**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

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**FORM 10-Q**

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| **x**                                            | **Quarterly report pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**  |
|--------------------------------------------------|-----------------------------------------------------------------------------------------------|
| ** **                                       | ** **                                                                                    |
| **For the  quarterly period ended July 2, 2006** |
|                                             |                                                                                          |
| OR                                               |
| ** **                                       | ** **                                                                                    |
| **o**                                            | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |

**Commission File Number: 0-51532**

**IKANOSCOMMUNICATIONS, 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.) |

**47669Fremont BoulevardFremont, California 94538**(Address of principal executive offices)

**(510)979-0400**(Registrant’s telephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”)during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days:   x   Yes   o   No

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

Large acceleratedfiler   o                 Accelerated filer   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   x   No

As of July 31,2006, there were approximately 27,296,000 shares of the registrant’s commonstock, par value $ 0.001, outstanding.

 

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**IKANOSCOMMUNICATIONS, INC.Table of Contents**
|               | ** ** | ** **                                                                                                 | ** ** | **Page No.** | ** ** |
|---------------|------------|------------------------------------------------------------------------------------------------------------|------------|--------------|------------|
| **PART  I.**  | ** ** | **FINANCIAL  INFORMATION**                                                                                 |       |         |       |   |   |
|          |       |                                                                                                       |       |         |       |   |   |
| **Item 1.**   |       | **Financial Statements (unaudited):**                                                                      |       |         |       |   |   |
|          |       |                                                                                                       |       |         |       |   |   |
|          |       | Condensed Consolidated Balance Sheets as of June 30,  2006 and December 31, 2005                           |       |         | 2          |   |   |
|          |       |                                                                                                       |       |         |       |   |   |
|          |       | Condensed Consolidated Statements of Operations for  the three and six months ended June 30, 2006 and 2005 |       |         | 3          |   |   |
|          |       |                                                                                                       |       |         |       |   |   |
|          |       | Condensed Consolidated Statements of Cash Flows for  the six months ended June 30, 2006 and 2005           |       |         | 4          |   |   |
|          |       |                                                                                                       |       |         |       |   |   |
|          |       | Notes to Condensed Consolidated Financial Statements                                                       |       |         | 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 4.**   | ** ** | **Submission of Matters to a Vote of Security Holders**                                                    |       |         | 48         |   |   |
| ** **    | ** ** | ** **                                                                                                 |       |         |       |   |   |
| **Item 6.**   | ** ** | **Exhibits**                                                                                               |       |         | 49         |   |   |
|          | ** ** | ** **                                                                                                 |       |         |       |   |   |
|          | ** ** | **Signatures**                                                                                             |       |         | 50         |   |   |
|          | ** ** | ** **                                                                                                 |       |         |       |   |   |
|          | ** ** | **Exhibit Index**                                                                                          |       |         | 51         |   |   |

 

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

**ITEM 1.****                             CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**IKANOSCOMMUNICATIONS, INC.CONDENSED CONSOLIDATED BALANCE SHEETS**(In thousands)(Unaudited)
| ** **                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **Assets**                                       |       |              |       |                  |       |
| Current assets:                                  |       |              |       |                  |       |
| Cash and cash  equivalents                       |       | $                 | 62,596     |                  | $          | 91,932 |   |
| Short-term  investments                          |       | 50,256            |       | 1,988                 |       |
| Accounts  receivable, net                        |       | 22,151            |       | 11,015                |       |
| Inventories                                      |       | 9,009             |       | 9,125                 |       |
| Prepaid expenses  and other current assets       |       | 2,254             |       | 2,235                 |       |
| Total current  assets                            |       | 146,266           |       | 116,295               |       |
| Property and equipment,  net                     |       | 15,362            |       | 8,384                 |       |
| Goodwill                                         |       | 4,741             |       | —                |       |
| Intangible assets, net                           |       | 13,496            |       | —                |       |
| Other assets                                     |       | 763               |       | 916                   |       |
| Total assets                                     |       | $                 | 180,628    |                  | $          | 125,595 |   |
| **Liabilities  and Stockholders’ Equity**   |       |              |       |                  |       |
| Current  liabilities:                            |       |              |       |                  |       |
| Accounts payable                                 |       | $                 | 9,445      |                  | $          | 8,371 |   |
| Accrued  liabilities                             |       | 13,570            |       | 11,284                |       |
| Capital lease  obligations, current portion      |       | 1,036             |       | 315                   |       |
| Notes payable,  current portion                  |       | 719               |       | 698                   |       |
| Total current  liabilities                       |       | 24,770            |       | 20,668                |       |
| Capital lease  obligations                       |       | 1,342             |       | 223                   |       |
| Notes payable                                    |       | 363               |       | 728                   |       |
| Total  liabilities                               |       | 26,475            |       | 21,619                |       |
|                                             |       |              |       |                  |       |
| Commitments and  contingencies (Note 9)          |       |              |       |                  |       |
| Stockholders’ equity:                       |       |              |       |                  |       |
| Preferred stock                                  |       | —            |       | —                |       |
| Common stock                                     |       | 27                |       | 24                    |       |
| Additional  paid-in capital                      |       | 243,980           |       | 195,398               |       |
| Warrants                                         |       | 914               |       | 914                   |       |
| Notes receivable  from stockholders              |       | (19               | )          | (19                   | )          |
| Deferred  stock-based compensation               |       | (371              | )          | (5,699                | )          |
| Accumulated  other comprehensive loss            |       | (153              | )          | (65                   | )          |
| Accumulated  deficit                             |       | (90,225           | )          | (86,577               | )          |
| Total  stockholders’ equity                 |       | 154,153           |       | 103,976               |       |
| Total liabilities and  stockholders’ equity |       | $                 | 180,628    |                  | $          | 125,595 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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**IKANOSCOMMUNICATIONS, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**(In thousands, except per share data)(Unaudited)
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                              | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues                                                            |       | $                                | 41,192     |                           | $          | 19,243 |   | $ | 77,017 |   | $ | 31,529 |   |
| Costs and  operating expenses:                                          |       |                             |       |                           |       |   |   |   |   |
| Cost of revenues(1)                                                     |       | 25,076                           |       | 8,841                          |       | 43,636 |   | 15,096 |   |
| Research and development(2)                                             |       | 13,429                           |       | 6,853                          |       | 27,099 |   | 13,423 |   |
| Selling, general and administrative(3)                                  |       | 6,131                            |       | 4,075                          |       | 11,695 |   | 7,506 |   |
| Common stock offering expenses                                          |       | —                           |       | —                         |       | 954 |   | — |   |
| Total costs and operating expenses                                      |       | 44,636                           |       | 19,769                         |       | 83,384 |   | 36,025 |   |
| Loss from  operations                                                   |       | (3,444                           | )          | (526                           | )          | (6,367 | ) | (4,496 | ) |
| Interest income,  net                                                   |       | 1,345                            |       | 90                             |       | 2,304 |   | 185 |   |
| Loss before  provision for income taxes                                 |       | (2,099                           | )          | (436                           | )          | (4,063 | ) | (4,311 | ) |
| Provision for  income taxes                                             |       | 110                              |       | —                         |       | 223 |   | — |   |
| Loss before  cumulative effect of change in accounting principle        |       | (2,209                           | )          | (436                           | )          | (4,286 | ) | (4,311 | ) |
| Cumulative  effect of change in accounting principle, net of tax        |       | —                           |       | —                         |       | 638 |   | — |   |
| Net loss                                                                |       | $                                | (2,209     | )                              | $          | (436 | ) | $ | (3,648 | ) | $ | (4,311 | ) |
|                                                                    |       |                             |       |                           |       |   |   |   |   |
| Basic and  diluted net loss per common share:                           |       |                             |       |                           |       |   |   |   |   |
| Before cumulative effect of change in accounting  principle, net of tax |       | $                                | (0.08      | )                              | $          | (0.24 | ) | $ | (0.17 | ) | $ | (2.38 | ) |
| Cumulative effect of change in accounting principle,  net of tax        |       | —                           |       | —                         |       | 0.03 |   | — |   |
| Basic and  diluted net loss per common share                            |       | $                                | (0.08      | )                              | $          | (0.24 | ) | $ | (0.14 | ) | $ | (2.38 | ) |
| Shares used in  computing basic and diluted net loss per common share   |       | 27,083                           |       | 1,847                          |       | 25,728 |   | 1,814 |   |
|                                                                    |       |                             |       |                           |       |   |   |   |   |
| Includes  stock-based compensation expense as follows:                  |       |                             |       |                           |       |   |   |   |   |
|                                                                    |       |                             |       |                           |       |   |   |   |   |
| (1)  Cost of  revenues                                             |       | $                                | 55         |                           | $          | 62 |   | $ | 99 |   | $ | 123 |   |
| (2) Research and  development                                      |       | $                                | 964        |                           | $          | 1,056 |   | $ | 1,863 |   | $ | 1,688 |   |
| (3)  Selling, general and administrative                           |       | $                                | 600        |                           | $          | 1,265 |   | $ | 1,609 |   | $ | 2,069 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

