       | n/a                             |       | 1.25 |   | n/a |   |
| Risk-free  interest rate - ESPP     |       | 5.0                              | %          | n/a                             |       | 5.0 | % | n/a |   |

 

*Expectedvolatility*:The expected volatility is based on a blend of the volatility of the Company’speer group in the industry in which it does business and the Company’shistorical volatility.

*Expectedterm*: The expected term is based on several factors includinghistorical observations of employee exercise patterns during the Company’shistory, peer company employee exercise behavior and expectations of employeeexercise behavior in the future giving consideration to the contractual termsof the stock-based awards. The expected term of options granted is derived fromthe average midpoint between vesting and the contractual term, as described inthe SEC’s Staff Accounting Bulletin No. (“SAB”) 107, *Share-BasedPayment*.

*Risk-freeinterest rate*: The yield on zero-coupon U.S. Treasurysecurities for a period that is commensurate with the expected term assumptionfor each group of employees is used as the risk-free interest rate.

*Pre-vestingforfeitures:* Estimates of pre-vesting option forfeitures arebased on Company experience and industry trends. The Company will adjust itsestimate of forfeitures over the requisite service period based on the extentto which actual forfeitures differ. For purposes of calculating pro formainformation under SFAS 123 for periods prior to fiscal 2006, the Companyaccounted for forfeitures as they occurred.

***Stock Option Plan Activity***

A summary ofoption activity through September 30, 2006 is presented below (in thousands,except per share amounts):

|                                    | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted-**    | ** ** | ** **    | ** ** |
|------------------------------------|------------|------------|------------|---------------|------------|------------------|------------|---------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Average**      | ** ** | ** **    | ** ** |
| ** **                         | ** ** | ** ** | ** ** | **Average**   | ** ** | **Remaining**    | ** ** | **Aggregate** | ** ** |
| ** **                         | ** ** | ** ** | ** ** | **Exercise**  | ** ** | **Contractual-** | ** ** | **Intrinsic** | ** ** |
| **Options**                        | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Term**         | ** ** | **Value**     | ** ** |
| Outstanding at  January 1, 2006    |       | 3,945      |       | $             | 3.92       |             |       |          |       |   |
| Granted                            |       | 856        |       | 13.24         |       |             |       |          |       |
| Exercised                          |       | (1,056     | )          | 1.82          |       |             |       |          |       |
| Forfeited or expired               |       | (288       | )          | 6.41          |       |             |       |          |       |
| Outstanding at September 30, 2006  |       | 3,457      |       | $             | 6.67       |             | 8.01       |          | $          | 21,042 |   |
| Exercisable at  September 30, 2006 |       | 1,314      |       | $             | 3.00       |             | 7.09       |          | $          | 11,566 |   |

 

12

----

Theweighted-average grant date fair value of options granted during the quarterended September 30, 2006 was $7.28 per option. The total intrinsic value ofoptions exercised during the quarter ended September 30, 2006 was $1.7 million.

The followingtable summarizes information about stock options as of September 30, 2006(number of options in thousands):

|                                         | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | ** **                   | ** ** | **Weighted-Average**         | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                              | ** ** | **Number**                   | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of**                       | ** ** | **of**                       | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **of** | ** ** | **Exercise Price** | ** ** |
| **Exercise Prices**                | ** ** | **Options**                  | ** ** | **(Years)**                  | ** ** | **per Share** | ** ** | **Options** | ** ** | **per Share** | ** ** |
| $  0.38  to $  1.08 |       | 1,165                        |       | 7.14                         |       | $ | 0.55 |   | 777 |   | $ | 0.59 |   |
| $  3.40  to $10.20            |       | 1,532                        |       | 8.10                         |       | $ | 6.57 |   | 520 |   | $ | 6.24 |   |
| $12.00 to $22.00                        |       | 760                          |       | 9.19                         |       | $ | 16.23 |   | 17 |   | $ | 13.25 |   |
|                                    |       | 3,457                        |       | 8.01                         |       | $ | 6.67 |   | 1,314 |   | $ | 2.99 |   |

 

A summary of theactivity of the Company’s nonvested shares through September 30, 2006 ispresented below (in thousands except per share amounts):
|                                 | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|---------------------------------|------------|------------|------------|---------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| **Nonvested Shares**       | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at January 1,  2006   |       | 12         |       | $                   | 14.31      |   |
| Granted                         |       | 526        |       | $                   | 16.95      |   |
| Vested                          |       | (9         | )          | $                   | 14.31      |   |
| Forfeited                       |       | (12        | )          | $                   | 18.47      |   |
| Nonvested at September 30, 2006 |       | 517        |       | $                   | 16.90      |   |

 

As of September30, 2006, there was $11.5 million in compensation cost related to nonvestedoptions that are not yet recognized and is expected to be recognized over a periodof 4 years. As of September 30, 2006, there was $7.9 million of totalunrecognized compensation cost related to nonvested share-based compensationarrangements. That cost is expected to be recognized on a declining basis overthe next 4 years. The total fair value of shares vested during the nine monthsended September 30, 2006 was $0.9 million.

***Pro Forma Disclosure for Threeand Nine Months Ended September 30, 2005***

Pro forma informationregarding net loss and net loss per share is required by SFAS 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure*. The fair value of the Company’s stock-basedawards to employees was estimated using the multiple option approach of theBlack-Scholes option-pricing model. The related expense was amortized using anaccelerated method over the vesting terms of the option. Had compensation costfor the Company’s stock-based compensation plans and the ESPP been determinedusing the fair value at the grant dates for awards under those plans calculatedusing the Black-Scholes method of SFAS 123, the Company’s net loss andbasic and diluted net loss per share would have been changed to the pro formaamounts for the three months and nine months ended September 30, 2005 indicatedbelow (in thousands, except per share amounts):

13

----

** **

|                                                                                                             | ** ** | **Three Months**  | ** ** | **Nine Months**   | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                  | ** ** | **Ended**              | ** ** | **Ended**              | ** ** |
| ** **                                                                                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                  | ** ** | **2005**               | ** ** | **2005**               | ** ** |
| Net income (loss), as  reported                                                                             |       | $                      | 3,071      |                   | $          | (1,240 | ) |
| Stock-based  employee compensation included in net income (loss) as reported, net of  related tax effects * |       | 1,905                  |       | 5,524                  |       |
| Stock-based  employee compensation using the fair value method, net of related tax effects  *               |       | (2,709                 | )          | (5,593                 | )          |
| Net income (loss), pro  forma                                                                               |       | $                      | 2,267      |                   | $          | (1,309 | ) |
|                                                                                                        |       |                   |       |                   |       |
| Basic net income (loss)  per common share:                                                                  |       |                   |       |                   |       |
| As reported                                                                                                 |       | $                      | 0.17       |                   | $          | (0.44 | ) |
| Pro forma                                                                                                   |       | $                      | 0.13       |                   | $          | (0.47 | ) |
|                                                                                                        |       |                   |       |                   |       |
| Diluted net income  (loss) per common share:                                                                |       |                   |       |                   |       |
| As reported                                                                                                 |       | $                      | 0.15       |                   | $          | (0.44 | ) |
| Pro forma                                                                                                   |       | $                      | 0.11       |                   | $          | (0.47 | ) |

 

----

*               The tax effects of stock-basedcompensation have been fully reserved as a result of a full valuation allowanceon the deferred tax assets.

***DisclosuresPertaining to All Stock-Based Award Plans***

Cash received from option exercises and ESPP contributions under allshare-based payment arrangements for the nine months ended September 30, 2006was $2.7 million. The Company has maintained a full valuation allowance sinceinception and has not been recognizing excess tax benefits from share-basedawards. The Company does not anticipate recognizing excess tax benefits fromstock-based payments for the foreseeable future, and the Company believes itwould be reasonable to exclude such benefits from deferred tax assets and netloss per common share calculations. Accordingly, the Company did not realizeany tax benefits from tax deductions related to share-based payment awardsduring the three and nine months ended September 30, 2006 and 2005.

**Note 4.   ComprehensiveIncome (Loss)**

Othercomprehensive income (loss) refers to losses that, under GAAP, are recorded asan element of stockholders’ equity and are excluded from net income (loss).Comprehensive income (loss) consisted of the following items (inthousands):
|                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                              | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss), as reported         |       | $                                | (3,564     | )                               | $          | 3,071 |   | $ | (7,212 | ) | $ | (1,240 | ) |
| Other  comprehensive loss:              |       |                             |       |                            |       |   |   |   |   |
| Unrealized gain (loss) on investments   |       | 67                               |       | —                          |       | (21 | ) | — |   |
| Foreign currency translation adjustment |       | —                           |       | (12                             | )          | — |   | (38 | ) |
| Comprehensive income  (loss)            |       | $                                | (3,497     | )                               | $          | 3,059 |   | $ | (7,233 | ) | $ | (1,278 | ) |

 

Accumulated othercomprehensive loss as of September 30, 2006and December 31, 2005 consisted of thefollowing (in thousands):

|                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Unrealized gain  (loss) on investments              |       | $                      | (6         | )                     | $          | 15 |   |
| Cumulative  foreign currency translation adjustment |       | (80                    | )          | (80                   | )          |
|                                                |       | $                      | (86        | )                     | $          | (65 | ) |

 

14

----

**Note 5.****       Short-TermInvestments**

The following is asummary of the Company’s short-term investments (in thousands):
|                                                   | ** ** | **September 30, 2006** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | ** **                       | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | ** **                       | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**                         | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| U.S. Treasury and other  U.S. government agencies |       | $                                | 15,485     |   | $ | — |   | $ | (6 | ) | $ | 15,479 |   |
| Auction rate securities                           |       | 43,400                           |       | — |   | — |   | 43,400 |   |
| Total short-term  investments                     |       | $                                | 58,885     |   | $ | — |   | $ | (6 | ) | $ | 58,879 |   |

 
|                                                   | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | ** **                      | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| U.S. Treasury and other  U.S. government agencies |       | $                               | 1,973      |   | $ | 15 |   | $ | — |   | $ | 1,988 |   |
|                                              |       | $                               | 1,973      |   | $ | 15 |   | $ | — |   | $ | 1,988 |   |

 

The Company’s marketable securities are classified asavailable-for-sale as of the balance sheet date and are reported at fair valuewith unrealized gains and losses reported as a separate component of accumulatedother comprehensive loss in stockholders’ equity, net of tax. Realized gainsand losses and permanent declines in value, if any, on available-for-salesecurities are reported in other income or expense as incurred. Estimated fairvalues were determined for each individual security in the investmentportfolio. The declines in value of these investments are primarily related tochanges in interest rates and are considered to be temporary in nature.

A significantportion of the Company’s available-for-sale portfolio is composed of auctionrate securities. Even though the stated maturity dates of these investmentsmay be one year or more beyond the balance sheet dates, the Company hasclassified these securities as short-term investments. In accordance withAccounting Research Bulletin No. 43, Chapter 3A, *WorkingCapital- Current Assets and Current Liabilities*, the Company viewsits available-for-sale portfolio as available for use in its currentoperations. Based upon historical experience in the financial markets as wellas the Company’s specific experience with these investments, the Companybelieves there is a reasonable expectation of completing a successful auctionwithin the subsequent twelve-month period. During its history of investing inthese securities, the Company has been able to sell its holdings of theseinvestments at its discretion. Accordingly, the Company believes that the riskof non-redemption of these investments within a year is minimal.

##### **Note 6.   Inventories**

Inventoriesconsisted of the following (in thousands):
|                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Finished goods                     |       | $                      | 2,588      |                  | $          | 1,955 |   |
| Work-in-process                    |       | 9,173                  |       | 4,762                 |       |
| Purchased parts and raw  materials |       | 123                    |       | 2,408                 |       |
|                               |       | $                      | 11,884     |                  | $          | 9,125 |   |

 

15

----

**Note 7.   Goodwilland Purchased Intangible Assets**

SFAS 142 requirespurchased intangible assets other than goodwill to be amortized over theirexpected useful lives unless these lives are determined to be indefinite.Purchased intangible assets are carried at cost less accumulated amortization.Amortization is computed over the estimated useful lives of the respectiveassets.

The carrying amount of intangible assets as of September 30, 2006 is asfollows (in thousands):
|                                   | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **Weighted**         | ** ** |
|-----------------------------------|------------|-------------------------|------------|------------------|------------|------------|------------|----------------------|------------|
| ** **                        | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **average**          | ** ** |
| ** **                        | ** ** | **Gross Carrying** | ** ** | **Accumulated**  | ** ** | **Net**    | ** ** | **useful life** | ** ** |
| ** **                        | ** ** | **Amount**              | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **(Years)**          | ** ** |
| Existing technology               |       | $                       | 6,145      |             | $          | (848       | )          | $                    | 5,297      |   | 4 |   |
| Patents/core technology           |       | 2,000                   |       | (313             | )          | 1,687      |       | 4                    |       |
| Trademarks                        |       | 1,000                   |       | (133             | )          | 867        |       | 5                    |       |
| Customer relationships            |       | 3,070                   |       | (386             | )          | 2,684      |       | 5                    |       |
| Order backlog                     |       | 1,200                   |       | (1,200           | )          | —     |       | 0.5                  |       |
| Non-competition  agreement        |       | 100                     |       | (21              | )          | 79         |       | 3                    |       |
| Transition services               |       | 1,000                   |       | (594             | )          | 406        |       | 1                    |       |
| Favorable supply  arrangement     |       | 5,000                   |       | (3,597           | )          | 1,403      |       | 1                    |       |
| Total acquired  intangible assets |       | $                       | 19,515     |             | $          | (7,092     | )          | $                    | 12,423     |   |   |   |

 

The amortizationof technology is charged to cost of revenue; the favorable supply arrangementis capitalized on to inventory at the time of purchase and is charged to costof revenue as the related inventory is sold; the amortization of patents ischarged to research and development; and the amortization of trademarks,customer relationships, order backlog and non-competition is charged toselling, general and administrative. Transition services are charged to cost ofrevenue, research and development and/or selling, general and administrativebased on the actual services performed.

For the three andnine months ended September 30, 2006, the amortization of intangible assets was$2.7 million and $7.1 million, respectively. The estimated future amortizationof purchased intangible assets as of September 30, 2006 is as follows (inthousands):

| Remaining 2006 |   | $     | 2,602  |   |
|----------------|--------|-------|--------|--------|
| 2007           |   | 3,127 |   |
| 2008           |   | 3,087 |   |
| 2009           |   | 2,551 |   |
| 2010           |   | 958   |   |
| 2011           |   | 98    |   |
|                |   | $     | 12,423 |   |

 

The change in the carrying amount of goodwill forthe nine months ended September 30, 2006 is as follows (in thousands):

| Beginning balance, as of  December 31, 2005 |   | $     | — |   |
|---------------------------------------------|--------|-------|--------|--------|
| Goodwill recorded in acquisition            |   | 4,800 |   |
| Ending balance, as of  September 30, 2006   |   | $     | 4,800  |   |

 

In the thirdquarter of 2006, the Company increased the carrying amount of goodwill byapproximately $60,000 as a result of additional transaction costs related tothe NPA acquisition.

16

----

###### **Note 8.  ****Accrued Liabilities**

Accruedliabilities consisted of the following (in thousands):
|                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Warranty accrual                           |       | $                      | 1,954      |                  | $          | 2,189 |   |
| Accrued rebates                            |       | 4,688                  |       | 2,909                 |       |
| Accrued compensation  and related benefits |       | 3,277                  |       | 2,919                 |       |
| Accrued accounting and  legal              |       | 828                    |       | 813                   |       |
| Accrued royalties                          |       | 1,478                  |       | 392                   |       |
| Employee stock purchase  plan.             |       | 906                    |       | 350                   |       |
| Other accrued  liabilities                 |       | 4,422                  |       | 1,712                 |       |
|                                       |       | $                      | 17,553     |                  | $          | 11,284 |   |

 

The followingtable summarizes the activity related to the product warranty liability, whichis included within accrued liabilities in the Company’s condensed consolidatedbalance sheets, at September 30, 2006 and 2005 (in thousands):
|                                           | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **September 30,**          | ** ** |
| ** **                                | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| Balance,  beginning of period             |       | $                               | 2,189      |   | $ | 1,084 |   |
| Accrual for  warranties during the period |       | 312                             |       | 1,074 |   |
| Settlements made  during the period       |       | (547                            | )          | (415 | ) |
| Balance, end of period                    |       | $                               | 1,954      |   | $ | 1,743 |   |

 

###### **Note 9.  ****Commitments and Contingencies**

***Lease Obligations***

TheCompany leases office facilities, equipment and software under non-cancelableoperating and capital leases with various expiration dates through 2011. Rentexpense for the years ended December 31, 2005 and 2004 was $1.0 millionand $0.6 million, respectively. The terms of the facility leases provide forrental payments on a graduated scale. The Company recognizes rent expense on astraight-line basis over the lease period, and has accrued for rent expenseincurred but not paid.