 

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**IKANOSCOMMUNICATION, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**(In thousands)(Unaudited)
| ** **                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| **Operating  activities**                                                                  |       |                                          |       |   |   |
| Net loss                                                                                   |       | $                                             | (3,648     | ) | $ | (4,311 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                          |       |   |   |
| Depreciation and amortization                                                              |       | 2,563                                         |       | 1,325 |   |
| Stock-based compensation expense                                                           |       | 3,571                                         |       | 3,880 |   |
| Amortization of intangible assets and acquired  technology                                 |       | 3,856                                         |       | — |   |
| Purchased in-process research and development                                              |       | 2,900                                         |       | — |   |
| Cumulative effect of change in accounting principle                                        |       | (638                                          | )          | — |   |
| Changes in operating assets and liabilities, net of  effect of acquisition:                |       |                                          |       |   |   |
| Accounts receivable                                                                        |       | (11,136                                       | )          | (3,933 | ) |
| Inventories                                                                                |       | 6,712                                         |       | 3,554 |   |
| Prepaid expenses and other assets                                                          |       | 134                                           |       | (419 | ) |
| Accounts payable and accrued liabilities                                                   |       | 3,080                                         |       | (2,520 | ) |
| Net cash provided (used in) by operating activities                                        |       | 7,394                                         |       | (2,424 | ) |
| ** **                                                                                 |       |                                          |       |   |   |
| **Investing  activities**                                                                  |       |                                          |       |   |   |
| Purchases of property and equipment                                                        |       | (5,741                                        | )          | (850 | ) |
| Purchases of investments                                                                   |       | (72,478                                       | )          | — |   |
| Maturities and sales of investments                                                        |       | 24,122                                        |       | — |   |
| Acquisition, net of cash acquired                                                          |       | (32,708                                       | )          | — |   |
| Net cash used in investing activities                                                      |       | (86,805                                       | )          | (850 | ) |
| ** **                                                                                 |       |                                          |       |   |   |
| **Financing  activities**                                                                  |       |                                          |       |   |   |
| Net proceeds from public offering                                                          |       | 48,562                                        |       | — |   |
| Net proceeds from issuances of common stock                                                |       | 2,391                                         |       | 20 |   |
| Repurchases of common stock                                                                |       | (1                                            | )          | (25 | ) |
| Payments of obligations under capital lease                                                |       | (533                                          | )          | (503 | ) |
| Repayment of notes receivable                                                              |       | —                                        |       | 40 |   |
| Borrowing under notes payable                                                              |       | —                                        |       | 552 |   |
| Payment of notes payable                                                                   |       | (344                                          | )          | (350 | ) |
| Net cash provided by (used in) financing activities                                        |       | 50,075                                        |       | (266 | ) |
| Effect of  foreign exchange rate changes on cash and cash equivalents                      |       | —                                        |       | (7 | ) |
| Net decrease in  cash and cash equivalents                                                 |       | (29,336                                       | )          | (3,547 | ) |
| Cash and cash  equivalents at beginning of period                                          |       | 91,932                                        |       | 25,428 |   |
| Cash and cash  equivalents at end of period                                                |       | $                                             | 62,596     |   | $ | 21,881 |   |
| ** **                                                                                 |       |                                          |       |   |   |
| **Supplemental  disclosures of non-cash investing and financing activities:**              |       |                                          |       |   |   |
| Property and equipment acquired under capital leases                                       |       | $                                             | 2,373      |   | $ | 39 |   |
| Exercise of  stock options by notes payable                                                |       | $                                             | —     |   | $ | 1 |   |

 

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

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**IKANOS COMMUNICATIONS, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

##### **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 for enhancedtriple-play services. The Company’s chipsets integrate analog, mixed-signal anddigital signal processing functions onto 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. Forpresentation purposes, the financial statements and notes have been presentedas ending on the 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 network processing and ADSL assetsfrom Analog Devices, Inc. (“ADI”), which we refer to as the NPA acquisition,for approximately $32.7 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 $48.6 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 $2.5 million in cash and the assumption of approximately177,000 options to purchase Ikanos 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 been condensed,or omitted, pursuant to the rules and regulations of the Securities andExchange 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 six months ended June 30, 2006 and 2005 areunaudited. The interim results presented are not necessarily indicative ofresults for any subsequent interim period, the year ending December 31,2006, or any future period.

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

 As discussedlater in Note 3. Share-Based Payment Compensation Expense, the Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 123(revised2004), *Share-Based Payment*(“SFAS 123 (R)”), on January 1,2006 using the modified prospective transition method. Accordingly, the Company’sloss from operations for the three and six months ended June 30, 2006 includesapproximately $1.6 million and $3.6 million in stock-based employeecompensation expense for stock options and its Employee Stock Purchase Plan (“ESPP”),respectively. Because the Company elected to use the modified prospectivetransition method, results for prior periods have not been restated.

These unaudited,condensed consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements and notes thereto forthe year ended December 31, 2005 included in the Company’s Annual Reporton Form 10-K filed with the SEC. The condensed consolidated balance sheetas of December 31, 2005 has been derived from the audited consolidated financialstatements of the Company.

***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 revenues and expenses during the periods presented. To the extentthere are material differences between these estimates and actual results, Ikanos’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 No. 142,*Goodwill and Other Intangible Assets*(“SFAS 142”), under which goodwill isno longer 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 No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets,* the Company evaluateslong-lived assets, other than goodwill, for impairment whenever events orchanges in circumstances indicate that the carrying value of an asset may notbe recoverable 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 June 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 investments are classified as available-for-sale.The Company does not hold or issue financial instruments for trading purposes.

Creditrisk with respect to accounts receivable is concentrated due to the number oflarge orders recorded in any particular reporting period. Three customersrepresented 46%, 18% and 14% of accounts receivable at June 30, 2006. Threecustomers represented 33%, 30% and 30% of accounts receivable at December 31,2005. The Company reviews credit evaluations of its customers but does notrequire collateral or other security to support customer

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receivables. Four customers accountedfor 19%, 18%, 26%, and 25% of net revenues for the three months ended June 30,2006 and 22%, 21%, 29% and 18%, of net revenues for the six months ended June30, 2006. Three customers accounted for 45%, 34%, and 19% for the three monthsended June 30, 2005, and 44%, 25%, and 26%, respectively of net revenues forthe six months ended June 30, 2005.

***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.

##### ***NetLoss Per Share***

Underthe provisions of SFAS No. 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 per share if their inclusion is antidilutive.

Thecalculation of basic and diluted net loss per common share is as follows (inthousands, except per share amounts):
| ** **                                        | ** ** | **Three Months Ended**June 30, | ** ** | **Six Months Ended**June 30, | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                      | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net loss                                          |       | $(2,209                                       | )          | $(436                                       | )          | $(3,648 | ) | $(4,311 | ) |
| Weighted average  shares outstanding              |       | 27,113                                        |       | 1,999                                       |       | 25,758 |   | 1,966 |   |
| Weighted average  unvested shares of common stock |       |                                          |       |                                        |       |   |   |   |   |
| subject to repurchase                             |       | (30                                           | )          | (152                                        | )          | (30 | ) | (152 | ) |
| Shares used in  computing basic net loss per      |       |                                          |       |                                        |       |   |   |   |   |
| common share                                      |       | 27,083                                        |       | 1,847                                       |       | 25,728 |   | 1,814 |   |
| Basic and diluted net  loss per common share      |       | $(0.08                                        | )          | $(0.24                                      | )          | $(0.14 | ) | $(2.38 | ) |

 

The following potential common shares have been excluded from thecalculation of diluted net loss per share due to the Company’s net loss and theeffect would have been anti-dilutive (in thousands):

** **
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                              | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                              | ** ** | **2006**               | ** ** | **2005**             | ** ** | **2006** | ** ** | **2005** | ** ** |
| Anti-dilutive securities:                               |       |                   |       |                 |       |   |   |   |   |
| Weighted-average redeemable convertible preferred stock |       | —                 |       | 15,312               |       | — |   | 15,312 |   |
| Warrants to purchase common stock                       |       | 6                      |       | 45                   |       | 6 |   | 45 |   |
| Weighted-average restricted stock units                 |       | 7                      |       | —               |       | 9 |   | — |   |
| Options to purchase common stock                        |       | 3,256                  |       | 3,136                |       | 3,256 |   | 3,136 |   |
|                                                    |       | 3,269                  |       | 18,493               |       | 3,271 |   | 18,493 |   |

 

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**Note2.   BusinessCombinations**

OnFebruary 17, 2006, the Company completed the NPA acquisition for $32.7million 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 wereincluded in the Company’s Condensed Consolidated Statement of Operations fromthe date of the acquisition.

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 the completionof the NPA acquisition. The allocation of the purchase price for thisacquisition, as of the date of the acquisition, is as follows (in thousands):

| Tangible assets acquired                       |   | $      | 7,475  |   |
|------------------------------------------------|--------|--------|--------|--------|
| Liability for  severance payment assumed       |   | (308   | )      |
| Goodwill                                       |   | 4,741  |   |
| 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                          |   | $      | 32,708 |   |

 

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 No. 141*, Business Combinations,*Financial Accounting Standards BoardInterpretations (“FIN”) No. 4, *Applicabilityof FASB Statement No. 2 to Business Combinations Accounted for by thePurchase Method*(“FIN 4”),and other relevant guidance. The Company believes that these identifiedintangible assets have no residual value. The purchase price allocated topurchased in-process research and development (“IPR&D”) and to identifiablepurchased intangible assets was determined by a third-party appraisal.

***Amortizable Acquired Intangible Assets***

*ExistingTechnology:* The existing technology comprises products thathave reached technological feasibility and includes the Eagle and Fusivproducts. The Company valued the existing technology utilizing a discountedcash flow (“DCF”) model, which uses forecasts of future revenues and expensesrelated to the intangible asset. The Company utilized a discount rate of 20%for existing technology and is amortizing on a straight-line basis theintangible assets over their estimated 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, whichrepresents the benefit of owning this intangible asset rather than payingroyalties for its use. The Company utilized a royalty rate of 2% and a discountrate of 26% for the patents/core technology and is amortizing on astraight-line basis this intangible asset over its estimated useful life offour years.

*Trademark:*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 on a straight-linebasis this intangible asset over its estimated useful life of three to fiveyears.

8

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

*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 Company expects these orders to bedelivered and billed within three to six months. The order backlog will beamortized in proportion to the value of the backlog shipped and was fullyamortized as of the end of the second quarter.

*Non-competitionAgreement:* The Company valued the non-competition agreementwith ADI by estimating the effect on our future net revenues and cash flows ifa non-compete were not in place, thereby allowing ADI to re-enter the marketand compete with us. The Company utilized a discount rate of 22% for thenon-compete agreement and is amortizing the intangible asset on a straight-linebasis over the three -year term of the agreement.

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

*FavorableSupply Agreement:* The favorable supply arrangement representsa $5.0 million credit for future purchases from a supplier and will beamortized in proportion to the value of related purchases from that supplier, andis expected to be utilized over 9 to 12 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 which was the quarter of the acquisition,in accordance with FIN 4. Projects that qualify as IPR&D representthose that have not yet reached technological feasibility and which have noalternative future use. Technological feasibility is established when anenterprise has completed all planning, designing, coding, and testingactivities that are necessary to establish that a product can be produced tomeet its design specifications including functions, features, and technicalperformance requirements. The value of IPR&D was determined by consideringthe importance of each project to our overall development plan, estimatingcosts to develop the purchased IPR&D into commercially viable products,estimating the resulting net cash flows from the projects when completed anddiscounting the net cash flows to their present value based on the percentageof completion of the IPR&D projects. The Company utilized the DCF model tovalue the IPR&D using discount rates ranging from 28% to 35%, depending onthe estimated useful life of 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$4.7 million of the goodwill recorded in connection with the NPAacquisition will be deductible for income tax purposes.

***Pro formaFinancial 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 

9

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businesses constituted asingle entity during such periods, and is not necessarily indicative of resultswhich may be obtained in the future. (in thousands, except per shareamounts):

|                                                                 | ** ** | **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                                 |       |

 

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

***Changes in Accounting Principle***

OnJanuary 1, 2006, the Company adopted the SFAS 123(R), which is a revisionof SFAS No. 123, *Accounting forStock-Based Compensation* (“SFAS 123”), SFAS 123 (R) supersedesAPB No. 25, *Accounting for Stock Issuedto Employees(“APB 25”),* and amends SFAS No. 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 acceleratedamortization method. The fair value of all share-based payment transactionsgranted subsequent to January 1, 2006 will be based on the grant date fairvalue estimated in accordance with the provisions of SFAS 123(R). The Companyrecognizes compensation expense for post adoption share-based awards on astraight-line basis over the requisite 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 were 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 of June30, 2006 represented the unamortized stock-based compensation which was derivedfrom awards granted prior to the Company’s initial Form S-1 registrationstatement filed with SEC on June 25, 2004. These awards were valued under theminimum value method and will be amortized over the remaining vesting period.