Futureminimum lease payments as of September 30, 2006 under non-cancelable leaseswith original terms in excess of one year are summarized as follows (inthousands):
|                                                         | ** ** | **Capital** | ** ** | **Operating** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-------------|------------|---------------|------------|------------|------------|
| ** **                                              | ** ** | **Leases**  | ** ** | **Leases**    | ** ** | **Total**  | ** ** |
| Remaining 2006                                          |       | $           | 254        |          | $          | 282        |       | $ | 536 |   |
| 2007                                                    |       | 909         |       | 2,765         |       | 3,674      |       |
| 2008                                                    |       | 826         |       | 2,179         |       | 3,005      |       |
| 2009                                                    |       | 189         |       | 1,189         |       | 1,378      |       |
| 2010                                                    |       | —      |       | 664           |       | 664        |       |
| 2011                                                    |       | —      |       | 168           |       | 168        |       |
|                                                    |       | $           | 2,178      |          | $          | 7,247      |       | $ | 9,425 |   |
| Less: Amount  representing interest                     |       | (115        | )          |          |       |       |       |
| Present value of  minimum lease payments                |       | 2,063       |       |          |       |       |       |
| Less: Current  portion                                  |       | (874        | )          |          |       |       |       |
| Obligations under  capital lease, net of current potion |       | $           | 1,189      |          |       |       |       |   |

 

17

----

***Purchase Commitments***

TheCompany entered into a technology access agreement in September 2006. Underterms of the agreement, the Company agreed to pay $ 0.7 million in 2006, $ 1.8million in 2007, $ 2.3 million in 2008 and $1.2 million in 2009.

***Indemnities,Commitments and Guarantees***

Duringits normal course of business, the Company has made certain indemnities,commitments and guarantees under which it may be required to make payments inrelation to certain transactions. These indemnities include intellectualproperty indemnities to the Company’s customers in connection with the sales ofits products, indemnities for liabilities associated with the infringement ofother parties’ technology based upon the Company’s products, and indemnities tovarious lessors in connection with facility leases for certain claims arisingfrom such facility or lease. The duration of these indemnities, commitments andguarantees varies, and in certain cases, is indefinite. The majority of theseindemnities, commitments and guarantees do not provide for any limitation ofthe maximum potential future payments that the Company could be obligated tomake. The Company believes its internal development processes and otherpolicies and practices limit its exposure related to the indemnificationprovisions of the various agreements that include indemnity provisions. Inaddition, the Company requires its employees to sign a proprietary informationand inventions agreement, which assigns the rights to its employees’development work to the Company. The Company has not recorded any liability forthese indemnities, commitments and guarantees in the accompanying consolidatedbalance sheets. The Company does, however, accrue for losses for any knowncontingent liability, including those that may arise from indemnificationprovisions, when future payment is probable and the amount of the loss can be reasonablyestimated, in accordance with SFAS 5, *Accountingfor Contingencies*.

Inaddition, we indemnify our officers and directors under the terms of indemnityagreements entered into with them, as well as pursuant to our certificate ofincorporation, bylaws, and applicable Delaware law. To date, we have notincurred any costs related to these indemnifications.

***Litigation***

In November 2006, purportedclass action lawsuits were filed in the United States District Court for theSouthern District of New York against the Company, its directors, an executiveofficer and a former executive officer as well as the Company’s lead investmentbankers in the offerings. The lawsuits allege certain misrepresentations by theCompany in its registration statements and prospectus related to its initialpublic offering in September 2005 and its follow-on offering in March 2006, andseeks unspecified damages.  The Companyhas not been served with the complaints. The Company cannot predict the likelyoutcome of these lawsuits, and an adverse result could have a material effecton the Company.

Additionally,the Company is a party to various legal proceedings and claims arising from thenormal course of business activities. Based on current available information,the Company does not expect that the ultimate outcome of these unresolvedmatters, individually or in the aggregate, will have a material adverse effecton its results of operations, cash flows, or financial position.

###### **Note 10. Borrowings**

OnOctober 21, 2004, the Company entered into a loan agreement with SiliconValley Bank that provides the Company the ability to finance up to $5.0 millionof working capital requirements (subject to certain limitations) and $2.0million of equipment purchases. The working capital line of credit matured onOctober 21, 2006, and Silicon Valley Bank’s commitment to extend workingcapital loans terminated. Borrowings under the agreement are capitalized by afirst priority lien on substantially all of the assets of the Company,excluding intellectual property. The loan agreement was amended onMarch 31, 2006. Pursuant to this amendment, the provisions of the loan andsecurity agreement relating to the financial covenant regarding theprofitability of Ikanos was amended to exclude stock-based compensation andcertain expenses and charges resulting from the NPA acquisition for each of thefiscal quarters in 2006.

18

----

As of September30, 2006, no balance was outstanding under the working capital facility and$0.9 million was outstanding under the equipment financing facility. Intereston borrowings under the equipment financing facility is payable monthly atfixed rates ranging from 6.0% to 6.3%.

###### **Note 11.Related Party Transactions**

The Company has aconsulting agreement with Texan Ventures, LLC entered into in the first quarterof 2006. Pursuant to the consulting agreement, G. Venkatesh, who is both theManaging Member of Texan Ventures, LLC and a member of the Company’s Board ofDirectors, will provide consulting services with respect to, among otherthings, general business advice relating to the operation of a public company,guidance and strategic advice in analyzing acquisition opportunities, assistingin negotiations of acquisition agreements and providing assistance and guidancein the integration of acquired companies. The consulting agreement will expireon December 31, 2006. Prior to this consulting agreement, the Company hada prior agreement with Texan Ventures, LLC entered into on November 7,2001. Effective October 2006, the agreement was amended whereby Mr. Venkateshwill serve as Executive Chairman of the Company’s Board of Directors, while theCompany searches for a permanent Chief Executive Officer.

Under theConsulting Agreement, Texan Ventures, LLC is entitled to $3,000 per month andreimbursement for reasonable expenses. The Company paid Texan Ventures, LLC$9,000 and $27,000 in the three and nine months ended September 30, 2006 forconsulting services, respectively. Commencing in October 2006, Texan Ventureswill be entitled to $18,000 per month while Mr Venkatesh serves as Chairman ofthe Company’s Board of Directors. In addition, Mr Venkatesh will receive anoption to purchase 125,000 shares of the Company’s common stock.

###### **Note 12. Recent Accounting Pronouncements**

InJune 2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48, *Accounting for Uncertainty in Income taxes – aninterpretation of FAS Statement No. 109*.  This Interpretation clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with SFAS 109, *Accountingfor Income Taxes.*  Itprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. It also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition.  It shall beeffective for fiscal years beginning after December 15, 2006.  The Company is assessing the impact, if any,on its consolidated results of operations, financial position and cash flows.

InJuly 2006, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 06-3, *How Taxes Collected from Customers Remitted to Governmental AuthoritiesShould be Presented in the Income Statement* (that is, Gross versusNet Presentation). The adoption of EITF Issue No. 06-03 did not have an impacton the Company’s consolidated financial statements. The Company’s accountingpolicy is to present the above mentioned taxes on a net basis, excluded fromrevenue.

InSeptember 2006, the FASB issued SFAS 157, *Fair Value Measurements*,which clarifies the definition of fair value, establishes guidelines formeasuring fair value and expands disclosures regarding fair valuemeasurements.  SFAS 157 does not require any new fair value measurementsand eliminates inconsistencies in guidance found in various prior accountingpronouncements.  SFAS 157 will be effective for the Company on January 1,2008. The Company is currently evaluating the impact of adopting SFAS 157 onits financial position, cash flows and results of operations.

InSeptember 2006, the SEC released SAB 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*. SAB 108 provides interpretiveguidance on the SEC’s views on how the effects of the carryover or reversal ofprior year misstatements should be considered in quantifying a current yearmisstatement. The provisions of SAB 108 will be effective for the Company forthe fiscal year ended December 31, 2006. The Company is currently evaluatingthe impact of applying SAB 108 but does not believe that the application of SAB108 will have a material effect on its financial position, cash flows, andresults of operations.

19

----

**Note 13.****  ****SignificantCustomer Information and Segment Reporting**

SFAS 131, *Disclosures about Segments of an Enterprise and Related Information*,establishes standards for the manner in which public companies reportinformation about operating segments in annual and interim financialstatements. It also establishes standards for related disclosures aboutproducts and services, geographic areas, and major customers. The method fordetermining the information to report is based on the way management organizesthe operating segments within the Company for making operating decisions andassessing financial performance.

The Company’s chiefoperating decision-maker is considered to be the Chief Executive Officer. TheChief Executive Officer reviews financial information presented on aconsolidated basis, accompanied by disaggregated information about revenue bygeographic region for purposes of making operating decisions and assessingfinancial performance. On this basis, the Company is organized and operates ina single segment: the design, development, marketing and sale ofsemiconductors.

The followingtable summarizes revenue on a percentage basis by geographic region, based onthe country in which the customer headquarters office is located:
|               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **    | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **    | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:      |       |                             |       |                            |       |   |   |   |   |
| Japan         |       | 41                               | %          | 76                              | %          | 43 | % | 73 | % |
| France        |       | 33                               | %          | 00                              | %          | 23 | % | 00 | % |
| Korea         |       | 13                               | %          | 21                              | %          | 23 | % | 24 | % |
| United States |       | 6                                | %          | 0                               | %          | 3 | % | 0 | % |
| Others        |       | 7                                | %          | 3                               | %          | 8 | % | 3 | % |
|          |       | 100                              | %          | 100                             | %          | 100 | % | 100 | % |

 

Four customers accounted for more than 10% of the Company’s total revenuefor the three and nine months ended September 30, 2006, and three customersaccounted for more than 10% of the Company’s total revenue for three and ninemonths ended September 30, 2005.

The distributionof long-lived assets (excluding goodwill) was as follows (in thousands):

|               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------|------------|-------------------|------------|------------------|------------|
| ** **    | ** ** | **2006**          | ** ** | **2005**         | ** ** |
| United States |       | $                 | 12,725     |             | $          | 4,082 |   |
| Taiwan        |       | 3,268             |       | 3,329            |       |
| India         |       | 2,388             |       | 761              |       |
| Other         |       | 1,058             |       | 212              |       |
|          |       | $                 | 19,439     |             | $          | 8,384 |   |

20

----

**ITEM 2.**                          MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

#### This Quarterly Report on Form 10-Q includes “forward-lookingstatements” within the meaning of the federal securities laws, particularlystatements referencing our expectations relating to license revenue, servicerevenue, deferred revenue, cost of license revenue as a percentage of licenserevenue, cost of service revenue as a percentage of service revenue, andoperating expenses as a percentage of total revenue; the recording ofamortization of acquired technology, share-based payment expense andstock-based compensation; provision for income taxes; the integration of our NPA and Doradus acquisitions; deferred taxes; internationalexpansion; the ability of our products to meet customer demand; the sufficiencyof our cash balances and cash flows for the next 12 months; investment andpotential investments of cash or stock to acquire or invest in complementarybusinesses, products or technologies; the impact of recent changes inaccounting standards; and assumptions underlying any of the foregoing. In somecases, forward-looking statements can be identified by the use of terminologysuch as “may,” “will,” “expects,” “intends,” “plans,” “anticipates,” “estimates,”“potential,” or “continue,” or the negative thereof, or other comparableterminology. Although we believe that the expectations reflected in theforward-looking statements contained herein are reasonable, these expectationsor any of the forward-looking statements could prove to be incorrect, and actualresults could differ materially from those projected or assumed in theforward-looking statements. Our future financial condition and results ofoperations, as well as any forward-looking statements, are subject to risks anduncertainties, including but not limited to the factors set forth under PartII, Item 1A. Risk Factors. All forward-looking statements and reasons whyresults may differ included in this Quarterly Report on Form 10-Q are made asof the date hereof, and we assume no obligation to update any suchforward-looking statements or reasons why actual results may differ.

Thefollowing discussion and analysis should be read in conjunction with ourcondensed consolidated financial statements and notes thereto in Part I, Item 1above and with our financial statements and notes thereto for the year endedDecember 31, 2005, contained in our Annual Report on Form 10-K filed onFebruary 27, 2006.

**Overview**

We are a leadingdeveloper and provider of highly programmable semiconductors that enable fiber-fastbroadband services over carriers’ existing copper lines. We have developedthese semiconductors using our proprietary semiconductor designs, specificpurpose digital signal processor and advanced mixed-signal semiconductor designcapabilities. In the first quarter of 2006, we acquired network processing andADSL assets from ADI, which we refer to as the NPA acquisition, and beganderiving revenue relating to network processing and ADSL products in the samequarter. In August 2006, we acquired Doradus, a developer of advanced signalprocessing products for communications and consumer applications. We offermultiple product lines that are designed to address different segments of thefiber-fast broadband communications semiconductor market for both carriernetworks and subscriber premise equipment. We outsource all of oursemiconductor fabrication, assembly and test functions, which enables us tofocus on design, development, sales and marketing of our products and reducesthe level of our capital investment. Our customers consist primarily oforiginal destination manufacturers (“ODMs”), contract manufacturers (“CMs”) andoriginal equipment manufacturers (“OEMs”), who in turn sell our chipsets aspart of their product solutions to carriers.

We were incorporatedin April 1999 and through December 31, 2001, we were engagedprincipally in research and development. We began commercial shipment of ourproducts in the fourth quarter of 2002. Over the last three years, we haveexperienced significant revenue growth, primarily due to a rapid rise indeployments of our products in Japan and Korea. Our revenue increased from$29.0 million in 2003 to $85.1 million in 2005 resulting fromincreased deployment of broadband services by carriers. Our revenue, however,can fluctuate significantly, even on a quarterly basis. For instance, in thefirst quarter of 2005, our revenue decreased $6.2 million or 33% from thefourth quarter of 2004, yet in the second quarter of 2005, our revenueincreased $7.0 million or 57% from the first quarter of 2005. Morerecently, in the third quarter of 2006, our revenue declined by $4.5 million or11% from the second quarter of 2006.  Quarterlyfluctuations in revenue are characteristic of our industry, as carrierspurchase equipment based on expected deployment and OEMs may occasionallymanufacture equipment at rates higher than equipment is deployed. As a result,periodically and usually without significant notice, carriers will reduceorders with OEMs for new equipment and OEMs in turn will reduce orders for ourproducts, which will adversely impact the quarterly demand for our products,even when

21

----

deployment ratesmay be increasing.  We believe thatour rate of growth in revenue in the four quarters ended June 30, 2006 may bein excess of carrier deployments. The revenue growth rates in each of the fourquarters ended June 30, 2006 were 15%, 26%, 14% and 30% quarter over quarter.In the third quarter of 2006, our revenue decreased 11% and we expect asignificant decline in the fourth quarter of 2006.

InSeptember 2005, we sold 6,400,000 shares of our common stock in ourinitial public offering at $12.00 per share. Aggregate net proceeds from ourinitial public offering, after deducting underwriting discounts and commissionsand issuance costs, were $67.9 million. We also had 15,311,840 shares ofredeemable convertible preferred stock outstanding that automatically convertedinto 15,311,840 shares of our common stock upon the closing of our initialpublic offering.

OnFebruary 17, 2006, we completed the NPA acquisition for approximately$32.8 million in cash. This acquisition has enabled us to enter thegrowing residential gateway semiconductor market and has diversified ourproduct offerings, allowing us to sell into new markets worldwide. As a resultof the NPA acquisition, we have incurred significant additional expensesrelated to the addition of employees and related expenses of developing andmarketing products as well as non-cash acquisition-related charges.