Theadoption of SFAS 123(R) also resulted in a cumulative benefit from accountingchange of $638,000 net of tax, which reflects the net cumulative impact ofestimating future forfeitures in the determination of period expense, ratherthan recording 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.The fair value of the Company’s stock-based awards was estimated assuming noexpected dividends with the following assumptions:

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** **
| ** **                          | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **June 30,**            | ** ** | **June 30,**          | ** ** |
| ** **                          | ** ** | **2006**                | ** ** | **2005**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Option Grants:                      |       |                    |       |                  |       |   |   |   |   |
| Expected volatility                 |       | 64                      | %          | 90                    | %          | 63 | % | 90 | % |
| Expected dividends                  |       | —                  |       | —                |       | — |   | — |   |
| Expected term of options (in years) |       | 4.8                     |       | 4.0                   |       | 4.8 |   | 4.0 |   |
| Risk-free interest rate             |       | 5.0                     | %          | 3.7                   | %          | 5.0 | % | 3.9 | % |
| 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 Company’s peer group in theindustry in which it does business and the Company’s historical 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. 107, Share-Based Payment.

*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 No. 123 for periods prior to fiscal 2006, the Companyaccounted for forfeitures as they occurred.

***Stock Option Plan Activity***

A summary ofoption activity through June 30, 2006 is presented below (in thousands, exceptper share amounts):

 
| ** **                      | ** ** | ** ** | ** ** | **Weighted-  Average**  Exercise | ** ** | **Weighted-  Average  Remaining**  Contractual- | ** ** | **Aggregate**  Intrinsic | ** ** |
|---------------------------------|------------|------------|------------|----------------------------------|------------|-------------------------------------------------|------------|--------------------------|------------|
| **Options**                     | ** ** | ** ** | ** ** | **Shares**                       | ** ** | **Price**                                       | ** ** | **Term**                 | ** ** | **Value** | ** ** |
| Outstanding at  January 1, 2006 |       | 3,945      |       | $                                | 3.92       |                                            |       |                     |       |   |
| Granted                         |       | 469        |       | 17.64                            |       |                                            |       |                     |       |
| Exercised                       |       | (881       | )          | 1.78                             |       |                                            |       |                     |       |
| Forfeited or expired            |       | (277       | )          | 6.37                             |       |                                            |       |                     |       |
| Outstanding at  June 30, 2006   |       | 3,256      |       | 6.28                             |       | 7.99                                            |       | $                        | 30,476     |   |
| Exercisable at June 30,  2006   |       | 1,299      |       | $                                | 2.46       |                                            | 7.17       |                     | $          | 16,535 |   |
|                                 |            |            |            |                                  |            |                                                 |            |                          |            |  |  |  |  |

 

Theweighted-average grant date fair value of options granted during the quarterended June 30, 2006 was $9.95 per option. The total intrinsic value ofoptions exercised during the quarter ended June 30, 2006 was $4.4 million.The weighted-average grant date fair value of ESPP granted during the quarterended June 30, 2006 was $7.30 per share. Upon the exercise of options andESPP, the Company issues new common stock from its authorized shares. As ofJune 30, 

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2006, there was $9.6 million in compensation costrelated to nonvested options not yet recognized and is expected to berecognized over a weighted-average of 2.0 years.

The followingtable summarizes information about stock options as of June 30, 2006 (number ofoptions 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** | ** ** |
| $0.48 to $1.08      |       | 1,119                    |       | 6.97                      |       | $ | 0.56 |   | 833 |   | $ | 0.59 |   |
| $3.60 to $10.20     |       | 1,585                    |       | 8.29                      |       | $ | 6.54 |   | 464 |   | $ | 5.78 |   |
| $12.00 to $22.00    |       | 552                      |       | 9.19                      |       | $ | 17.09 |   | 2 |   | $ | 12.00 |   |
|                |       | 3,256                    |       | 7.99                      |       | $ | 6.27 |   | 1,299 |   | $ | 2.46 |   |

 

A summary of theactivity of the Company’s nonvested shares through June 30, 2006 is presentedbelow (in thousands except per share amounts):

| Nonvested Shares         | ** ** | ** ** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|----------------------------------------------------|------------|
| Nonvested at  January 1, 2006 |       | 12         |       | $          | 14.31      |                                               |
| Granted                       |       | 178        |       | $          | 20.63      |                                               |
| Vested                        |       | (6         | )          | $          | 14.31      |                                               |
| Forfeited                     |       | (6         | )          | $          | 20.63      |                                               |
| Nonvested at June 30,  2006   |       | 178        |       | $          | 20.42      |                                               |

 

As of June 30,2006, there was $3.5 million of total unrecognized compensation cost related tononvested share-based compensation arrangements. That cost is expected to berecognized on a declining basis over the next 4 years. The total fair value ofshares vested during the six months ended June 30, 2006 was $0.2 million.

***Pro Forma Disclosure for Threeand Six Months Ended June 30, 2005***

Pro forma information regarding net loss and net loss per share wasrequired by SFAS No. 148, Accounting for Stock-Based Compensation — Transitionand Disclosure. The fair value of the Company’s stock-based awards toemployees was estimated using the multiple option approach of the Black-Scholesoption-pricing model. The related expense was amortized using an acceleratedmethod over the vesting terms of the option. Had compensation cost for theCompany’s stock-based compensation plans and the ESPP been determined using thefair value at the grant dates for awards under those plans calculated using theBlack-Scholes method of SFAS 123, the Company’s net loss and basic anddiluted net loss per share would have been changed to the pro forma amounts forthe three months and six months ended June 30, 2005 indicated below (inthousands, except per share amounts):
| ** **                                             | ** ** | **Three Months  Ended**  June 30, | ** ** | **Six Months  Ended**  June 30, | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                    | ** ** | **2005**                                  | ** ** |
| Net loss, as  reported                                 |       | $                                           | (436       | )                                         | $          | (4,311 | ) |
| Stock-based employee compensation included             |       |                                        |       |                                      |       |
| in net loss as reported, net of related tax effects  * |       | 2,213                                       |       | 3,619                                     |       |
| Stock-based employee compensation using the            |       |                                        |       |                                      |       |
| fair value method, net of related tax effects *        |       | (1,617                                      | )          | (2,941                                    | )          |
| Net income  (loss), pro forma                          |       | $                                           | 160        |                                      | $          | (3,633 | ) |
| Basic and  diluted net loss per common share:          |       |                                        |       |                                      |       |
| As reported                                            |       | $                                           | (0.24      | )                                         | $          | (2.38 | ) |
| Pro forma                                              |       | $                                           | 0.09       |                                      | $          | (2.00 | ) |

----

*                    The tax effects on stock-based compensation havebeen fully reserved by way of a valuation allowance.

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***Summary of Plans***

*Amended andRestated 2004 Equity Incentive Plan*

OnSeptember 21, 2005, the Company adopted the 2004 Equity Incentive Plan,(the “2004 Plan”), upon the closing of its initial public offering. The 2004Plan allows for the issuance of incentive stock options nonstatutory stockoptions, restricted stock, restricted stock units, stock appreciation rights,deferred stock units, performance units and performance shares to the Company’semployees, directors and consultants. Options generally vest at a rate of 25%on the first anniversary of the grant date and 1/48 per month thereafter.Generally, options terminate ten years after the date of grant. The term of anincentive stock option may not exceed ten years, except that with respectto any participant who owns 10% of the voting power of all classes of ouroutstanding stock, the term must not exceed five years and the exercise pricemust equal at least 110% of the fair market value on the grant date**.**The number of shares reserved under the 2004 Planautomatically increases  annually on the first day of the Compay’s fiscalyear beginning in 2006 by an amount equal to the lesser of; 4.4% of theoutstanding shares on such date or 3.3 million shares or an amount determinedby the Board of Directors.