InMarch 2006, we sold 2,500,000 shares of our common stock in a follow-onoffering at $20.75 per share. Aggregate net proceeds from the follow-onoffering, after deducting underwriting discounts and commissions and issuancecosts, were $48.5 million. In the follow-on offering, selling stockholdersincluding members of our senior management sold 3,250,000 shares of commonstock held by them. Ikanos did not receive any proceeds from the sale of sharesby the selling stockholders.

InAugust 2006, we acquired Doradus, a developer of advanced signal processingproducts for communications and consumer applications. This acquisition willenable us to expand our offering of triple play products. The purchaseprice was approximately $2.1 million in cash, including $0.1 million inacquisition-related expenses and the assumption of $0.1 million in liabilities.Doradus stockholders are also entitled to receive up to an additional $0.5million in cash based on the achievement of certain revenue milestones. Inaddition, the restricted stock and options of certainDoradus stock and option holders were assumed by Ikanos and convertedinto approximately 178,000 shares of restricted stock and approximately177,000 options to purchase shares of Ikanos common stock. As a result of theDoradus acquisition, we expect to incur additional expenses related to theaddition of employees and related expenses of developing and marketing relatedproducts as well as non-cash acquisition-related charges.

*Net loss.*  As of September 30, 2006,we had an accumulated deficit of $93.8 million and a total stockholders’ equityof $153.6 million. For the three month period ended September 30, 2006 ascompared to the three month period ended September 30, 2005, our net lossincreased primarily because cost of revenue as a percentage of revenueincreased even though our revenue increased in this timeframe. Additionally, ourresearch and development and selling, general and administrative expenses alsoincreased from 2005 to 2006. The three month period ended September 30, 2006included amortization of acquired intangible assets and fair value adjustmentof acquired inventory.

*Revenue.*Our revenue is primarily derivedfrom sales of our chipset products. Revenue from product sales are generallyrecognized upon shipment, net of sales returns, rebates and allowances. As istypical in our industry, the selling prices of our products generally declineover time. Therefore, our ability to increase revenue is dependent upon ourability to increase unit sales volumes of existing products and to introduceand sell new products in greater quantities. Our ability to increase unit salesvolume is dependent primarily upon our ability to increase and fulfill currentcustomer demand and obtain new customers.

Wesell our products to OEMs through a combination of our direct sales forceand third-party sales representatives. Sales are generally made undershort-term non-cancelable purchase orders. We also have volume purchaseagreements with certain customers who provide us with non-binding forecasts.Although our OEM customers may provide us with rolling forecasts, ourability to predict future sales in any given period is limited and subject tochange based on demand for our OEM customers’ systems and their supply chaindecisions.

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 thatsignificant customer concentration will 

22

----

continue for theforeseeable future. The following OEMs accounted for more than 10% of ourrevenue for the periods indicated. Sales made to these OEMs were madethrough the indicated third-party sales representatives:
| ** **                    | ** ** | ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **Sales Representative** | ** ** | **OEM Customer**               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| NEC Corporation  (USA)        |       | NEC  Corporation (Magnus)           |       | 23                               | %          | 45                              | %          | 22 | % | 46 | % |
| Altima                        |       | Sumitomo  Electric Industries, Ltd. |       | 18                               | %          | 34                              | %          | 20 | % | 27 | % |
| Sagem                         |       | Sagem                               |       | 32                               | %          | n/a                             |       | 22 | % | n/a |   |
| Uniquest                      |       | Dasan                               |       | 8                                | %          | 12                              | %          | 12 | % | 11 | % |
| Uniquest                      |       | Others                              |       | 5                                | %          | 9                               | %          | 11 | % | 13 | % |

 

Moreover,through the NPA acquisition, we expect to continue to sell network processingand ADSL products to the existing customer base for these products. The SAFRANGroup, of which Sagem Communication is a subsidiary, represented 73% of salesfor the acquired business for the 12 months ended October 29, 2005.

Historically,substantially all of our sales are to customers outside the United States.Sales to customers in Asia accounted for 60% and 97% for the three months endedSeptember 30, 2006 and 2005, respectively. We anticipate that a majority of ourrevenue will continue to be represented by sales to customers outside theUnited States.

#### **Critical Accounting Policies and Estimates**

Inpreparing our condensed consolidated financial statements, we make assumptions,judgments, and estimates that can have a significant impact on amounts reportedin our condensed consolidated financial statements. We base our assumptions,judgments, and estimates on historical experience and various other factorsthat we believe to be reasonable under the circumstances. Actual results coulddiffer materially from these estimates under different assumptions orconditions. On a regular basis we evaluate our assumptions, judgments, andestimates and make changes accordingly. We also discuss our critical accountingestimates with the Audit Committee of the Board of Directors. We believe thatthe assumptions, judgments, and estimates involved in the accounting forinventories, income taxes, impairment of goodwill, acquisitions, and stock-based compensation expense have thegreatest potential impact on our condensed consolidated financial statements,so we consider these to be our critical accounting policies. We discuss belowthe critical accounting estimates associated with these policies. Historically,our assumptions, judgments, and estimates relative to our critical accountingpolicies have not differed materially from actual results.

Thecritical accounting policies are described in Item 7, “Management Discussionand Analysis of Financial Condition and Results of Operations,” of our AnnualReport on Form 10-K for the year ended December 31, 2005, and have not changedmaterially as of September 30, 2006 with the exception of the following:

***Accounting for Impairment of Goodwill***

During the fourth quarterof 2006 we will assess the fair value of the goodwill that resulted from theNPA acquisition for impairment in accordance with SFAS 142, *Goodwill and Other Intangible Assets*, which requires thatgoodwill be tested for impairment at the “reporting unit level” and morefrequently upon the occurrence of certain events, as defined by SFAS 142. Ifsuch comparison reflected potential impairment, we would then prepare thediscounted cash flow analyses. Such analyses are based on cash flow assumptionsthat are consistent with the plans and estimates being used to manage thebusiness. An excess carrying value compared to fair value would indicate thatgoodwill may be impaired. Finally, if we determine that goodwill may have beenimpaired, we will compare the “implied fair value” of the goodwill, as definedby SFAS 142, to its carrying amount to determine the impairment loss, if any.

***Acquisitions***

We arerequired to allocate the purchase price of acquired companies to the tangibleand intangible assets acquired, liabilities assumed, as well as purchasedIPR&D based on their estimated fair values. We engage 

23

----

independentthird-party appraisal firms to assist us in determining the fair values ofassets acquired and liabilities assumed. This valuation requires management tomake significant estimates and assumptions, especially with respect tolong-lived and intangible assets.

Critical estimates in valuing certain of theintangible assets include but are not limited to future expected cash flowsfrom customer contracts, customer lists, distribution agreements, and acquireddeveloped technologies and patents; expected costs to develop the IPR&Dinto commercially viable products and estimating cash flows from the projectswhen completed; the acquired company’s brand awareness and market position, aswell as assumptions about the period of time the brand will continue to be usedin the combined company’s product portfolio; and discount rates. Management’sestimates of fair value are based upon assumptions believed to be reasonablebut which are inherently uncertain and unpredictable. Assumptions may beincomplete or inaccurate, and unanticipated events and circumstances may occur.

***Stock-Based Compensation Expense***

Weaccount for share-based compensation related to share-based transactions inaccordance with the provisions of SFAS 123 (R). Under the fair valuerecognition provisions of SFAS 123(R), share-based payment expense is estimatedat the grant date based on the fair value of the award and is recognized asexpense ratably over the requisite service period of the award. Determining theappropriate fair value model and calculating the fair value of stock-basedawards requires judgment, including estimating stock price volatility,forfeiture rates and expected life.

We have estimatedthe expected volatility as an input into the Black-Scholes valuation formulawhen assessing the fair value of options granted. Our current estimate ofvolatility was based upon a blend of average historical volatilities of ourstock price and that of our peer group.****To the extentvolatility of our stock price increases in the future, our estimates of thefair value of options granted in the future could increase, thereby increasingshare-based payment expense in future periods. In addition, we apply anexpected forfeiture rate when amortizing share-based payment expense. Ourestimate of the forfeiture rate was based primarily upon historical experienceof employee turnover. To the extent we revise this estimate in the future; ourshare-based payment expense could be materially impacted in the quarter ofrevision, as well as in following quarters. Our expected term of optionsgranted was derived from the historical option exercises, post-vestingcancellations, and estimates concerning future exercises/cancellations ofvested/unvested options that remain outstanding. In the future, as empiricalevidence regarding these input estimates is able to provide more directionallypredictive results, we may change or refine our approach of deriving theseinput estimates. These changes could impact our fair value of options grantedin the future.

**RecentAccounting Pronouncements**

For recent accounting pronouncements see Note 12 tothe Condensed Consolidated Financial Statements in Part I, Item.1 ofthis Quarterly Report on Form 10-Q.

24

----

 

### **Results of Operations**

Thefollowing table presents certain financial data for the three and nine monthsended September 30, 2006 and 2005 as a percentage of total revenue:
|                                                                           | ** ** | **Three Months**             | ** ** | **Nine Months**              | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                                                | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                                                | ** ** | **2006**                          | ** ** | **2005**                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue                                                                   |       | 100                               | %          | 100                               | %          | 100 | % | 100 | % |
| Costs and  operating expenses:                                            |       |                              |       |                              |       |   |   |   |   |
| Cost of revenue                                                           |       | 63                                |       | 44                                |       | 59 |   | 46 |   |
| Research and development                                                  |       | 35                                |       | 28                                |       | 35 |   | 37 |   |
| Selling, general and marketing                                            |       | 16                                |       | 16                                |       | 15 |   | 20 |   |
| Common stock offering expenses                                            |       | —                            |       | —                            |       | 1 |   | — |   |
| Total costs and operating expenses                                        |       | 114                               |       | 88                                |       | 110 |   | 103 |   |
| Income (loss) from operations                                             |       | (14                               | )          | 12                                |       | (10 | ) | (3 | ) |
| Interest income,  net                                                     |       | 4                                 |       | 0                                 |       | 3 |   | 1 |   |
| Income (loss) before provision for income taxes                           |       | (10                               | )          | 12                                |       | (7 | ) | (2 | ) |
| Provision for (benefit  from) income taxes                                |       | (0                                | )          | —                            |       | 0 |   | — |   |
| Income (loss)  before cumulative effect of change in accounting principle |       | (10                               | )          | 12                                |       | (7 | ) | (2 | ) |
| Cumulative  effect of change in accounting principle, net of tax          |       | —                            |       | —                            |       | 1 |   | — |   |
| Net Income (loss)                                                         |       | (10                               | )%         | 12                                | %          | (6 | )% | (2 | )% |

 

# ***Revenue***

The following sets forth,for the periods indicated, our revenue (in thousands, except percentages):
|            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** ** | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** ** | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Revenue    |       | $                                | 36,670     |                            | $          | 25,010 |   | 47 | % | $ | 113,687 |   | $ | 56,539 |   | 101 | % |
|            |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue increased to$36.7 million in the three months ended September 30, 2006, from $25.0 millionin the comparable period in 2005. Included in revenue for the three months ended September 30, 2006 isrevenue from products related to the NPA acquisition completed in the firstquarter of 2006 in the amount of $13.7 million. Revenue from our broadband chipsets declined by 8% in this timeframe,resulting from a decrease in average selling prices per port of such chipsets,even though the number of port shipments of these chipsets increased as a resultof continued deployment of VDSL-based products by carriers in Asia andEurope.  The decrease in average sellingprices was due to a shift in the mix of shipments towards products targetingsubscriber located equipment, which typically have lower selling prices thanproducts installed into carrier networks and the central office. 

 

For the nine months endedSeptember 30, 2006, revenue increased to $113.7 million from $56.5 million fromthe comparable period in 2005 due to the addition of $31.2 million in revenuefrom the NPA acquisition and $26.0 million in revenue growth from our broadbandproducts resulting from increased deployment of VDSL equipment by carriers.

***Cost of Revenue***

The following sets forth,for the periods indicated, our cost of revenue (in thousands, exceptpercentages):
|                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **      | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Cost of revenue |       | $                                | 23,051     |                            | $          | 10,950 |   | 111 | % | $ | 66,687 |   | $ | 26,046 |   | 156 | % |
|                 |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

25

----

 

Ourcost of revenue consists primarily of silicon wafers purchased from third-partyfoundries and third-party costs associated with assembling, testing, andshipping of our semiconductors.  Inaddition, cost of revenue includes accruals for estimated warranty obligationsand write-downs of excess and obsolete inventories, payroll and relatedpersonnel costs, depreciation of equipment, stock-based compensation expensesand amortization of acquisition-related intangibles. Cost of revenue increasedto $23.1 million for the three months ended September 30, 2006 as compared to$11.0 million for the three months ended September 30, 2005. Cost of revenueincreased to $66.7 million for the nine months ended September 30, 2006 ascompared to $26.0 million for the nine months ended September 30, 2005. The$12.2 million, or 111%, increase and $40.7 million, or 156%, increase forthe three and nine months ended September 30, 2006, respectively, compared tothe same periods in 2005 were primarily due to higher volumes of productsshipped including two full quarters of cost of products sold related to the NPAacquisition. Gross margin was 37% for the three months ended September 30, 2006as compared to 56% for the three months ended September 30, 2005 and 41% forthe nine months ended September 30, 2006 as compared to 54% for the nine monthsended September 30, 2005. The decreases in gross margin percentage areprimarily a result of a product mix change and price decreases on our broadbandchipsets that exceeded our cost decreases on those chipsets. The product mixchange commenced in February 2006, when we began selling products from the NPAacquisition that have lower margins than our broadband chipsets. In addition,in the nine months ended September 30, 2006, in connection with the NPA andDoradus acquisitions, we charged to cost of revenue $4.7 million related to theamortization of intangibles, including $3.6 million related to the favorablesupply agreement. We also charged to cost of revenue $1.0 million related tothe fair value adjustment to the acquired inventory.

Weexpect that the gross margin in the fourth quarters of 2006 will decline fromthe third quarter of 2006 as a result of an increase in the percentage of lowermargin products expected to be sold in the fourth quarter of 2006 and theanticipated reduction in revenue, which will increase the fixed overheadcomponent as a percentage of total cost of sales. 

***Research and Development***

Thefollowing sets forth, for the periods indicated, our research and developmentexpenses (in thousands, except percentages):
|                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Research and  development |       | $                                | 12,912     |                            | $          | 7,108 |   | 82 | % | $ | 40,011 |   | $ | 20,530 |   | 95 | % |
|                           |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourresearch and development expenses consist primarily of payroll and relatedpersonnel costs, engineering services and support from third-party foundriesand depreciation. In addition, there are substantial charges related to theamortization of intangible assets related to the NPA acquisition and chargesrelated to stock-based compensation. Research and development expensesincreased to $12.9 million in the third quarter of 2006 as compared to $7.1million in the third quarter of 2005, representing approximately 35% and 28%respectively, of revenue for those periods. Personnel costs increased by $2.2million due to the growth in our engineering and development team, includingthe addition of personnel from the NPA and Doradus acquisitions. Softwarelicense costs increased by $0.8 million due to the increase in the number ofproduct development employees. Depreciation increased by approximately $0.8million as our asset base grew. In addition, the amortization of intangiblesrelated to the NPA acquisition and the in-process R&D charge from the Doradusacquisition contributed to an additional $0.8 million in expenses. Charges forstock-based compensation increased by $0.4 million in the third quarter of 2006from the comparable period in 2005.

Researchand development expenses were $40.0 million for the nine months ended September30, 2006 versus $20.5 million for the nine months ended September 30, 2005. The95% increase was due to several reasons. First, our personnel costs increasedby $5.2 million resulting from an increase in our research and developmentheadcount primarily due to the growth in our engineering teams and the additionof employees from the NPA and Doradus acquisitions. Second, our outsideengineering service and support costs increased by $4.7 million due to an increasein the number of new product introductions and related tapeouts. Third,facilities cost increased by $1.2 million as a result of the expansion of ourprimary research and development facility and the addition of new facilitiesrelating to the NPA acquisition. Fourth, depreciation increased by $1.8 milliondue to the growth in our asset base. Finally, in connection with the NPAacquisition in the first quarter of 2006 and the Doradus acquisition in thethird quarter of 2006, we expensed $3.5 million of IPR&D and incurred $0.6million in amortization of intangibles related to research and developmentexpenses for the nine months ended September 30, 2006, whereas we did not incurthese costs in 2005. Stock-based compensation expense associated with researchand development personnel increased by $0.5 million in the third quarter of2006 from the comparable period in 2005.