The 2004 Plan providesfor the automatic grant of non-statutory stock options to our non-employeedirectors. Each non-employee director appointed to the board will receive aninitial option to purchase 30,000 shares upon such appointment except for thosedirectors who become non-employee directors by ceasing to be employeedirectors. Initial option grants shall vest as to 25% of the shares on thefirst anniversary of the date of grant and as to 1/48th of the shares eachmonth thereafter, subject to the director continuing to serve as a director oneach vesting date. In addition, non-employee directors who have been directorsfor at least six months will receive a subsequent option to purchase 12,000shares on the date of each annual meeting of our stockholders. These subsequentoption grants shall vest as to 1/12th of the shares each month following thedate of grant, subject to the director continuing to serve as a director oneach vesting date. All options granted under these automatic grant provisionshave a term of ten years and an exercise price equal to the fair market valueof our common stock on the date of grant.******As of June 30, 2006, the Company hadapproximately 772,000 authorized options and awards available for grant andapproximately 3,434,000 options and awards outstanding under the 2004 IncentivePlan.

*1999 Stock Option Plan*

OnSeptember 24, 1999, the Company adopted the 1999 Stock Plan (the “1999Plan”) under which 5,716,833 shares of the Company’s common stock were reservedfor issuance to employees, directors and consultants. Options granted under the1999 Plan may be incentive stock options or non statutory stock options.Incentive stock options may only be granted to employees. Options topurchase shares of the Company’s common stock are granted at a price equal tothe fair market value of the stock at the date of grant, as determined by theboard of directors. Options generally vest at a rate of 25% on the firstanniversary of the grant date and 1/48 per month thereafter. Generally, optionsterminate ten years after the date of grant. Incentive stock options granted toemployees who own more than ten percent of the total combined voting power ofall classes of stock of the Company terminate five years from the date of thegrant. Should an employee subsequently leave, the Company has the right torepurchase the shares that had not vested at the departure date. Uponcompletion of the Company’s initial public offering in September 2005, the1999 Plan was terminated and no shares are available for future issuance underthe 1999 Plan.

*2004 Employee Stock Purchase Plan*

On September 21,2005, the Company adopted the ESPP, upon the closing of its initial publicoffering. A total of 1,000,000 shares of the Company’s common stock will bemade available for sale under the ESPP. All of the Company’s employees areeligible to participate if they are customarily employed by the Company or any 

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participating subsidiary for at least 20 hoursper week and more than five months in any calendar year. The Company’s  ESPP is intended to qualify underSection 423 of the Internal Revenue Code and provides for consecutive,overlapping 24-month offering periods. Each offering period includes four6-month purchase periods. The offering periods generally start on the first tradingday on or after May 1 and November 1 of each year, except that thefirst offering period commenced on the first trading day on after the Company’sinitial offering and will end on the earlier of (1) the first trading dayon or after November 1, 2006 and (2) twenty-seven months after theoffering period commences, and the second offering period will commence on thefirst trading day on or after May 1, 2005. As of June 30, 2006, theCompany had approximately 919,000 authorized shares available for grant underthe ESPP. The number of shares reserved under the ESPP automatically increaseson the first day of the Company’s fiscal year beginning in 2005 through 2014 byan amount equal to the lesser of; 2.5% of the outstanding common shares on suchdate or 1.5 million shares or by an amount determined by the Board ofDirectors.

***Disclosures Pertaining to All Stock-Based Award Plans***

Cash received from option exercises and ESPP contributions under allshare-based payment arrangements for the six months ended 2006 was $2.4million. The Company has been in full valuation allowance since inception andhas not been recognizing excess tax benefits from share-based awards. TheCompany is unlikely to recognize excess tax benefits from the stock-basedpayment for the foreseeable future. The Company does not anticipate recognizingexcess tax benefits from stock-based payments for the foreseeable future, andthe Company believes it would be reasonable to exclude such benefits fromdeferred tax assets and net loss per common share calculations. Accordingly,the Company did not realize any tax benefits from tax deductions related toshare-based payment awards during the three and six months ended June 30, 2006and 2005.

**Note 4.   ComprehensiveLoss**

Othercomprehensive loss refers to losses that, under GAAP, are recorded as anelement of stockholders’ equity and are excluded from net loss. Comprehensiveloss consisted of the following items (in thousands):

|                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                              | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net loss, as  reported                  |       | $                                | (2,209     | )                              | $          | (436 | ) | $ | (3,648 | ) | $ | (4,311 | ) |
| Other comprehensive  loss:              |       |                             |       |                           |       |   |   |   |   |
| Unrealized loss on investments          |       | (36                              | )          | —                         |       | (88 | ) | — |   |
| Foreign currency translation adjustment |       | —                           |       | (4                             | )          | — |   | (25 | ) |
| Comprehensive loss                      |       | $                                | (2,245     | )                              | $          | (440 | ) | $ | (3,736 | ) | $ | (4,336 | ) |

 

Accumulated other comprehensive loss as of June 30, 2006 and December 31, 2005 consistedof the following (in thousands):

|                                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Unrealized gain  (loss) on investments              |       | $                 | (73        | )                     | $          | 15 |   |
| Cumulative  foreign currency translation adjustment |       | (80               | )          | (80                   | )          |
|                                                |       | $                 | (153       | )                     | $          | (65 | ) |

 

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** **

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

The following is asummary of the Company’s short-term investments (in thousands):

|                                                    | ** ** | **June 30, 2006** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                         | ** ** | ** **                  | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                         | ** ** | ** **                  | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                         | ** ** | **Cost**                    | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| U.S. Treasury  and other U.S.  government agencies |       | $                           | 11,992     |   | $ | — |   | $ | (73 | ) | $ | 11,919 |   |
| Auction rate  securities                           |       | 38,337                      |       | — |   | — |   | 38,337 |   |
| Total short-term  investments                      |       | $                           | 50,329     |   | $ | — |   | $ | (73 | ) | $ | 50,256 |   |

** **

|                                                   | ** ** | **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 ofaccumulated other comprehensive loss in stockholders’ equity, net of tax.Realized gains and losses and permanent declines in value, if any, onavailable-for-sale securities are reported in other income or expense as incurred.Estimated fair values were determined for each individual security in theinvestment portfolio. The declines in value of these investments are primarilyrelated to changes in interest rates and are considered to be temporary innature.

A significant portionof the Company’s available-for-sale portfolio is composed of auction ratesecurities. 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):

|                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Finished goods                     |       | $                 | 4,214      |                  | $          | 1,955 |   |
| Work-in-process                    |       | 4,246             |       | 4,762                 |       |
| Purchased parts  and raw materials |       | 549               |       | 2,408                 |       |
|                               |       | $                 | 9,009      |                  | $          | 9,125 |   |

 

**Note 7. Goodwilland Purchased Intangible Assets**

SFAS No. 142requires purchased intangible assets other than goodwill to be amortized overtheir expected 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.

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The carrying amount of intangible assets as of June 30, 2006 is asfollows (in thousands):

|                                   | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **Weighted**         | ** ** |
|-----------------------------------|------------|-------------------------|------------|------------------|------------|------------|------------|----------------------|------------|
| ** **                        | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **average**          | ** ** |
| ** **                        | ** ** | **Gross Carrying** | ** ** | **Accumulated**  | ** ** | **Net**    | ** ** | **useful life** | ** ** |
| ** **                        | ** ** | **Amount**              | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **(Years)**          | ** ** |
| Existing  technology              |       | $                       | 4,600      |             | $          | (459       | )          | $                    | 4,141      |   | 3 |   |
| Patents/core  technology          |       | 2,000                   |       | (188             | )          | 1,812      |       | 4                    |       |
| Trademarks                        |       | 1,000                   |       | (80              | )          | 920        |       | 3                    |       |
| Customer  relationships           |       | 3,000                   |       | (225             | )          | 2,775      |       | 5                    |       |
| Order backlog                     |       | 1,200                   |       | (1,200           | )          | —     |       | 0.5                  |       |
| Non-competition  agreement        |       | 100                     |       | (13              | )          | 87         |       | 1                    |       |
| Transition  services              |       | 1,000                   |       | (485             | )          | 515        |       | 1                    |       |
| Favorable supply  arrangement     |       | 5,000                   |       | (1,754           | )          | 3,246      |       | 1                    |       |
| Total acquired  intangible assets |       | $                       | 17,900     |             | $          | (4,404     | )          | $                    | 13,496     |   |   |   |

 

The amortizationof technology is charged to cost of revenues; the favorable supply arrangementis capitalized on to inventory at the time of purchase and is charged to costof revenues 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 ofrevenues, research and development and/or selling, general and administrativebased on the actual services performed.

For the six monthsended June 30, 2006, the Company amortized intangibles of $3.9 million to; costof revenues $1.8 million, research and development $0.5 million, and selling,general and administrative $1.6 million. The remaining amortization of $0.5million pertaining to the favorable supply agreement was capitalized asinventory and will be charged to cost of revenues as the inventory is consumedor sold.

For the three andsix months ended June 30, 2006, the amortization of intangible assets was $3.4million and $4.4 million, respectively. The estimated future amortization ofpurchased intangible assets as of June 30, 2006 is as follows (in thousands):

| Remaining 2006 |   | $     | 5,048  |   |
|----------------|--------|-------|--------|--------|
| 2007           |   | 2,572 |   |
| 2008           |   | 2,572 |   |
| 2009           |   | 2,251 |   |
| 2010           |   | 957   |   |
| 2011           |   | 96    |   |
|           |   | $     | 13,496 |   |

 

The changes in the carrying amount of goodwill for the six months endedJune 30, 2006 is as follows (in thousands):
| ** **                                  | ** ** | **June 30,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **2006**          | ** ** |
| Beginning  balance, as of December 31, 2005 |       | $                 | —     |   |
| Goodwill  recorded in acquisition           |       | 4,741             |       |
| Ending balance, as of  June 30, 2006        |       | $                 | 4,741      |   |

 

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** **

**Note 8. AccruedLiabilities and Warranty**

Accruedliabilities consisted of the following (in thousands):

|                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Warranty accrual                           |       | $                 | 2,006      |                  | $          | 2,189 |   |
| Accrued rebates                            |       | 2,798             |       | 2,909                 |       |
| Accrued  compensation and related benefits |       | 3,147             |       | 2,919                 |       |
| Accrued  accounting and legal              |       | 835               |       | 813                   |       |
| Other accrued  liabilities                 |       | 4,784             |       | 2,454                 |       |
|                                       |       | $                 | 13,570     |                  | $          | 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 June 30, 2006 and 2005 (in thousands):

|                                           | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **June 30,**              | ** ** |
| ** **                                | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Balance,  beginning of period             |       | $                              | 2,189      |   | $ | 1,084 |   |
| Accrual for  warranties during the period |       | 312                            |       | 638 |   |
| Settlements made  during the period       |       | (495                           | )          | (86 | ) |
| Balance, end of period                    |       | $                              | 2,006      |   | $ | 1,636 |   |

 

**Note 9. Commitmentsand Contingencies**

***   Lease Obligations***

TheCompany leases office facilities and equipment under non-cancelable operatingand capital leases with various expiration dates through 2011. Rent expense forthe years ended December 31, 2005 and 2004 was $1,025,000 and $605,000,respectively. The terms of the facility lease provide for rental payments on agraduated scale. The Company recognizes rent expense on a straight-line basisover the lease period, and has accrued for rent expense incurred but not paid.

Futureminimum lease payments as of June 30, 2006 under non-cancelable leases withoriginal terms in excess of one year are summarized as follows (in thousands):
| ** **                                              | ** ** | **Capital** | ** ** | **Operating** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-------------|------------|---------------|------------|------------|------------|
| ** **                                              | ** ** | **Leases**  | ** ** | **Leases**    | ** ** | **Total**  | ** ** |
| Remaining 2006                                          |       | $           | 609        |          | $          | 510        |       | $ | 1,119 |   |
| 2007                                                    |       | 903         |       | 988           |       | 1,891      |       |
| 2008                                                    |       | 819         |       | 1,038         |       | 1,857      |       |
| 2009                                                    |       | 187         |       | 927           |       | 1,114      |       |
| 2010                                                    |       | —      |       | 664           |       | 664        |       |
| 2011                                                    |       | —      |       | 168           |       | 168        |       |
|                                                    |       | 2,518       |       | $             | 4,295      |       | $          | 6,813 |   |
| Less: Amount  representing interest                     |       | (140        | )          |          |       |       |       |
| Present value of  minimum lease payments                |       | 2,378       |       |          |       |       |       |
| Less: Current  portion                                  |       | (1,036      | )          |          |       |       |       |
| Obligations under  capital lease, net of current potion |       | $           | 1,342      |          |       |       |       |   |

 

***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 

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products, and indemnities to various lessors inconnection with facility leases for certain claims arising from such facilityor lease. The duration of these indemnities, commitments and guarantees varies,and in certain cases, is indefinite. The majority of these indemnities,commitments and guarantees do not provide for any limitation of the maximumpotential future payments that the Company could be obligated to make. TheCompany believes its internal development processes and other policies andpractices limit its exposure related to the indemnification provisions of thevarious agreements that include indemnity provisions. In addition, the Companyrequires its employees to sign a proprietary information and inventionsagreement, which assigns the rights to its employees’ development work to theCompany. The Company has not recorded any liability for these indemnities,commitments and guarantees in the accompanying consolidated balance sheets. TheCompany does, however, accrue for losses for any known contingent liability,including those that may arise from indemnification provisions, when futurepayment is probable andthe amount of the loss can be reasonably estimated, in accordance with SFAS No.5, *Accounting for 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***

TheCompany 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 $5,000,000of working capital requirements (subject to certain limitations) and $2,000,000of equipment purchases. The working capital line of credit matures onOctober 21, 2006 and Silicon Valley Bank’s commitment to extend workingcapital loans terminates. 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.

As of June 30,2006, no balance was outstanding under the working capital facility and $1.1million was outstanding under the equipment financing facility. Interest onborrowings under the working capital line is payable monthly and is calculatedat a floating rate of interest equal to Silicon Valley Bank’s prime rate plus0.5%, while interest on the equipment financing facility is payable monthly ata fixed rate of interest equal to Silicon Valley Bank’s prime rate plus 1.0%,Interest rates on the amounts drawn under the equipment financing facilityrange 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. The consulting agreement was effective as of March 30, 2006.Pursuant to the consulting agreement, G. Venkatesh, who is both the ManagingMember of Texan Ventures, LLC and a member of the Company’s Board of Directors,will provide consulting services with respect to, among other things, generalbusiness advice relating to the operation of a public company, guidance andstrategic advice in analyzing acquisition opportunities, assisting innegotiations of acquisition agreements and providing assistance and guidance inthe integration of acquired companies. The consulting agreement will expire onDecember 31, 2006. Prior to this consulting agreement, the Company had aprior agreement with Texan Ventures, LLC entered into on November 7, 2001.

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Under the ConsultingAgreement, Texan Ventures, LLC is entitled to $3,000 per month andreimbursement for reasonable expenses. The Company paid Texan Ventures, LLC$9,000 and 18,000 in the three and six months ended June 30, 2006 forconsulting services, respectively.