We expect research and development expenses in thefourth quarter of 2006 to increase in absolute dollars and as a percentage ofrevenues from the third quarter of 2006 due, primarily to an anticipatedincrease in tape out costs.

26

----

***Selling, General andAdministrative***

Thefollowing sets forth, for the periods indicated, our selling, general andadministrative (SG&A) expenses (in thousands, except percentages):
|                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Selling, general  and administrative |       | $                                | 5,825      |                            | $          | 3,958 |   | 47 | % | $ | 17,520 |   | $ | 11,465 |   | 53 | % |
|                                      |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

SG&Aexpenses were $5.8 million in the third quarter of 2006 as compared to $4.0million in the third quarter of 2005, an increase of $1.9 million, or 47%.Payroll and related costs and outside services increased due to the effects ofthe NPA acquisition and normal growth. Amortization expense of intangibles was$0.2 million in the third quarter of 2006. Stock-based compensation expenseassociated with sales, marketing and administrative personnel was $1.0 millionin each of the three month periods ended September 30, 2006 and 2005. SG&Aexpenses for the nine months ended September 30, 2006 were $17.5 millioncompared to $11.5 million for the nine months ended September 30, 2005. The 53%increase is attributable to higher payroll and related costs and higher costsrelated to both the NPA acquisition and our follow-on offering, which occurredduring the first quarter of 2006. The amortization of the NPA-relatedintangibles that was charged to SG&A expenses amounted to $1.9 million.Stock-based compensation costs were $2.6 million for the nine months ended September30, 2006 versus $3.1 million for the nine months ended September 30, 2005.

Weexpect SG&A expenses in the fourth quarter of 2006 to increase from thethird quarter of 2006 primarily due to increased professional fees inconnection with the year end audit and Sarbanes-Oxley compliance, as well asseverance costs related to employee departures.

# ***Common StockOffering Expense***

Commonstock offering expenses for the three and nine months ended September 30, 2006were $0 and $1.0 million, respectively. These expenses relate to theproportionate share of expenses incurred by us on behalf of the sellingstockholders in our common stock offering in March 2006.

# ***InterestIncome, net***

Thefollowing sets forth, for the periods indicated, our interest income, net (inthousands, except percentages):
|                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **            | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Interest income,  net |       | $                                | 1,484      |                            | $          | 77 |   | 1827 | % | $ | 3,788 |   | $ | 262 |   | 1346 | % |
|                       |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interestincome, net consists primarily of interest income earned on our cash, cashequivalents and short-term investments, which is partially offset by interestexpense. Interest income, net increased to $1.5 million for the three monthsended September 30, 2006 as compared to $0.1 million for the three months endedSeptember 30, 2005. Interest income, net, increased to $3.8 million for thenine months ended September 30, 2006 as compared to $0.3 million for the ninemonths ended September 30, 2005. The increases for both periods were due tointerest earned on higher average cash, cash equivalents and short terminvestment balances that resulted from our common stock offerings and cashprovided by operations. These increases were partially offset by cash paid for theNPA and Doradus acquisitions during the first and third quarters of 2006.

27

----

# ***Income TaxProvision (benefit)***

Forthe three months and nine months ended September 30, 2006, we recordedimmaterial amounts of income tax provisions (benefit). Our income tax provisionfor the remainder of 2006 may fluctuate based upon our operating results foreach taxable jurisdiction in which we operate and the amount of statutory taxthat we incur in each jurisdiction.

***Cumulative Effect of Change in Accounting Principle***

In thethree and nine months ended September 30, 2006 the adoption of SFAS 123(R)resulted in a cumulative benefit from accounting change of zero and $0.6million net of tax, respectively, which reflects the net cumulative impact ofestimating future forfeitures in the determination of period expense, ratherthan recording forfeitures when they occur as previously permitted.

**Liquidity and Capital Resources**

Cash,cash equivalents and short-term investments increased to $111.5 million atSeptember 30, 2006 from $93.9 million as of December 31, 2005, an increase of$17.6 million. This increase was primarily due to the $48.5 million of netproceeds raised in our follow-on offering and $14.1 million generated fromoperations, offset by payments for the NPA and Doradus acquisitions for $34.9million and capital expenditures of $11.5 million. We believe there will beadditional working capital requirements to fund and operate our business. Weexpect to finance our operations primarily through operating cash flows andexisting cash balances.

Weexpect to grow our operating expenses as we continue to execute our businessstrategy. This increase in operating expenses may not result in anincrease in our revenue and our anticipated revenue may not be sufficientto support these increased expenditures. We anticipate that operating expensesand working capital will constitute a material use of our cash and cashequivalents.

As of September 30, 2006,we have funded our operations primarily through cash from private and publicofferings of our common stock, cash generated from the sale of our products,and proceeds from the exercise of stock options and stock purchased under ouremployee stock purchase plan. Our uses of cash include payroll andpayroll-related expenses, manufacturing costs and operating expenses such astape outs, marketing programs, travel, professional services and facilities andrelated costs. We have also used cash to acquire businesses and technologies toexpand our product offerings.

***Operating Activities***

Duringthe nine months ended September 30, 2006, we generated $14.1 million of netcash from operating activities as compared to net cash generated by operatingactivities of $8.0 million during the nine months ended September 30, 2005. Wegenerated cash from operations despite incurring a net loss of $7.2 millionduring the nine months ended September 30, 2006 because included in that losswas approximately $21.0 million in various non-cash expenses and chargesconsisting of depreciation and amortization, stock based compensation expense,amortization of intangible assets and acquired technology, purchased IPR&Dand cumulative effect of change in accounting principles. During the ninemonths ended September 30, 2006, cash receipts from customers increased to $97.0million from $52.4 million in the same period in 2005, while cash payments tovendors and employees increased to $86.5 million from $44.7 million.  These increases in both receipts and paymentswere due to the overall growth in our business as revenue increased from $56.5million to $113.7 million in the same periods.

***Investing Activities***

We used net cash of$103.3 million in investing activities in the nine months ended September 30,2006 as compared to $2.1 million during the nine months ended September 30,2005. Cash used in investing activities in the nine months ended September 30,2006  related primarily to the NPA and Doradus acquisitions aggregating$34.9 million, the purchase of property and equipment of $11.5 million and thenet purchase of short-term investments totaling $56.9 million. We anticipatethat we will continue to purchase necessary property and equipment in thenormal course of our business. The amount and timing of these purchases and therelated cash outflows in future 

28

----

periodsdepend on a number of factors, including the hiring of employees, the rate ofchange of computer hardware and software used in our business, and our businessoutlook. We have classified our investment portfolio as “available for sale,”and our investment objectives are to preserve principal and provide liquiditywhile maximizing yields without significantly increasing risk. We may sell aninvestment at any time if the quality rating of the investment declines, theyield on the investment is no longer attractive, or we are in need of cash.Because we invest only in investment securities that are highly liquid with aready market, we believe that the purchase, maturity, or sale of our investmentshas no material impact on our overall liquidity. We have used cash to acquirebusinesses and technologies that enhance and expand our product offerings, andwe anticipate that we will continue to do so in the future. The nature of thesetransactions makes it difficult to predict the amount and timing of such cashrequirements.

***Financing Activities***

Ourfinancing activities provided $49.9 million in the nine months ended September30, 2006 as compared to $67.4 million generated during the nine months endedSeptember 30, 2005. Cash generated by financing activities during the ninemonths ended September 30, 2006 was primarily due to the completion of ourfollow-on offering in which we raised $48.5 million of net proceeds.  We have, and continue to intend to use, thenet proceeds for working capital and general corporate purposes, which mayinclude the acquisition of businesses, products, product rights ortechnologies, strategic investments or purchases of common stock.

***Line of Credit***

OnOctober 21, 2004, we entered into a loan and security agreement withSilicon Valley Bank that provides for a revolving line of credit up to $5.0million and a $2.0 million equipment financing facility. As of September30, 2006, we had no balance outstanding under the revolving line of credit and$0.9 million outstanding under the equipment financing facility, which bearinterest rates ranging from 6.0% to 6.3%. On October 21, 2006, therevolving line of credit matured, and Silicon Valley Bank’s commitment toextend revolving loans terminated. The outstanding equipment facilities will bepaid in full by February 2008 and is collateralized by a first prioritylien on substantially all of our assets, excluding intellectual property. Theloan and security agreement requires us to maintain certain financialcovenants.  We were not in compliancewith the minimum profitability financial covenant during the quarter endedMarch 31, 2005. Silicon Valley Bank agreed to waive this non-compliancefor the quarter ended March 31, 2005. As of September 30, 2006, we were incompliance with all covenants.

We believe that ourexisting cash, cash equivalents and cash flows expected to be generated fromfuture operations, if any, will be sufficient to meet our anticipated cashneeds for at least the next 12 months. Our future capital requirementswill depend on many factors including our rate of revenue growth, the timingand extent of spending to support development efforts, the expansion of salesand marketing activities, the timing of introductions of new products andenhancements to existing products, the costs to ensure access to adequatemanufacturing capacity and the continuing market acceptance of our products.Although we are currently not a party to any agreement with respect topotential investments in, or acquisitions of, complementary businesses,products or technologies except as noted below, we may enter into thesetypes of arrangements in the future, which could also require us to seekadditional equity or debt financing. The sale of additional equity securitiesor convertible debt securities would result in additional dilution to ourstockholders. Additional debt would result in increased interest expenses andcould result in covenants that would restrict our operations. We have not madearrangements to obtain additional financing and there is no assurance that suchfinancing, if required, will be available in amounts or on terms acceptable tous, if at all.

***Other Uses of Cash***

InFebruary 2006, in connection with the NPA acquisition, we used approximately$32.8 million in cash as part of the consideration. In August 2006, inconnection with the Doradus acquisition, we used approximately $2.1 million incash as part of the purchase price, and we may be required to pay additionalcontingent consideration of up to $0.5 million.   A portion of our cash may be further used toacquire or invest in other businesses or products or to obtain the right to useother complementary technologies. From time to time, in the ordinary course ofbusiness, 

29

----

we may evaluatepotential acquisitions of such businesses, products, or technologies. Thenature of these transactions makes it difficult to predict the amount andtiming of such cash requirements.

***Contractual Commitments***

We lease certain office facilities, equipment andsoftware under non-cancelable operating leases. See Note 9 to theCondensed Consolidated Financial Statements in Part I, Item 1. of thisQuarterly Report on Form 10-Q. The following table summarizes our contractualobligations at September 30, 2006, and the effect those obligations areexpected to have on our liquidity and cash flow in future periods (inthousands):
|                                 | ** ** | **Payment Due by Period** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | ** **                               | ** ** | ** ** | ** ** | **2007 and** | ** ** | **2009 and** | ** ** | **2011 and** | ** ** |
| ** **                      | ** ** | **Total**                                | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Operating lease  payments       |       | $                                        | 7,247      |   | $ | 282 |   | $ | 4,944 |   | $ | 1,853 |   | $ | 168 |   |
| Capital lease  obligations      |       | 2,178                                    |       | 254 |   | 1,735 |   | 189 |   | — |   |
| Notes payable                   |       | 906                                      |       | 179 |   | 727 |   | — |   | — |   |
| Inventory  purchase obligations |       | 6,083                                    |       | 6,083 |   | — |   | — |   | — |   |
| Access to  technology           |       | 5,900                                    |       | 650 |   | 4,100 |   | 1,150 |   | — |   |
| Other  obligations              |       | 950                                      |       | 200 |   | 750 |   | — |   | — |   |
|                            |       | $                                        | 23,264     |   | $ | 7,648 |   | $ | 12,256 |   | $ | 3,192 |   | $ | 168 |   |

 

Forthe purpose of this table, purchase obligations for the purchase of goods orservices are defined as agreements that are enforceable and legally binding andthat specify all significant terms, including: fixed or minimum quantities tobe purchased; fixed, minimum or variable price provisions; and the approximatetiming of the transaction. Our purchase orders are based on our current manufacturingneeds and are fulfilled by our vendors within short time horizons. In addition,we have purchase orders that represent authorizations to purchase rather thanbinding agreements. We do not have significant agreements for the purchase ofraw materials or other goods specifying minimum quantities or set prices thatexceed our expected requirements.

***Off-Balance Sheet Arrangements***

We do not use off-balance-sheet arrangements withunconsolidated entities or related parties, nor do we use other forms ofoff-balance-sheet arrangements such as special purpose entities and researchand development arrangements. Accordingly, our liquidity and capital resourcesare not subject to off-balance-sheet risks from unconsolidated entities. As ofSeptember 30, 2006, we did not have any off-balance-sheet arrangements, asdefined in Item 303(a)(4)(ii) of SEC Regulation S-K.

We have entered intooperating leases for most United States and international offices in the normalcourse of business. These arrangements are often referred to as a form ofoff-balance-sheet financing. As of September 30, 2006, we leased facilities andcertain equipment under non-cancelable operating leases expiring between 2006and 2011. Future minimum lease payments under our operating leases as ofSeptember 30, 2006 are detailed previously in “Liquidity and Capital Resources- *ContractualCommitments.*”

In the normal course of business, we provideindemnifications of varying scope to customers against claims of intellectualproperty infringement made by third parties arising from the use of ourproducts. Historically, costs related to these indemnification provisions havenot been significant, and we are unable to estimate the maximum potentialimpact of these indemnification provisions on our future consolidated resultsof operations.

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

All market risk sensitiveinstruments were entered into for non-trading purposes. We do not usederivative financial instruments for speculative trading purposes, nor do wehedge our foreign currency exposure in a manner that entirely offsets theeffects of changes in foreign exchange rates. As of September 30, 2006, we didnot hold derivative financial instruments.

30

----

**Interest Rate Risk**

Our exposure to market risk for changes in interestrates relates primarily to our investment portfolio. We do not use derivativefinancial instruments in our investment portfolio. The primary objective of ourinvestment activities is to preserve principal and meet liquidity needs, whilemaximizing yields and without significantly increasing risk. Our investmentpolicy specifies credit quality standards for our investments and limits theamount 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 atmarket value, which approximates cost.

As of September 30, 2006, we had cash, cashequivalents and short term investments totaling $111.5 million. These amountswere invested primarily in money market funds and short-term investments thatare held for working capital purposes. We do not enter into investments fortrading or speculative purposes. Due to the short-term nature of theseinvestments, we do not believe that a 10% change in interest rates would have amaterial impact on our financial position and results of operations. However,declines in interest rates will reduce future investment income.

OnOctober 21, 2004, we entered into a loan and security agreement withSilicon Valley Bank that provides for a $5.0 million revolving line ofcredit and a $2.0 million equipment financing facility. As of September30, 2006, we had no balance outstanding under the revolving line of credit and$0.9 million outstanding under the equipment financing facility, which bearinterest rates ranging from 6.0% to 6.3%. Due to the fixed nature of theequipment facility interest rates, we are not exposed to interest rate risk onour loan arrangements. The revolving line of credit expired on October 21,2006, with no advances made in October 2006.

**ForeignCurrency Risk**

Ourrevenue and cost, including subcontractor manufacturing expenses, aredenominated in U.S. dollars. An increase of the U.S. dollar relative to thecurrencies of the countries that our customers operate in would make ourproducts more expensive to them and increase pricing pressure or reduce demandfor our products. We do not currently enter into forward exchange contracts tohedge exposure denominated in foreign currencies or any other derivativefinancial instruments for trading or speculative purposes. In the future, if wefeel our foreign currency exposure has increased, we may consider entering intohedging transactions to help mitigate that risk. We expect that our foreigncurrency exposure will increase as our operations in India and other countriesexpand.

**ITEM 4.  CONTROLS AND PROCEDURES**

*Evaluation of Disclosure Controls and Procedures.*Our management evaluated, with the participation of our Chief Executive Officerand our Chief Financial Officer, the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this Quarterly Report onForm 10-Q. Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer have concluded that our disclosure controls and proceduresare effective to ensure that information we are required to disclose in reportsthat we file or submit under the Securities Exchange Act of 1934 (i) isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms, and (ii) isaccumulated and communicated to Ikanos’ management, including our ChiefExecutive Officer and our Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure. Our disclosure controls andprocedures are designed to provide reasonable assurance that such informationis accumulated and communicated to our management. Our disclosure controls andprocedures include components of our internal control over financial reporting.

*Changes in Internal Control over Financial Reporting.*There was no change in our system of internal control over financial reportingduring the three months ended September 30, 2006 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

*Limitations on the effectiveness of controls.* In designing and evaluating our disclosure controls and procedures, managementrecognized that disclosure controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the disclosure controls and procedures are met.Additionally, in designing disclosure controls and procedures, our managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible disclosure controls and procedures. The

31

----

design of anydisclosure controls and procedures also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.

**PART II:                OTHER INFORMATION**

# **ITEM 1.  LEGAL PROCEEDINGS**

InNovember 2006, purported class action lawsuits were filed in the United StatesDistrict Court for the Southern District of New York against us, our directors,an executive officer and a former executive officer. The lawsuits allegecertain misrepresentations by us in our registration statements and prospectusrelated to our initial public offering in September 2005 and the follow-onoffering in March 2006, and seeks unspecified damages.  We have not been served with the complaints.We cannot predict the likely outcome of these lawsuits, and an adverse result couldhave a material effect on our financial statements.

Inaddition, from time to time, we may be involved in litigation relating toclaims arising in the ordinary course of business.  As of the date of this report, except asdescribed in this report, we are not engaged in any legal proceeding that isexpected to have a material, adverse effect on our business, financialcondition or operating results.

# **ITEM 1A.               RISK FACTORS**

*Investing in our common stock involves a high degree ofrisk. You should carefully consider the following risk factors, as well as theother information in this Quarterly Report on Form 10-Q, and in our otherfilings with the SEC, including our Annual Report on Form 10K for the yearended December 31, 2005 and subsequent reports on Forms 10-Q and 8-K, beforedeciding whether to invest in shares of our common stock. Additional risks anduncertainties not presently known to us or that we currently deem immaterialmay also affect our business. If any of these known or unknown risks oruncertainties actually occurs with material adverse effects on Ikanos, ourbusiness, financial condition and results of operations could be seriouslyharmed. In that event, the market price for our common stock will likelydecline and you may lose all or part of your investment.*

***Risks Related to Our Business***

**Wehave a limited operating history, and our quarterly operating resultsmay fluctuate significantly. As a result, we may fail to meet orexceed our forecasts or the expectations of securities analysts or investors,which could cause our stock price to decline. In addition, we have experiencedperiods of volatility in our revenue in recent fiscal quarters. We expectrevenue to continue to be volatile in future periods, including, but notlimited to, the fourth quarter of 2006.**

Wehave a limited operating history, which makes it difficult to evaluate ourprospects. While our commercial operations began in 1999, we did not begincommercial shipments of our products until the fourth quarter of 2002. Sincethen, our quarterly revenue and operating results have varied significantly andare likely to continue to vary from quarter to quarter due to a number offactors, many of which are not within our control. For example, in the firstquarter of 2005, our revenue decreased by $6.2 million, or 33%, from thepreceding quarter, but then increased by $7.0 million, or 57%, in the followingquarter. Additionally, in the third quarter of 2006, our revenue declined by11% from the second quarter of 2006. We are currently forecasting revenue tofurther decrease in the fourth quarter of 2006. Quarterly fluctuations in revenue are typical in our industry, and arelikely to continue in the future. Quarterly fluctuations in revenue are characteristic of our industry, ascarriers purchase equipment based on expected deployment and OEMs mayoccasionally manufacture equipment at rates higher than equipment is deployed.As a result, periodically and usually without significant notice, carriers willreduce orders with OEMs for new equipment and OEMs in turn will reduce ordersfor our products, which can adversely impact the quarterly demand for ourproducts, even when deployment rates may be increasing.  In addition, our expenses are also subject toquarterly fluctuations resulting from factors including the costs related tonew product releases. If our operating results do not meet the expectations ofsecurities analysts or investors for any quarter or other reporting period, themarket price of our common stock may decline. Fluctuations in ouroperating results may be due to a number of 

32

----

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 ofour operating results as an indicator of future performance.

**Werecently completed the NPA acquisition, and if we are not successful inestablishing relationships with existing customers and suppliers, integratingthe technology and employees from the acquisition into our existing business,then our operating results may be harmed.**

InFebruary 2006, we completed the NPA acquisition. Through this acquisition,we added 47 employees in Hyderabad, India, 12 in Toronto, Canada and 18 inSan Jose, California. This was our first acquisition, and we face numerouschallenges in integrating these employees into our organization as well asintegrating the newly acquired technologies we purchased into our existingbroadband solutions.

Therevenue from the acquired business has been highly concentrated amongcustomers. We did not have a prior relationship with many of these customers.The success of our business is dependent in part upon our ability todevelop strong relationships with these customers and for the customers tocontinue to order network processing products from us.

TheNPA business relies on a limited number of suppliers for certain key componentsand materials. We are currently engaged in efforts to ensure a continuingsupply of certain key components and materials from such suppliers and if thesesuppliers are unable to supply us with components and materials in the volumeswe require, at the cost we have budgeted or in the timeframes we haverequested, our financial results will be negatively impacted. We recently haveexperienced increased cost from suppliers inherited from the NPA business, andthis may continue. Further, if we do not obtain the components and materials asneeded or the cost as budgeted to meet customer demand, customer relationshipsmay be harmed, and this could impact our future business and financial results.

Wemay experience more difficulty and costs than we anticipate in integratingthe technology we acquired in the NPA acquisition. Although we do have certainrights to seek indemnification from the seller in the event third parties makeclaims with respect to ownership of these technologies, these types of claims,if filed, are inherently costly to litigate and distract management from theoperation of the business. In addition, we may not be successful indefending ourselves against any such claims. If customer demand for the networkprocessing products we acquired in the NPA acquisition does not meet ourexpectations, or we do not receive sufficient supply capacity to supply suchproducts, we will have expended significant management and financial resourceson assets that will not realize their revenue potential. If any of these riskswere to be realized, our operating results would be harmed. We expect ourworking capital requirements to increase significantly as a result of the NPAacquisition as that business has historically been, and may continue tobe, operated on different, and frequently less favorable, terms than those wehave historically negotiated to operate our fiber-fast broadband business. Forexample, payment terms on products shipped were generally on longer terms thanwe customarily provide.

Additionally,purchasing decisions were frequently made in advance of receiving customerforecasts. As a result, we have a higher risk of excess inventory with respectto this business. If we are unsuccessful in addressing these challenges, ouroperating results may be harmed.

**Wehave a history of losses, and future losses may cause the market price ofour common stock to decline. We may not be able to generate sufficientrevenue in the future to achieve or sustain profitability.**

Sinceinception, we have only been profitable in the third and fourth fiscal quarterof 2005. We incurred significant net losses prior to such quarters, and weincurred losses in the past three quarters. As a result of the sequentialdecrease in revenue in the third quarter of 2006, our expectation of asignificant decrease in revenue in the fourth quarter of 2006 and the effect ofnon-cash acquisition related charges arising from the NPA and Doradusacquisitions, we expect a net loss in 2006. As of September 30, 2006, we had anaccumulated deficit of $93.8 million. To achieve profitability again, wewill need to generate and sustain higher revenue, while maintaining reasonablecost and expense levels. We expect to increase expense levels to supportincreased research and development efforts related to new and existing productdevelopment, to increase sales and marketing efforts, and to supportadministrative efforts related to costs of being a public company and managingan increasing complex 

33

----

business, as wellas to support the recently acquired NPA assets. Because many of our expensesare fixed in the short term, or are incurred in advance of anticipated sales,we may not be able to decrease our costs and expenses in a timely mannerto offset any shortfall of sales. Although we have achieved profitability inthe last two quarters of 2005, we may not be able to achieve profitabilityagain and even if we were able to attain profitability again, we may not beable to sustain profitability on a quarterly or an annual basis in the future.

**Ifdemand for our chipsets declines or does not grow, we will be unable toincrease or sustain our revenue and our operating results will be harmed.**

Wecurrently expect our existing chipsets to account for substantially all of ourrevenue for the foreseeable future. We began deriving revenue in the firstquarter of 2006 from products related to the NPA acquisition. If we are unableto develop new products or successfully integrate the newly acquired productsto meet our customers’ demand in a timely manner or demand for our chipsetsdeclines or fails to grow as a result of competition or technological changes,it would harm our business. The markets for our products are characterized byfrequent introduction of new chipsets, short product life cycles andsignificant price competition. If we or our OEM customers are unable to manageproduct transitions in a timely and cost-effective manner, our revenue wouldsuffer. In addition, frequent technology changes and introduction of nextgeneration products may result in inventory obsolescence, which wouldincrease our cost of revenue and adversely affect our operating performance.

**Changesin current or future laws or regulations or the imposition of new laws orregulations by federal or state agencies or foreign governments could impedethe sale of our products or otherwise harm our business.**

Theeffects of regulation on our customers or the industries in which they operatemay materially and adversely impact our business.  For example, theFederal Communications Commission, or FCC, has broad jurisdiction over ourtarget markets in the United States, and the European Union, or EU, has broadjurisdiction over our target markets in Europe.  Although the laws andregulations of these and other federal or state agencies are not directlyapplicable to our products, they do apply to much of the equipment into whichour products are incorporated. Governmental regulatory agencies worldwide,including the FCC and EU, may affect the ability of telephone companies tooffer certain services to their customers or other aspects of their business,which may in turn impede sales of our products.

**Theaverage selling prices of our products are subject to rapid declines, whichmay harm our revenue and profitability.**

Theproducts we develop and sell are used for high volume applications and aresubject to rapid declines in average selling prices. We have lowered our pricessignificantly at times to gain market share, and we expect that we willcontinue to reduce prices in the future. Offering reduced prices to onecustomer could impact our average selling prices to all customers. Ourfinancial results will suffer if we are unable to offset any future reductionsin our average selling prices by increasing our sales volumes, or if we areunable to reduce our cost and expenses or develop new or enhanced products on atimely basis with higher selling prices.

**Becausewe 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 sellexisting and new products to our key customers in significant quantities or ourfailure to attract new significant customers could adversely impact our revenueand harm our business.**

We derive asubstantial portion of our revenue from sales to a relatively small number ofcustomers. As a result, the loss of any significant customer or a decline inbusiness with any significant customer would materially and adversely affectour financial condition and results of operations. The following OEM customersaccounted for more than 10% of our revenue for any one of the periodsindicated. Sales made to these OEMs were made through the indicated third partysales representative.

34

----

** **
| ** **                    | ** ** | ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **Sales Representative** | ** ** | **OEM Customer**               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| NEC Corporation  (USA)        |       | NEC  Corporation (Magnus)           |       | 23                               | %          | 45                              | %          | 22 | % | 46 | % |
| Altima                        |       | Sumitomo  Electric Industries, Ltd. |       | 18                               | %          | 34                              | %          | 20 | % | 27 | % |
| Sagem                         |       | Sagem                               |       | 32                               | %          | n/a                             |       | 22 | % | n/a |   |
| Uniquest                      |       | Dasan                               |       | 8                                | %          | 12                              | %          | 12 | % | 11 | % |
| Uniquest                      |       | Others                              |       | 5                                | %          | 9                               | %          | 11 | % | 13 | % |

 

Weexpect that a small group of OEM customers, the composition of which has variedover time, will continue to account for a substantial portion of our revenue in2006 and in the foreseeable future. In addition, we expect to continue to sellthe network processing and ADSL broadband products acquired in the NPAacquisition to the existing customer base for these products. The SAFRAN Groupof, which Sagem Communication is a subsidiary, represented 73% of revenue forthe acquired business for the twelve months ended October 29, 2005.Accordingly, our future operating results will continue to depend on thesuccess of our largest OEM customers and on our ability to sell existing andnew products to these customers in significant quantities. Demand for ourchipset products is based on carrier demand for our OEM customers’ systemsproducts. Accordingly, a reduction in growth of carrier deployment offiber-fast broadband services would adversely affect our product sales andbusiness.

Inaddition, our relationships with some of our larger OEM customers may alsodeter other potential customers who compete with these customers from buyingour products. To attract new customers or retain existing OEM customers, wehave offered and may continue to offer certain customers favorable priceson our products. If these prices are lower than the prices paid by our existingOEM customers, we may have to offer the same lower prices to certain ofour customers. In that event, our average selling prices would decline. Theloss of a key customer, a reduction in sales to any major customer or ourinability to attract new significant customers could harm our business.

**We may beunable to attract a CEO in a timely manner; and we may be unable to attract,retain and motivate key senior management and technical personnel, which couldharm our development of technology and ability to be competitive.**

Ourfuture success depends to a significant extent upon the continued service ofour senior executives and key technical personnel. We do not have employmentagreements with any of these executives or any other key employees that governthe length of their service. The loss of the services of senior management ortechnical personnel could harm our business. In October 2006, our thenPresident and Chief Executive Officer, Rajesh Vashist, was replaced asPresident and Chief Executive Officer and resigned from the Board of theDirectors.  While we are activelyconducting a search for Mr. Vashist’s permanent replacement, we cannot assureyou that we will be able to recruit a qualified individual in a timelymanner.  Even though we have establishedan interim management team to assume Mr. Vashist’s responsibilities andretained Mr Vashist as a consultant for a limited transition period, anydisruption resulting from Mr. Vashist’s departure may adversely impact ourcustomer relationships, employee morale and our business.  Furthermore, our future success depends onour ability to continue to attract, retain and motivate other senior managementand qualified technical personnel, particularly software engineers, digitalcircuit designers, mixed-signal circuit designers and systems and algorithmsengineers, and we are currently in the process of trying to hire a generalmanager. Competition for these employees is intense. Stock options and otherequity incentives generally comprise a significant portion of our compensationpackages for all employees, and the expected volatility in the price of ourcommon stock may make it more difficult for us to attract and retain keyemployees, which could harm our ability to provide technologically competitiveproducts.

**Becauseof the rapid nature of technological development in our industry and theintense competition we face, our products become outmoded in a relatively shortperiod of time, which requires us to provide frequent updates and/or replacementsto existing products. If we do not successfully manage the transition processto next generation chipset products, our operating results may be harmed.**

Ourindustry is characterized by rapid technological innovation and intensecompetition. Accordingly, our success depends in part on our ability todevelop next generation chipset products in a timely and cost-effective manner.The development of new chipset products is expensive, complex and timeconsuming. If we do not rapidly develop our next generation chipset productsahead of our competitors, we may lose both existing and potentialcustomers to our competitors. Conversely, even if we are successful in rapidlydeveloping new chipset products ahead of our competitors and we do notcost-effectively manage our inventory levels of existing products when makingthe transition to the new chipset products, our financial results may benegatively affected by high levels of obsolete inventory. If either of theforegoing were to occur, then our operating results would be harmed.

**Werely on a limited number of independent subcontractors to manufacture, packageand test our current products, and our failure to secure and maintainsufficient capacity with these subcontractors could impair our relationshipswith customers and decrease sales, which would negatively impact our marketshare and operating results.**

We area fabless semiconductor company in that we do not own or operate a fabricationor manufacturing facility. Currently, eight outside factory subcontractors,located in Austria, China, Israel, Korea, Malaysia, Singapore, Taiwan and theUnited States, manufacture, assemble and test all of our semiconductor devicesin current production, five of which are also our wafer foundries. In pastperiods of high demand in the semiconductor market, we have experienced delaysin meeting our capacity demand and as a result were unable to deliver productsto our customers on a timely basis. In addition, we have experienced similardelays due to technical and quality control problems at our subcontractors’facilities. Furthermore, our costs for manufacturing services or componentshave increased without significant notice. In the future, if any of theseevents occur, or if these facilities suffer any damage, power outages,financial difficulties or any other disruption, we may be unable to meetour customer demand on a timely basis, or at all, and we may be required toincur additional costs and may need to successfully 

35

----

qualify analternative facility in a timely manner in order to not disrupt our business.We typically require several months or more to qualify a new facility orprocess before we can begin shipping products. If we cannot accomplish thisqualification in a timely manner, we would experience a significantinterruption in supply of the affected products and our costs of revenue mayincrease. If we are unable to secure sufficient capacity at our subcontractors’existing facilities, or in the event of a closure or significant delay at anyof these facilities, our relationships with our customers would be harmed andour market share and operating results would suffer as a result. In addition,we do not have formal pricing agreements with our subcontractors regarding thepricing for the products and services that they provide us. If their pricingfor the products and services they provide increases and we are unable to passalong such increases to our OEM customers, our operating results would beadversely affected.