**Note 12. RecentAccounting Pronouncements**

InJune 2006, the FASB issued FIN 48, *Accountingfor Uncertainty in Income taxes — an interpretation of FAS Statement No. 109*.  This Interpretation clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with FAS Statement No. 109, *Accounting for Income Taxes.* It  prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return. Italso provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.  It shall be effective for fiscal yearsbeginning after December 15, 2006.  TheCompany is assessing the impact, if any, on its consolidated results ofoperations, financial position and cash flows.

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

SFAS No. 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’schief operating decision-maker is considered to be the Chief Executive Officer.The Chief Executive Officer reviews financial information presented on aconsolidated basis, accompanied by disaggregated information about revenues 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 sales of semiconductorchipsets.

The followingtable summarizes net revenues on a percentage basis by geographic region, basedon the country in which the customer’s headquarter office is located:

|               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **    | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues: |       |                             |       |                           |       |   |   |   |   |
| Japan         |       | 37                               | %          | 78                             | %          | 43 | % | 69 | % |
| Korea         |       | 26                               | %          | 19                             | %          | 28 | % | 26 | % |
| France        |       | 26                               | %          | 2                              | %          | 19 | % | 2 | % |
| Others        |       | 11                               | %          | 1                              | %          | 10 | % | 3 | % |
|          |       | 100                              | %          | 100                            | %          | 100 | % | 100 | % |

 

The distributionof long lived assets, net as of June 30, 2006 and 2005 was as follows (inthousands):

|                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Long-lived  assets (excluding goodwill): |       |              |       |                  |       |
| United States                            |       | $                 | 9,336      |                  | $          | 4,082 |   |
| Taiwan                                   |       | 3,658             |       | 3,329                 |       |
| Other                                    |       | 2,368             |       | 973                   |       |
|                                     |       | $                 | 15,362     |                  | $          | 8,384 |   |

 

Four customers accounted for more than 10% of the Company’s totalrevenues in the three and six months ended June 30, 2006 and three customersaccounted for more than 10% of the Company’s total revenues in three and

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six months ended June 30,2005.  At June 30, 2006 and 2005, threecustomers accounted for more than 10% of the accounts receivable balance.

**Note 14.****Subsequent Event**

On July31, 2006, the Company entered into a definitive agreement to acquireDoradus Technology, Inc. (“Doradus”), a private company incorporated in SanJose providing advanced signal processing products for communications andconsumer applications, for $2.5 million in cash and the assumption ofapproximately 177,000 options to purchase Ikanos common stock and approximately178,000 shares of restricted stock. On August 1, 2006, the Companycompleted the acquisition of Doradus. The Company acquired Doradus by enteringinto an Agreement and Plan of Merger (the “Merger Agreement”) by and among theCompany and the holders of the shares of Doradus.  Management is in the process of finalizing thepurchase price allocation.

 

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**ITEM 2.**                    MANAGEMENT’SDISCUSSION AND ANALYSIS 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 revenues, servicerevenues, deferred revenues, cost of license revenues as a percentage oflicense revenues, cost of service revenues as a percentage of service revenues,and operating expenses as a percentage of total revenues; the recording ofamortization of acquired technology, share-based payment expense andstock-based compensation; provision for income taxes; the integration of our acquisitionof the network processing and ADSL assets of Analog Devices, Inc. (“ADI”); the integration of our acquisition of DoradusTechnology, Inc. (“Doradus”); deferredtaxes; international expansion; the ability of our products to meetcustomer demand; the sufficiency of our cash balances and cash flows for thenext 12 months; investment and potential investments of cash or stock toacquire or invest in complementary businesses, products, or technologies; theimpact of recent changes in accounting standards; and assumptions underlyingany of the foregoing. In some cases, forward-looking statements can beidentified by the use of terminology such as “may,” “will,” “expects,” “intends,”“plans,” “anticipates,” “estimates,” “potential,” or “continue,” or thenegative thereof, or other comparable terminology. Although we believe that theexpectations reflected in the forward-looking statements contained herein arereasonable, these expectations or any of the forward-looking statements couldprove to be incorrect, and actual results could differ materially from thoseprojected or assumed in the forward-looking statements. Our future financialcondition and results of operations, as well as any forward-looking statements,are subject to risks and uncertainties, including but not limited to thefactors set forth under Part II, Item 1A. Risk Factors. All forward-lookingstatements and reasons why results may differ included in this Quarterly Reporton Form 10-Q are made as of the date hereof, and we assume no obligation toupdate any such forward-looking statements or reasons why actual results maydiffer.

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 enablefiber-fast broadband services over carriers’ existing copper lines. We havedeveloped these semiconductors using our proprietary semiconductor designs,specific purpose digital signal processor and advanced mixed-signalsemiconductor design capabilities. In the first quarter of 2006, we acquirednetwork processing and ADSL assets from ADI, which we refer to as the NPAacquisition, and began deriving revenues relating to network processing andADSL products in the first quarter of 2006. In August 2006, we acquiredDoradus, a developer of advanced signal processing products for communicationsand consumer applications. We offer multiple product lines that are designed toaddress different segments of the fiber-fast broadband communicationssemiconductor market for both carrier networks and subscriber premiseequipment. We outsource all of our semiconductor fabrication, assembly and testfunctions, which enables us to focus on design, development, sales andmarketing of our products and reduces the level of our capital investment. Ourcustomers are original equipment manufacturers (“OEMs”) who in turn sell ourchipsets as part of their product solutions to carriers.

We wereincorporated in April 1999 and through December 31, 2001, we wereengaged principally in research and development. We began commercial shipmentof our products in the fourth quarter of 2002. Over the last three years, wehave experienced significant net revenue growth, primarily due to a rapid risein deployments of our products in Japan and Korea. Our net revenues haveincreased from $29.0 million in 2003 to $85.1 million in 2005. Ournet revenues, however, can fluctuate significantly on a quarterly basis. Forinstance, in the first quarter of 2005, our net revenues decreased$6.2 million or 33% from the fourth quarter of 2004, yet in the secondquarter of 2005, our net revenues increased $7.0 million or 57% from thefirst quarter of 2005. Quarterly fluctuations in net revenues are characteristicof our industry, as carriers purchase equipment based on expected deploymentand OEMs may occasionally manufacture equipment at rates higher thanequipment is deployed. As a result, periodically and usually withoutsignificant notice, carriers will reduce orders with OEMs for new equipment andOEMs in turn will reduce orders for our products, which will adversely impactthe quarterly demand for our products, even when deployment rates may beincreasing. We believe that our rate of growth in net revenues in the last fourquarters 

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ended June 30, 2006may be in excess of carrier deployments. The net revenue growth rates ineach of the last four fiscal quarters were 15%, 26%, 14% and 30% quarter overquarter. We do not expect similar net revenue growth rates in future periods.

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$32.7 million in cash. This acquisition enables us to enter the growingresidential gateway semiconductor market. This acquisition has diversified ourproduct offerings and allow us to sell into new markets worldwide. As a resultof the NPA acquisition, we expect to incur significant additional expensesrelated to the addition of employees and related expenses of developing andmarketing related 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 $48.6 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.

In August 2006, weacquired Doradus, a developer of advanced signal processing products forcommunications and consumer applications. This acquisition will enable us toexpand our offering of triple play products. Doradus stockholders areentitled to receive approximately $2.5 millionin cash. In addition, the restricted stock and options of certainDoradus stock and option holders were assumed by Ikanos and converted intoapproximately 178,000 shares of restricted stock and approximately 177,000 optionsto purchase shares of Ikanos common stock. As a result of the Doradusacquisition, we expect to incur additional expenses related to the addition ofemployees and related expenses of developing and marketing related products aswell as non-cash acquisition-related charges.