**Whendemand for manufacturing capacity is high, we may take various actions totry to secure sufficient capacity, which may be costly and negativelyimpact our operating results.**

Theability of each of our subcontractors’ manufacturing facilities to provide uswith semiconductors is limited by its available capacity and existingobligations. Although we have purchase order commitments to supply specifiedlevels of products to our OEM customers, we do not have a guaranteed level ofproduction capacity from any of our subcontractors’ facilities that we dependon to produce our semiconductors. Facility capacity may not be availablewhen we need it or at reasonable prices. We place our orders on the basis ofour OEM customers’ purchase orders or our forecast of customer demand, and oursubcontractors may not be able to meet our requirements in a timelymanner. For example, in 2003, in the first nine months of 2004, the second halfof 2005 and in the first half of 2006, general market conditions in thesemiconductor industry resulted in a significant increase in demand at thesefacilities. The demand for our OEM customers’ products increased significantly,and we were asked to produce significantly higher quantities than in the pastand to deliver on short notice. In addition, our subcontractors have alsoallocated capacity to the production of other companies’ products and reduceddeliveries to us on short notice. It is possible that our subcontractors’ othercustomers that are larger and better financed than we are, or that havelong-term agreements with our subcontractors, may have induced oursubcontractors to reallocate capacity to them. If this reallocation were tooccur again, it would impair our ability to deliver products on a timely basis.

Althoughwe use five independent wafer foundries to manufacture all of our semiconductorproducts, each of our products is designed to be manufactured in a specificprocess at only one of these wafer foundries. Accordingly, if one of thesewafer foundries were unable to provide us with semiconductors as needed, wecould experience significant delays in securing sufficient supplies of thosesemiconductors. We cannot assure you that any of the existing or new waferfoundries that we use will be able to produce semiconductor devices withacceptable manufacturing yields, or that the wafer foundries will be able todeliver enough devices to us on a timely basis, or at reasonable prices. Thiscould impair our ability to meet our OEM customers’ needs.

Inorder to secure sufficient manufacturing facility capacity when demand is highand mitigate the risks described in the foregoing paragraphs, we may enterinto various arrangements with subcontractors that could be costly and harm ouroperating results, including:

·                  option paymentsor other prepayments to a subcontractor;

·                  nonrefundabledeposits with or loans to subcontractors in exchange for capacity commitments;

·                  contracts thatcommit us to purchase specified quantities of components over extended periods;

·                  purchase oftesting equipment for specific use at our subcontractors’ facilities;

·                  issuance of ourequity securities to a subcontractor; and

·                  othercontractual relationships with subcontractors.

Wemay not be able to make any such arrangements in a timely fashion or atall, and any arrangements may be costly, reduce our financial flexibilityand not be on terms favorable to us. Moreover, if we are able to securefacility capacity, we may be obligated to use all of that capacity orincur penalties. These penalties and obligations may be expensive and requiresignificant capital and could harm our business.

**Inthe event we seek to use new wafer foundries to manufacture a portion of oursemiconductor products, we may not be able to bring the new foundrieson-line rapidly enough and may not achieve the anticipated costreductions.**

36

----

Asindicated, we use five independent wafer foundries to manufacture all of oursemiconductor products, which exposes us to a substantial risk of delay,increased costs and customer dissatisfaction in the event that any of thesefoundries were unable to provide us with our semiconductor requirements.Particularly during times when semiconductor capacity is limited, wemay seek to qualify additional wafer foundries to meet our requirements.In order to bring these new foundries on-line, our customers would need toqualify the new facility, which process could take as long as several months.Once qualified, these new foundries would then require an additional number ofmonths to actually begin producing semiconductors to meet our needs, by whichtime our perceived need for additional capacity may have passed or theopportunities we previously identified may have been lost to ourcompetitors. Furthermore, even if these new foundries offer better pricing thanour existing manufacturers, if they prove to be less reliable than our existingmanufacturers, we would not achieve some or all of our anticipated costreductions.

**Ifour subcontractors’ manufacturing facilities do not achieve satisfactory yieldsor quality, our relationships with our customers and our reputation will beharmed, our revenue and operating results could decline, and our cost ofrevenue as a percentage of revenue could increase.**

Thefabrication of semiconductors is a complex and technically demanding process.Minor deviations in the manufacturing process can cause substantial decreasesin yields, and in some cases, cause production to be stopped or suspended. We have experienced difficulties in achieving acceptable yields on someof our products, particularly with new products, which frequently involve newermanufacturing processes and smaller geometry features than previousgenerations. Maintaining high numbers of shippable die per wafer is critical toour operating results, as decreased yields can result in higher per-unit cost, shipmentdelays and increased expenses associated with resolving yield problems. Although we work closely with our subcontractors to minimize thelikelihood of reduced manufacturing yields, their facilities have from time totime experienced lower than anticipated manufacturing yields that have resultedin our inability to meet our customer demand.  For instance, in the thirdquarter of 2006, we were unable to fulfill a certain amount of our customers’orders due to difficulties in attaining acceptable yields on one of ourproducts.  We are currently in the process of implementing design changesand new testing programs to this product in an effort to increase theirmanufacturing yields.  However, we cannot assure you that we will besuccessful in improving yields on this product or any future product.

It iscommon for yields in semiconductor fabrication facilities to decrease in timesof high demand or due to poor workmanship or operational problems at thesefacilities. When these events occur, especially simultaneously, as happens fromtime to time, we may be unable to supply our customers’ demand.  Manyof these problems are difficult to detect at an early stage of themanufacturing process and may be time consuming and expensive to correct. In addition, because we purchase wafers, our exposure to low wafer yieldsfrom our subcontractors’ wafer foundries are increased. Poor yields from thewafer foundries or defects, integration issues or other performance problems inour products could cause us significant customer relations and businessreputation problems, or force us to sell our products at lower gross marginsand therefore harm our financial results. Conversely, unexpected yieldimprovements could result in us holding excess inventory that would also negativelyimpact our gross margins. In addition, manufacturing defects may not bedetected by the testing process performed by our subcontractors. If defects arediscovered after we have shipped our products, our reputation would be harmedand our revenue and operating income could decline and our cost of revenue as apercentage of revenue could increase.

**Webase orders for inventory on our forecasts of our OEM customers’ demand and ifour forecasts are inaccurate, our financial condition and liquidity wouldsuffer.**

Weplace orders with our suppliers based on our forecasts of our OEM customers’demand. Our forecasts are based on multiple assumptions, each of whichmay introduce errors into our estimates. In the past, when the demand forour OEM customers’ products increased significantly, we were not able to meetdemand on a timely basis, and we expended a significant amount of time workingwith our customers to allocate limited supply and maintain positive customerrelations. If we underestimate customer demand, we may forego revenueopportunities, lose market share and damage our customer relationships.Conversely, if we overestimate customer demand, we may allocate resourcesto manufacturing products that we may not be able to sell when we expectto or at all. As a result, we would have excess or obsolete inventory,resulting in a decline in the value of our inventory, which would 

37

----

increase our costof revenue and create a drain on our liquidity. Our failure to accuratelymanage inventory against demand would adversely affect our financial results.

**Toremain competitive, we need to continue to transition our semiconductor chipsto increasingly smaller sizes, and our failure to do so may harm ourbusiness.**

Weperiodically evaluate the benefits, on a product-by-product basis, of migratingto smaller chips, which are measured in microns and referred to as geometryprocesses. We have designed our products to be manufactured in 0.8 micron, 0.25micron, 0.18 micron and 0.13 micron geometry processes. We are currentlymigrating some of our products to even smaller 90 nanometer geometry process technology, and over time, we arelikely to migrate to even smaller geometries. The smaller chip size reduces ourproduction and packaging costs, which may enable us to be competitive in ourpricing. The transition to smaller geometries requires us to work with oursubcontractors to modify the manufacturing processes for our products and toredesign some products. In the past, we have experienced some difficulties inshifting to smaller geometry process technologies or new manufacturingprocesses, which resulted in reduced manufacturing yields, delays in productdeliveries and increased expenses. We may face similar difficulties,delays and expenses as we continue to transition our products to smallergeometry processes, all of which could harm our relationships with ourcustomers, and our failure to do so would impact our ability to providecompetitive prices to our customers, which would have a negative impact on oursales.  Additionally, upfront expensesassociated with smaller geometry process technologies such as for masks andtooling can be significantly higher than those for the processes that wecurrently use, and our migration to these newer process technologies can resultin significantly higher research and development expenses.

**Weface intense competition in the semiconductor industry and the broadbandcommunications markets, which could reduce our market share and negativelyimpact our revenue.**

Thesemiconductor industry and the broadband communications markets are intenselycompetitive. We currently compete or expect to compete with, among others,Broadcom Corporation, Centillium Communications, Inc., ConexantSystems, Inc., Infineon Technologies A.G., Marvell TechnologyGroup Ltd., Metalink Ltd., STMicroelectronics N.V. and TexasInstruments Incorporated, which companies, we believe, have experience invery-high-bit-rate-digital subscriber line, or VDSL, or VDSL-like, technology.We also expect to compete with, among others, FreescaleSemiconductor, Inc., Intel Corporation, Marvell Technology Group Ltd.,PMC-Sierra, Inc. and Realtek Semiconductor Corp in the network processingmarket. We expect competition to continue to increase. Competition has resultedand may continue to result in declining average selling prices for ourproducts and market share.

Weconsider other companies that have access to discrete multi-tone, or DMT,technology as potential competitors in the future, and we also may facecompetition from newly established competitors, suppliers of products based onnew or emerging technologies and customers who choose to develop their ownchipsets. To remain competitive, we need to provide products that are designedto meet our customers’ needs. Our products must:

·                  achieve optimalproduct performance;

·                  comply withindustry standards;

·                  becost-effective for our customers’ use in their systems;

·                  meet functionalspecifications;

·                  be introducedtimely to the market; and

·                  besupported by a high-level of customer service and support.

Manyof our competitors operate their own fabrication facilities or have strongermanufacturing partner relationships than we have. In addition, many of ourcompetitors have extensive technology libraries that could enable them to incorporatefiber-fast broadband or network processing technologies into a more attractiveproduct line than ours. Many of them also have longer operating histories,greater name recognition, larger customer bases, and significantly greaterfinancial, sales and marketing, manufacturing, distribution, technical andother resources than we do. These competitors may be able to adapt morequickly to new or emerging technologies and changes in customer requirements.In addition, current and potential competitors have established ormay establish financial or 

38

----

strategicrelationships among themselves or with existing or potential customers,resellers or other third parties. Accordingly, new competitors or alliancesamong competitors could emerge and rapidly acquire significant market share.Existing or new competitors may also develop technologies that moreeffectively address our markets with products that offer enhanced features andfunctionality, lower power requirements, greater levels of semiconductor integrationor lower cost. We cannot assure you that we will be able to competesuccessfully against current or new competitors, in which case we may losemarket share in our existing markets and our revenue may fail to increaseor may decline.

**Otherdata transmission technologies and network processing technologiesmay compete effectively with the carrier services addressed by ourproducts, which could adversely affect our revenue and business.**

Ourrevenue is dependent on the increase in demand for carrier services that useintegrated residential gateways. Residential gateways compete against a varietyof different data transmission technologies, including other DMT-basedtechnologies, cable modem and satellite and other wireless technologies. If anyof these competing technologies proves to be more reliable, faster or lessexpensive than, or has any other advantages over, the fiber-fast broadbandtechnologies we provide, the demand for our products may decrease and ourbusiness would be harmed.

**Werely on third-party technologies for the development of our products and ourinability to use such technologies in the future would harm our ability toremain competitive.**

Werely on third parties for technologies that are integrated into some of ourproducts, including memory cells, input/output cells and core processor logic.If we are unable to continue to use or license these technologies on reasonableterms, or if these technologies fail to operate properly, we may not beable to secure alternatives in a timely manner and our ability to remaincompetitive would be harmed. In addition, if we are unable to successfullylicense technology from third parties to develop future products, wemay not be able to develop such products in a timely manner or at all.

**Ifwe are unable to develop, introduce or to achieve market acceptance of our newchipset products, our operating results would be adversely affected.**

Ourfuture success depends on our ability to develop new chipset products andtransition to new products, introduce these products in a cost-effective andtimely manner and convince OEMs to select our products for design into theirnew systems. Our historical quarterly results have been, and we expect that ourfuture results will continue to be, dependent on the introduction of arelatively small number of new products and the timely completion and deliveryof those products to customers. The development of new chipset products iscomplex, and from time to time we have experienced delays in completing thedevelopment and introduction of new products. We have in the past investedsubstantial resources in emerging technologies that did not achieve the marketacceptance that we had 

39

----

expected. Ourability to develop and deliver new chipset products successfully will depend onvarious factors, including our ability to:

·                  successfullyintegrate the technologies acquired in the NPA acquisition into our productlines;

·                  accuratelypredict market requirements and evolving industry standards;

·                  accuratelydefine new chipset products;

·                  timely completeand introduce new product designs;

·                  timely qualifyand obtain industry interoperability certification of our products and theequipment into which our products will be incorporated;

·                  ensure that oursubcontractors have sufficient foundry capacity and packaging materials andachieve acceptable manufacturing yields;

·                  shift ourproducts to smaller geometry process technologies to achieve lower cost andhigher levels of design integration; and

·                  gainmarket acceptance of our products and our OEM customers’ products.

If weare unable to develop and introduce new chipset products successfully and in acost-effective and timely manner, we will not be able to attract new customersor retain our existing customers, which would harm our business.

**Oursuccess is dependent on achieving design wins into commercially successful OEMsystems.**

Ourproducts are generally incorporated into our OEMs customers’ systems at thedesign stage. As a result, we rely on OEMs to select our products to bedesigned into their systems, which we refer to as a design win. We often incursignificant expenditures on the development of a new product without anyassurance 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 orprovide information that we need to achieve a design win. Some of these thirdparties may not supply this information to us on a timely basis, if atall. Furthermore, even if an OEM designs one of our products into its systemoffering, we cannot be assured that its equipment will be commerciallysuccessful or that we will receive any revenue as a result of that design win.Our OEM customers are typically not obligated to purchase our products and canchoose at any time to stop using our products if their own systems are notcommercially successful, if they decide to pursue other systems strategies, orfor any other reason. If we are unable to achieve design wins or if our OEMcustomers’ systems incorporating our products are not commercially successful,our revenue would suffer.

**Acquisitions,strategic partnerships, joint ventures or investments may impair ourcapital and equity resources, divert our management’s attention or otherwisenegatively impact our operating results.**

Weintend to continue to actively pursue acquisitions, strategic partnerships andjoint ventures that we believe may allow us to complement our growthstrategy, increase market share in our current markets and expand into adjacentmarkets, broaden our technology and intellectual property and strengthen ourrelationships with carriers and OEMs. For example, in August 2006 weacquired Doradus, a developer of advanced signal processing products forcommunications and consumer applications for $2.1 million in cash, including$0.1 million in transaction expenses, and the assumption of liabilities of $0.1million, options to purchase approximately 177,246 shares of Ikanos commonstock and approximately 178,000 shares of restricted stock. Any futureacquisition, partnership joint venture or investment may require that wepay significant cash, issue stock or incur substantial debt. Acquisitions,partnerships or joint ventures may also result in the loss of keypersonnel and the dilution of existing stockholders as a result of issuingequity securities. In addition, acquisitions, partnerships or joint venturesrequire significant managerial attention, which may be diverted from ourother operations. These capital, equity and managerial commitments may impairthe operation of our business. Furthermore, acquired businesses may not beeffectively integrated, may be unable to maintain key pre-acquisitionbusiness relationships, may contribute to increased fixed costs andmay expose us to unanticipated liabilities and otherwise harm ouroperating results.

**Werely on third-party sales representatives to assist in selling our products,and the failure of these representatives to perform as expected couldreduce our future sales.**

40

----

Wesell our products to some of our OEM customers through third-party salesrepresentatives. Our relationships with some of our third-party salesrepresentatives have been established within the last three years, and we areunable to predict the extent to which our third-party sales representativeswill be successful in marketing and selling our products. Moreover, many of ourthird-party sales representatives also market and sell competing products. Ourthird-party sales representatives may terminate their relationships withus at any time. Our future performance will also depend, in part, on ourability to attract additional third-party sales representatives that will beable to market and support our products effectively, especially in markets inwhich we have not previously distributed our products. If we cannot retain ourcurrent third-party sales representatives or recruit additional or replacementthird-party sales representatives, our revenue and operating results could beharmed.

**Rapidlychanging standards and regulations could make our products obsolete, whichwould cause our revenue and operating results to suffer.**

Wedesign our products to conform to regulations established by governmentsand to standards set by industry standards bodies worldwide such as TheAmerican National Standards Institute and The Committee T1E1.4 in NorthAmerica, European Telecommunications Standards Institute in Europe and ITU-Tand the Institute of Electrical and Electronics Engineers, Inc. worldwide.Because our products are designed to conform to current specific industrystandards, if competing standards emerge that are preferred by our customers,we would have to make significant expenditures to develop new products. If ourcustomers adopt new or competing industry standards with which our products arenot compatible, or the industry groups adopt standards or governments issueregulations with which our products are not compatible, our existing productswould become less desirable to our customers and our revenue and operatingresults would suffer.

**Ifwe fail to secure or protect our intellectual property rights, competitorsmay be able to use our technologies, which could weaken our competitiveposition, reduce our revenue or increase our cost.**

Oursuccess will depend, in part, on our ability to protect our intellectualproperty. We rely on a combination of patent, copyright, trademark and tradesecret laws, confidentiality procedures and licensing arrangements to establishand protect our proprietary rights in the United States. We do not currently haveany applications on file in any foreign jurisdictions with respect to ourintellectual property notwithstanding the fact that a significant portion ofour revenue is generated abroad. Our pending patent applications may notresult in issued patents, and our existing and future patents may not besufficiently broad to protect our proprietary technologies or may be heldinvalid or unenforceable in court. While we are not currently aware ofmisappropriation of our existing technology, policing unauthorized use of ourtechnology is difficult and we cannot be certain that the steps we have takenwill prevent the misappropriation or unauthorized use of our technologies,particularly in foreign countries where we have not applied for patentprotections and, even if such protections were available, the laws may notprotect our proprietary rights as fully as U.S. law. The patents we haveobtained or licensed, or may obtain or license in the future, may notbe adequate to protect our proprietary rights. Our competitorsmay independently develop or may have already developed technologysimilar to ours, duplicate our products or design around any patents issued tous or our other intellectual property. In addition, we may be required tolicense our patents as a result of our participation in various standardsorganizations. If competitors appropriate our technology and we are notadequately protected, our competitive position would be harmed, our legal costswould increase and our revenue would be harmed.

**Third-partyclaims of infringement or other claims against us could adversely affect ourability to market our products, require us to redesign our products or seeklicenses from third parties, and harm our business. In addition, any litigationrequired to defend such claims could result in significant expenses anddiversion of our resources.**

Companiesin the semiconductor industry often aggressively protect and pursue theirintellectual property rights. From time to time, we receive, andmay continue to receive in the future, notices that claim we haveinfringed upon, misappropriated or misused other parties’ proprietary rights.While we are not aware that we are currently infringing on the proprietaryrights of third parties, we may in the future be engaged in litigationwith parties who claim that we have infringed their patents or misappropriatedor misused their trade secrets or who may seek to invalidate one or moreof our patents, and it is possible that we would not prevail in any futurelawsuits. An adverse determination in any of these types of claims couldprevent us from manufacturing or selling some of our products,

41

----

could increase our costsof products and could expose us to significant liability. Any of these claimscould harm our business. For example, in a patent or trade secret action, acourt could issue a preliminary or permanent injunction that would require usto withdraw or recall certain products from the market or redesign certainproducts offered for sale or that are under development. In addition, wemay be liable for damages for past infringement and royalties for futureuse of the technology and we may be liable for treble damages ifinfringement is found to have been willful. Even if claims against us are notvalid or successfully asserted, these claims could result in significant costsand a diversion of management and personnel resources to defend.

**Anypotential dispute involving our patents or other intellectual property couldalso include our manufacturing subcontractors and OEM customers, which couldtrigger our indemnification obligations to them and result in substantialexpense to us.**

In any potentialdispute involving our patents or other intellectual property, our manufacturingsubcontractors and OEM customers could also become the target of litigation.Because we often indemnify our customers for intellectual property claims madeagainst them for products incorporating our technology, any litigation couldtrigger technical support and indemnification obligations in some of ourlicense agreements, which could result in substantial expenses. While to datenone of our OEM customers has made an indemnification claim against us, in theevent an indemnification claim were made, it could adversely affect ourrelationships with our OEM customers and result in substantial costs to us.

**Ourproducts typically have lengthy sales cycles, which may cause our operatingresults to fluctuate and result in volatility in the price of our common stock.An OEM customer or a carrier may decide to cancel or change its productplans, which could cause us to lose anticipated sales.**

After we havedelivered a product to an OEM customer, the OEM will usually test and evaluateour product with its carrier customer prior to the OEM completing the design ofits own equipment that will incorporate our product. Our OEM customers and thecarriers may need three to more than six months to test, evaluate andadopt our product and an additional three to more than nine months to beginvolume production of equipment that incorporates our product. Due to thislengthy sales cycle, we may experience significant delays from the time weincrease our operating expenses and make investments in inventory until thetime that we generate revenue from these products. It is possible that wemay never generate any revenue from these products after incurring theseexpenditures and investments. Even if an OEM customer selects our product toincorporate into its equipment, we have no assurances that the customer willultimately market and sell its equipment or that such efforts by our customerwill be successful. The delays inherent in our lengthy sales cycle increasesthe risk that an OEM customer or carrier will decide to cancel or change itsproduct plans. From time to time, we have experienced changes and cancellationsin the purchase plans of our OEM customers. A cancellation or change in plansby an OEM customer or carrier could cause us to not achieve anticipated revenueand result in volatility of the price of our common stock. In addition, ouranticipated sales could be lost or substantially reduced if a significant OEMcustomer or carrier reduces or delays orders during our sales cycle or choosesnot to release equipment that contains our products.

**As ourinternational manufacturing, sales and research and development operationsexpand, we will be increasingly exposed to various legal, business, politicaland economic risks associated with our international operations.**

We currentlyobtain substantially all of our manufacturing, assembly and testing servicesfrom suppliers and subcontractors located outside the United States, and have asignificant portion of our research and development team located in Bangaloreand Hyderabad, India. In addition, 97% of our revenue for the nine months endedSeptember 30, 2006 and 99% of our revenue for the nine months ended September30, 2005 was derived from sales to customers outside the United States. We haveexpanded our international business activities and may open other designand operational centers abroad. International operations are subject to manyother inherent risks, including but not limited to:

·                  political, social and economicinstability, including terrorist acts;

·                  exposure to different legalstandards, particularly with respect to intellectual property;

·                  naturaldisasters and public health emergencies;

42

----

·                  trade and travel restrictions;

·                  the imposition of governmentalcontrols and restrictions or unexpected changes in regulatory requirements;

·                  burdens of complying with a varietyof foreign laws;

·                  import and export licenserequirements and restrictions of the United States and each other country in whichwe operate;

·                  foreign technical standards;

·                  changes in tariffs;

·                  difficulties in staffing and managinginternational operations;

·                  fluctuations in currency exchangerates;

·                  difficulties in collectingreceivables from foreign entities or delayed revenue recognition; and

·                  potentiallyadverse tax consequences.

Because we arecurrently substantially dependent on our foreign sales, research anddevelopment and operations, any of the factors described above couldsignificantly harm our ability to produce quality products in a timely and costeffective manner, and increase or maintain our foreign sales.

**Significantfluctuations or a slowdown in deployment of fiber extension over copper andbroadband over copper in Asia would adversely affect our operating results.**

Sales to customerslocated in Asia accounted for 70% of our revenue for the nine months endedSeptember 30, 2006 and 98% for the nine months ended September 30, 2005. Oursales have been dependent on the continuous growth of new fiber extension overcopper and broadband over copper subscribers in Asia. Fluctuations in or aplateau of new subscribers in Asia could impact our revenue and a sustainedslow down in growth of fiber extension over copper and broadband over coppersubscribers in Asia may cause our revenue to decline.

**We arein the process of implementing a new ERP system, which could disrupt ouroperations, negatively impact our sales volume and revenue and adversely affectour ability to integrate the assets we acquired in the NPA acquisition.**

InJanuary 2006, we completed the first of many phases of a new comprehensiveenterprise resource planning, or ERP, information system to manage our businessoperations.  In September 2006, wesubstantially completed the second phase of the ERP information system.  We have operated this new system for only alimited time and may experience difficulties in successfully transitioning fromthe prior system to the new system.  Further,we will require subsequent enhancements to this new system, which could disruptour operations. We have experienced difficulties in the past in implementingnew information systems. The process of implementing new information systemscould also adversely impact our ability to do the following in a timely manner:

·                  report financial results;

·                  accurately reflect inventory costs;

·                  accept and process customer orders;

·                  receive inventory and ship products;

·                  invoice and collect receivables;

·                  place purchase orders and payinvoices; and

·                  accuratelyreflect all other business transactions related to the finance, order entry,purchasing, supply chain and human resource processes within the new ERPinformation system.

**Fluctuationsin exchange rates between and among the Japanese yen, the Korean won, theIndian rupee, the U.S. dollar, the Canadian dollar and the Euro, as well asother currencies in which we do business, may adversely affect ouroperating results.**

We transactbusiness in an international environment. As a result, we may experienceforeign exchange gains or losses due to the volatility of other currenciescompared to the U.S. dollar. Our sales have been historically 

43

----

denominated in U.S.dollars and an increase in the U.S. dollar relative to the currencies of thecountries that our customers operate in could materially affect our Asian andEuropean customers’ demand for our products, thereby forcing them to reducetheir orders, which would adversely affect our business. We incur a portion ofour expenses in currencies other than the U.S. dollar, including the Japaneseyen, Korean won, Indian rupee, Canadian dollar and the Euro. As we report ourresults in U.S. dollars, the difference in exchange rates in one periodcompared to another directly impacts period to period comparisons of ouroperating results. Furthermore, currency exchange rates have been especiallyvolatile in the recent past and these currency fluctuations may make itdifficult for us to predict and/or provide guidance on our results.

Currently we havenot implemented any strategies to mitigate risks related to the impact offluctuations in currency exchange rates. Even if we were to implement hedgingstrategies, not every exposure is or can be hedged, and, where hedges are putin place based on expected foreign exchange exposure, they are based onforecasts which may vary or which may later prove to have beeninaccurate. Failure to hedge successfully or anticipate currency risks properlycould adversely affect our operating results. We cannot predict future currencyexchange rate changes.

**We havehistorically derived a substantial amount of our revenue from Asia, and withthe NPA acquisition, a majority of our network processing revenue comes from asingle customer in Europe. If we fail to diversify the geographic sources andcustomer base of our revenue in the future, our operating results could beharmed.**

A substantialportion of our revenue is derived from sales into Japan, Korea and France, andour revenue has been heavily dependent on developments in these markets. As aresult, our sales are subject to economic downturns, decrease in demand andoverall negative market conditions in Asia and France. For instance, ourrevenue declined sequentially by 11% in the third quarter of 2006 and isprojected to further decline in the fourth quarter principally due to a reductionin demand for our products in Japan and Korea as well as a general slow down inthe telecommunication integrated circuit (“IC”) market. While part ofour strategy is to continue to diversify the geographic sources andcustomer base of our revenue, our failure to successfully penetrate marketsoutside of Japan, Korea and France, and to successfully diversify our customerbase could harm our business and operating results.

**Thecomplexity of our products could result in unforeseen delays or expenses and inundetected defects or bugs, which could damage our reputation with current orprospective customers and adversely affect the market acceptance of newproducts.**

Highly complexproducts such as those that we offer frequently contain defects and bugs, particularlywhen they are first introduced or as new versions are released. In the past, wehave experienced, and may in the future experience, defects and bugs inour products. If any of our products contains defects or bugs, or havereliability, quality or compatibility problems, our reputation may bedamaged and our OEM customers may be reluctant to buy our products, whichcould harm our ability to retain existing customers and attract new customers.In addition, these defects or bugs could interrupt or delay sales or shipmentof our products to our customers.

**Recentchanges to environmental laws and regulations applicable to manufacturers ofelectrical and electronic equipment are causing us to redesign our products,and may result in increases to our costs and greater exposure toliability.**

The implementationof new environmental regulatory legal requirements, such as lead freeinitiatives, could impact our product designs and manufacturing processes. Theimpact of such regulations on our product designs and manufacturing processescould affect the timing of compliant product introductions as well as theircommercial success. For example, a recent directive in the European Unionbanned the use of lead and other heavy metals in electrical and electronic equipmentafter July 1, 2006. As a result, some of our customers selling products inEurope have begun demanding product from component manufacturers that do notcontain these banned substances. Because most of our existing assemblyprocesses (as well as those of most other manufacturers) utilize a tin-leadalloy as a soldering material in the manufacturing process, we must redesignmany of our products if we are to meet customer demand. This redesignmay result in increased research and development and manufacturing andquality control costs. In addition, the products that we manufacture thatcomply with the new regulatory standards may not perform as well asour current products. Moreover, if we are unable to successfully and timelyredesign existing products and introduce new products that meet the standardsset by environmental regulation and our customers, 

44

----

sales of our productscould decline, which could materially adversely affect our business, financialcondition and results of operations.

**We haveincurred, and expect to continue to incur, increased costs as a result of beinga public company.**

Recently enactedand proposed changes in the laws and regulations affecting public companies,including the provisions of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley,and recent rules enacted and proposed by the SEC and the Nasdaq NationalMarket, are resulting in increased costs to us as we respond to theirrequirements. In particular, the costs to comply with Section 404 ofSarbanes-Oxley, as presently in effect, could have an adverse effect on ourresults of operations. The new rules could also make it more difficult forus to obtain certain types of insurance, including director and officerliability insurance, and we may be forced to accept reduced policy limitsand coverage and/or incur substantially higher costs to obtain the same orsimilar coverage. The impact of these events could also make it more difficultfor us to attract and retain qualified persons to serve on our board ofdirectors, on committees of our board of directors, or as executive officers.

**Compliancewith the requirements imposed by Section 404 of the Sarbanes-Oxley Actcould harm our operating results, our ability to operate our business andinvestors’ view of us.**

Pursuant toSection 404 of the Sarbanes-Oxley Act, beginning with our Annual Report onForm 10-K for the fiscal year ending December 31, 2006, we will berequired to furnish a report by our management on our internal control overfinancial reporting. In order to achieve compliance with Section 404 ofSarbanes-Oxley within the prescribed period, we have commenced a process todocument and evaluate our internal control over financial reporting, which willbe both costly and challenging. We can provide no assurance as to our or ourindependent registered public accounting firm’s conclusions with respect to theeffectiveness of our internal control over financial reporting underSection 404 of Sarbanes-Oxley. There is a risk that neither we nor ourindependent registered public accounting firm will be able to conclude that ourinternal controls over financial reporting are effective as required bySection 404 of Sarbanes-Oxley.

In addition,during the course of our testing we may identify deficiencies that wemay not be able to remediate in time to meet the deadline imposed bySarbanes-Oxley for compliance with the requirements of Section 404.Furthermore, if we fail to achieve and maintain the adequacy of our internalcontrols, as such standards are modified, supplemented or amended from time totime, we may not be able to ensure that we can conclude on an ongoingbasis that we have effective internal control over financial reporting inaccordance with Section 404 of Sarbanes-Oxley. Effective internalcontrols, particularly those related to revenue recognition, are necessary forus to produce reliable financial reports and are important to helping preventfinancial fraud. If we cannot provide reliable financial reports or preventfraud, our business and operating results could be harmed, investors could loseconfidence in our reported financial information, and the trading price of ourstock could drop significantly.

**We needto attract and retain key employees in our finance department. If we fail to doso our ability to meet reporting and compliance regulations could be affected****.**

In 2006, the employmentof several key employees in our finance department terminated. We have recentlyhired certain key financial personnel and may need to hire additional personnelin the future. As a result of these changes, we may face difficulties inintegrating these employees and adhering to reporting and complianceregulations, which could harm the ability to operate our business as a publiccompany and investors’ may lose confidence in our ability to operate incompliance with existing internal controls rules and regulations, either ofwhich could result in a decline in our stock price.

**Due tothe cyclical nature of the semiconductor and telecommunications industries, ouroperating results may fluctuate significantly, which could adverselyaffect the market price of our common stock.**

The semiconductorindustry is highly cyclical and subject to rapid change and evolving industrystandards and, from time to time, has experienced significant downturns. Thesedownturns are characterized by decreases in product demand, excess customerinventories and accelerated erosion of prices. These factors could causesubstantial fluctuations in our revenue and in our operating results. Anydownturns in the semiconductor or broadband communications industry may besevere and prolonged, and any failure of this industry or the broadband 

45

----

communications markets tofully recover from downturns could harm our business. The semiconductorindustry also periodically experiences increased demand and production capacityconstraints, which may affect our ability to ship products. Accordingly,our operating results may vary significantly as a result of the generalconditions in the semiconductor or broadband communications industry, whichcould cause our stock price to decline.

In addition, thetelecommunications industry from time to time has experienced andmay again experience a pronounced downturn. To respond to a downturn, manycarriers may be required to slow their capital expenditures, cancel ordelay new developments, reduce their workforces and inventories and take acautious approach to acquiring new equipment and technologies from OEMs, whichwould have a negative impact on our business. In the future, a downturn in thetelecommunications industry may cause our operating results to fluctuatefrom year to year, which also may tend to increase the volatility of theprice of our common stock and harm our business.

**Severalof the facilities that manufacture our products, most of our OEM customers andthe carriers they serve, and our California facility are located in regionsthat are subject to earthquakes and other natural disasters.**

Several of oursubcontractors’ facilities that manufacture, assemble and test our products,and one of our subcontractor’s wafer foundries, are located in Taiwan. Ourcustomers are currently primarily located in Japan and Korea. The Asia-Pacificregion has experienced significant earthquakes in the past and could be subjectto additional seismic activities. Any earthquake or other natural disaster inthese areas could significantly disrupt these manufacturing facilities’production capabilities and could result in our experiencing a significantdelay in delivery, or substantial shortage, of wafers in particular, andpossibly in higher wafer prices, and our products in general. Our headquartersin California are also located near major earthquake fault lines. If there is amajor earthquake or any other natural disaster in a region where one of ourfacilities is located, it could significantly disrupt our operations.

**Changesin our tax rates could affect our future results.**

Our futureeffective tax rates could be favorably or unfavorably affected by the absoluteamount and future geographic distribution of our pre-tax income, our ability tosuccessfully shift our operating activities to our foreign operations and theamount and timing of inter-company payments from our foreign operations subjectto U.S. income taxes related to the transfer of certain rights and functions.

***Risks Related toour Common Stock***

**Ourstock price may be volatile, and you may not be able to resell sharesof our common stock at or above the price you paid, or at all.**

The market priceof our common stock has fluctuated substantially since our initial publicoffering and is likely to continue to be highly volatile and subject to widefluctuations. Fluctuations have occurred and may continue to occur inresponse to various factors, many of which we cannot control, including:

·                  quarter-to-quarter variations in ouroperating results;

·                  changes in accounting rules,particularly those related to the expensing of stock options;

·                  announcements of changes in oursenior management;

·                  the gain or loss of one or moresignificant customers or suppliers;

·                  announcements of technologicalinnovations or new products by our competitors, customers or us;

·                  the gain or loss of market share inany of our markets;

·                  general economic and politicalconditions and specific conditions in the semiconductor industry and broadbandtechnology  markets, including seasonality in sales of consumer productsinto which our products are incorporated;

·                  continuing international conflictsand acts of terrorism;

·                  changes in earnings estimates orinvestment recommendations by analysts;

·                  changes in investor perceptions; or

46

----

·                  changesin expectations relating to our products, plans and strategic position or thoseof our competitors or customers.

In addition, themarket prices of securities of semiconductor and other technology companieshave been volatile, particularly companies, like ours, with low tradingvolumes. This volatility has significantly affected the market prices ofsecurities of many technology companies for reasons frequently unrelated to theoperating performance of the specific companies. Accordingly, you may notbe able to resell your shares of common stock at or above the price you paid.

**Class actionlitigation due to stock price volatility or other factors could cause us toincur substantial costs and divert our management’s attention and resources.**

In November 2006, purportedclass action lawsuits were filed in the United States District Court for theSouthern District of New York against us, our directors, an executive officerand a former executive officer. The lawsuits allege certain misrepresentationsby us in our registration statements and prospectus related to our initialpublic offering in September 2005 and the follow-on offering in March 2006, andseeks unspecified damages.  We have notbeen served with the complaints. We cannot predict the likely outcome of theselawsuits, and an adverse result could have a material effect on our financialstatements.

If we are notsuccessful in our defense of such claims, we could be forced to makesignificant payments to our stockholders and their lawyers, and such paymentscould have a material adverse effect on our business, financial condition andresults of operations if not covered by our insurance carriers. Even if suchclaims are not successful, the litigation could result in substantial expensesand the diversion of management’s attention, which could have an adverse effecton our business.

**Ifsecurities or industry analysts do not publish research or reports about ourbusiness, or if they issue an adverse opinion regarding our stock, our stockprice and trading volume could decline.**

The trading marketfor our common stock is influenced by the research and reports that industry orsecurities analysts publish about us or our business. If one or more of theanalysts who cover us issue an adverse opinion regarding our stock, our stockprice would likely decline. If one or more of these analysts cease coverage ofour company or fail to regularly publish reports on us, we could losevisibility in the financial markets, which in turn could cause our stock priceor trading volume to decline.

**Substantialfuture sales of our common stock in the public market could cause our stockprice to fall.**

As of September30, 2006, we had approximately 27.6 million shares of common stock outstanding.Of these shares, 6,400,000 were sold in our initial public offering inSeptember 2005 and an additional 2,500,000 were recently sold ina follow-on public offering, all of which are freely tradableunder federal and state securities laws without further registration under theSecurities Act of 1933, as amended (the “Securities Act”), or the SecuritiesAct, except that any shares held by our “affiliates” (as that term is definedunder Rule 144 of the Securities Act) may be sold only in compliancewith the limitations under Rule 144. The remaining outstanding shares are “restrictedsecurities” and generally will be available for sale in the public market atvarious times upon qualification for exemption pursuantto Rules 144 and/or 701 of the Securities Act.

Inaddition, certain of our stockholders are entitled to rights tocause their shares to be registered for sale under theSecurities Act. Following the completion of our recent follow-onpublic offering, the number of shares entitled to registrationrights decreased as a result of the participation as selling stockholdersof these stockholders possessing registration rights. Registration ofthese stockholders’ remaining shares under the Securities Act would resultin these shares, other than shares purchased by our affiliates, becoming freelytradable without restriction under the Securities Act immediately upon theeffectiveness of the registration statement.

In the future, wemay also issue additional shares to our employees, directors orconsultants, in connection with corporate alliances or acquisitions, and infollow-on offerings to raise additional capital. Due to these factors, sales ofa substantial number of shares of our common stock in the public market could occurat any time. These sales could reduce the market price of our common stock.

47

----

**Ourcorporate actions are substantially controlled by our directors, executiveofficers and their affiliated entities who could exert control over our companyin a manner that may be contrary to the interests of other investors.**

Our directors,executive officers and their affiliated entities beneficially own over 25% ofour outstanding common stock. These stockholders, if they acted together, couldexert substantial control over matters requiring approval by our stockholders,including electing directors and approving mergers or other businesscombination transactions. This concentration of ownership may alsodiscourage, delay or prevent a change in control of our company, which coulddeprive our stockholders of an opportunity to receive a premium for their stockas part of a sale of our company and might reduce our stock price. Theseactions may be taken even if they are opposed by our other stockholders,including those who purchase shares in this offering.

**Delawarelaw and our corporate charter and bylaws contain anti-takeover provisions thatcould delay or discourage takeover attempts that stockholders may considerfavorable.**

Provisions in ourcertificate of incorporation may have the effect of delaying or preventinga change of control or changes in our management. These provisions include thefollowing:

·                  the right of the board of directorsto elect a director to fill a vacancy created by the expansion of the board ofdirectors;

·                  the establishment of a classifiedboard of directors requiring that not all members of the board be elected atone time;

·                  the prohibition of cumulative votingin the election of directors which would otherwise allow less than a majorityof stockholders to elect director candidates;

·                  the requirement for advance noticefor nominations for election to the board of directors or for proposing mattersthat can be acted upon at a stockholders’ meeting;

·                  the ability of the board of directorsto alter our bylaws without obtaining stockholder approval;

·                  the ability of the board of directorsto issue, without stockholder approval, up to 5,000,000 shares of preferredstock with terms set by the board of directors, which rights could be senior tothose of common stock;

·                  the required approval of holders ofat least two-thirds of the shares entitled to vote at an election of directorsto adopt, amend or repeal our bylaws or amend or repeal the provisions of ourcertificate of incorporation regarding the election and removal of directorsand the ability of stockholders to take action;

·                  the required approval of holders of amajority of the shares entitled to vote at an election of directors to removedirectors for cause; and

·                  theelimination of the right of stockholders to call a special meeting ofstockholders and to take action by written consent.

We are alsosubject to provisions of the Delaware General Corporation Law that, in general,prohibit any business combination with a beneficial owner of 15% or more of ourcommon stock for three years after the point in time that such stockholderacquired shares constituting 15% or more of our shares, unless the holder’sacquisition of our stock was approved in advance by our board of directors.

**ITEM 2.****                             UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

Our firstregistration statement, which we filed on Form S-1 (FileNo. 333-113880) under the Securities Act, wasdeclared effective by the SEC in connection with our initial publicoffering of our common stock, par value $0.001, in September 2005. Afterdeducting the underwriters’ commission and the estimated offering costs, wereceived net proceeds of $67.9 million from our initial public offering.

The SEC declaredour second registration statement, which we filed on Form S-1 (FileNo. 333-132067), under the Securities Act,  in connection with apublic offering of our common stock, par value $0.001, effective in March 2006.Citigroup and Lehman Brothers acted as the lead underwriters of the offering. Atotal of 5,750,000 shares of 

48

----

common stock were sold inthe offering at $20.75 per share. 2,500,000 of the shares of common stock weresold by us and 3,250,000 of the shares of common stock were sold by sellingstockholders. The offering terminated after the sale of all of the securitiesregistered on the registration statement. After deducting the underwriters’commission and the estimated offering costs, we received net proceeds of $48.5million from the offering. None of the expenses were paid, directly or indirectly,to directors, officers or persons owning 10% or more.

To date, we usedapproximately $34.9 million of the net proceeds of these offerings to fund theNPA and Doradus acquisitions, and the remainder of the net proceeds has beenapplied to temporary investments and the purchase of capital equipment andlicensing technology.

**ITEMS3 and 5 are not applicable and have been omitted.**

ITEM 5. OtherInformation

# **ITEM 6.  EXHIBITS**

AnExhibit Index has been attached as part of this Quarterly Report onForm 10-Q and is incorporated herein by reference.

49

----

**SIGNATURES**

Pursuant to the requirements of the Securities ExchangeAct of 1934 the Company has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 
|                   | **IKANOS  COMMUNICAITONS, INC.**             |     |
|-------------------|----------------------------------------------|----------|
|              |                                         |     |
| November 15, 2006 | /s/   DANIEL  K. ATLER        |     |
|              | Daniel K. Atler                              |     |
| * *          | *President and Chief Executive Officer*      | * * |
| * *          | *(Principal Executive Officer)*              | * * |
| * *          | * *                                     | * * |
| November 15, 2006 | /s/   CORY  J. SINDELAR       |     |
|              | Cory J. Sindelar                             |     |
| * *          | *Vice President and Chief Financial Officer* | * * |
| * *          | *(Principal Financial Officer)*              | * * |

 

50

----

**IKANOS COMMUNICATIONS, INC.**

**EXHIBITSTO FORM 10-Q QUARTERLY REPORT**

**Forthe Quarter Ended September 30, 2006**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                               |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                          |
| 10.1             |       | Amended and Restated 1999 Stock Option Plan.  Incorportated by reference to Exhibit 10.1 of the Registrant’s Quarterly  Report on Form 10-Q filed with the SEC on August 16,2006 (file No.  000-57532).                                  |
|             |       |                                                                                                                                                                                                                                          |
| 10.2 **          |       | Amendment to 2006 Sales Compensation Plan for Vice  President of Worldwide Sales. Incorporated by reference Exhibit 10.2 of the  Registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 16,  2006 (file No. 000-51532). |
|             |       |                                                                                                                                                                                                                                          |
| 10.3             |       | Form of Restricted Stock Unit Agreement.  Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report  on Form 8-K filed with the SEC on July 11, 2006 (File No. 000-51532).                                            |
|             |       |                                                                                                                                                                                                                                          |
| 10.4             |       | Form of Amended and Restated Stock Option Agreement.  Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report  on Form 8-K filed with the SEC on July 11, 2006 (File No. 000-51532).                                |
|             |       |                                                                                                                                                                                                                                          |
| 10.5             |       | French Sub-Plan for the Grant of Restricted Stock  Units. Incorporated by reference to Exhibit 10.3 of the Registrant’s Current  Report on Form 8-K filed with the SEC on July 11, 2006 (File No. 000-51532).                            |
|             |       |                                                                                                                                                                                                                                          |
| 10.5.1           |       | Form of Restricted Stock Unit Agreement for  Employees in France. Incorporated by reference to Exhibit 10.3.1 of the  Registrant’s Current Report on Form 8-K filed with the SEC on July 11, 2006  (File No. 000-51532).                 |
|             |       |                                                                                                                                                                                                                                          |
| 10.6             |       | French Sub-Plan for the Grant of Stock Options.  Incorporated by reference to Exhibit 10.4 of the Registrant’s Current Report  on Form 8-K filed with the SEC on July 11, 2006 (File No. 000-51532).                                     |
|             |       |                                                                                                                                                                                                                                          |
| 10.6.1           |       | Form of Stock Option Agreement for Employees in  France. Incorporated by reference to Exhibit 10.4.1 of the Registrant’s  Current Report on Form 8-K filed with the SEC on July 11, 2006 (File No.  000-51532).                          |
|             |       |                                                                                                                                                                                                                                          |
| 10.7             |       | India Sub-Plan. Incorporated by reference to Exhibit  10.4.2 of the Registrant’s Current Report on Form 8-K filed with the SEC on  July 11, 2006 (File No. 000-51532).                                                                   |
|             |       |                                                                                                                                                                                                                                          |
| 10.7.1           |       | Form of Restricted Stock Unit Agreement for  Employees in India. Incorporated by reference to Exhibit 10.1 of the  Registrant’s Current Report on Form 8-K filed with the SEC on July 11, 2006  (File No. 000-51532).                    |
|             |       |                                                                                                                                                                                                                                          |
| 10.7.2           |       | Form of Stock Option Agreement for Employees in  India. Incorporated by reference to Exhibit 10.1 of the Registrant’s Current  Report on Form 8-K filed with the SEC on July 11, 2006 (File No. 000-51532).                              |
|             |       |                                                                                                                                                                                                                                          |
| 31.1*            |       | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                |
|             |       |                                                                                                                                                                                                                                          |
| 31.2*            |       | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                              |

 

51

----

 
| 32.1* |   | Certification of the 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.                                                                    |
|----|--------|------------------------------------------------------------------------------------|
| ** |   | Confidential treatment has been requested as to  certain portions of this exhibit. |

 

52

----