*Netloss.*  As of June 30, 2006, we had an accumulateddeficit of $90.2 million and a total stockholders’ equity of $154.2 million.For the three month period ended June 30, 2006 as compared to the three monthperiod ended June 30, 2005, our net loss increased primarily because cost ofrevenues as a percentage of revenue increased. This occurred even though ournet revenues increased and our research and development and selling, generaland administrative expenses decreased as a percentage of net revenues. Thethree month period ended June 30, 2006 included amortization of acquiredintangible assets and fair value adjustment of acquired inventory.

*Netrevenues.*Our net revenues are primarily derived from salesof our chipset products. Net revenues 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 net revenues is dependent uponour ability to increase unit sales volumes of existing products and tointroduce and sell new products in greater quantities. Our ability to increaseunit sales volume is dependent primarily upon our ability to increase andfulfill current customer demand and obtain new customers.

We sell ourproducts to OEMs through a combination of our direct sales force andthird-party sales representatives. Sales are generally made under short-termnon-cancelable purchase orders. We also have volume purchase agreements withcertain customers who provide us with non-binding forecasts. Although our OEMcustomers may provide us with rolling forecasts, our ability to predictfuture sales in any given period is limited and subject to change based on demandfor our OEM customers’ systems and their supply chain decisions.

Historically, asmall number of customers have accounted for a substantial portion of our netrevenues, and we expect that significant customer concentration will continuefor the foreseeable future. We expect that a small group of OEM customers, thecomposition of which has varied over time, will continue to account for asubstantial portion of our net revenues in the foreseeable future. Thefollowing OEMs accounted for more than 10% of our net revenues 

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for the periodsindicated. Sales made to these OEMs were made through the indicatedthird-party sales representatives:
| ** **                                        | ** ** | ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **OEM Customer**                             | ** ** | **Sales Representative**   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| NEC Corporation  (Magnus)                         |       | NEC Corporation (USA) |       | 19                                              | %          | 45                                            | %          | 22 | % | 44 | % |
| Sumitomo Electric Industries, Ltd. |       | Altima                          |       | 18                                              | %          | 34                                            | %          | 21 | % | 25 | % |
| Sagem                                             |       | Sagem                           |       | 25                                              | %          | n/a                                           |       | 18 | % | n/a |   |
| Dasan                                             |       | Uniquest                        |       | 9                                               | %          | 17                                            | %          | 14 | % | 21 | % |

 

Moreover, throughthe NPA acquisition, we expect to continue to sell network processing and ADSLproducts to the existing customer base for these products. The SAFRAN Group, ofwhich Sagem Communication is a subsidiary, represented 73% of net sales for theacquired 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 69% and 98% for the three months endedJune 30, 2006 and 2005, respectively. We anticipate that a majority of ournet revenues will continue to be represented by sales to customers outside theUnited States.

**CriticalAccounting 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 for,inventories, income taxes, accounting for impairment of goodwill, acquisitions, and stock-based compensationexpense have the greatest potential impact on our condensed consolidatedfinancial statements, so we consider these to be our critical accountingpolicies. We discuss below the critical accounting estimates associated withthese policies. Historically, our assumptions, judgments, and estimatesrelative to our critical accounting policies have not differed materially fromactual 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 June 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 of ADI for impairment in accordance with SFAS 142, *Goodwill and Other Intangible Assets*(“SFAS 142”), whichrequires that goodwill be tested for impairment at the “reporting unit level” andmore frequently upon the occurrence of certain events, as defined by SFAS 142.If such 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 are required toallocate the purchase price of acquired companies to the tangible and intangibleassets acquired, liabilities assumed, as well as purchased in-process researchand development (“IPR&D”) based on their estimated fair values. We engageindependent third-party appraisal firms to assist us in determining the fairvalues of assets acquired and liabilities assumed. This valuation requiresmanagement to make significant estimates and assumptions, especially withrespect to long-lived and intangible assets.

Criticalestimates in valuing certain of the intangible assets include but are notlimited to future expected cash flows from customer contracts, customer lists,distribution agreements, and acquired developed technologies and 

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patents; expected coststo develop the IPR&D into commercially viable products and estimating cashflows from the projects when completed; the acquired company’s brand awarenessand market position, as well as assumptions about the period of time the brandwill continue to be used in the combined company’s product portfolio; anddiscount rates. Management’s estimates of fair value are based upon assumptionsbelieved to be reasonable but which are inherently uncertain and unpredictable.Assumptions may be incomplete or inaccurate, and unanticipated events andcircumstances may occur.

***Stock-Based Compensation Expense***

We account forshare-based compensation related to share-based transactions in accordance withthe provisions of SFAS No. 123(revised 2004), *Share-BasedPayment* (“SFAS 123 (R)”). Under the fair value recognitionprovisions of SFAS 123(R), share-based payment expense is estimated at thegrant date based on the fair value of the award and is recognized as expenseratably 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 and market-basedimplied volatilities of our stock price. To the extent volatility of our stockprice increases in the future, our estimates of the fair value of optionsgranted in the future could increase, thereby increasing share-based paymentexpense in future periods. In addition, we apply an expected forfeiture ratewhen amortizing share-based payment expense. Our estimate of the forfeiturerate was based primarily upon historical experience of employee turnover. Tothe extent we revise this estimate in the future, our share-based paymentexpense could be materially impacted in the quarter of revision, as well as infollowing quarters. Our expected term of options granted was derived from thehistorical option exercises, post-vesting cancellations, and estimatesconcerning future exercises/cancellations of vested/unvested options thatremain outstanding. In the future, as empirical evidence regarding these inputestimates are able to provide more directionally predictive results, we maychange or refine our approach of deriving these input estimates. These changescould impact our fair value of options granted in the future.

**RecentAccounting Pronouncements**

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

**Results ofOperations**

Thefollowing table presents certain financial data for the three and six monthsended June 30, 2006 and 2005 as a percentage of total net revenues:
| ** **                                                       | ** ** | **Three Months**        | ** ** | **Six Months**          | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **Ended June 30,** | ** ** | **Ended June 30,** | ** ** |
| ** **                                                       | ** ** | **2006**                     | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues                                                     |       | 100                          | %          | 100                          | %          | 100 | % | 100 | % |
| Costs and  operating expenses:                                   |       |                         |       |                         |       |   |   |   |   |
| Cost of revenues                                                 |       | 60                           |       | 46                           |       | 57 |   | 48 |   |
| Research and development                                         |       | 33                           |       | 36                           |       | 35 |   | 43 |   |
| Selling, general and marketing                                   |       | 15                           |       | 21                           |       | 15 |   | 24 |   |
| Common stock offering expenses                                   |       | —                       |       | —                       |       | 1 |   | — |   |
| Total costs and operating expenses                               |       | 108                          |       | 103                          |       | 108 |   | 115 |   |
| Loss from operations                                             |       | (8                           | )          | (3                           | )          | (8 | ) | (15 | ) |
| Interest income,  net                                            |       | 3                            |       | 1                            |       | 2 |   | 1 |   |
| Loss before provision for income taxes                           |       | (5                           | )          | (2                           | )          | (6 | ) | (14 | ) |
| Provision for  income taxes                                      |       | —                       |       | —                       |       | — |   | — |   |
| Loss before cumulative effect of change in  accounting principle |       | (5                           | )          | (2                           | )          | (6 | ) | (14 | ) |
| Cumulative  effect of change in accounting principle, net of tax |       | —                       |       | —                       |       | 1 |   | — |   |
| Net loss                                                         |       | (5                           | )%         | (2                           | )%         | (5 | )% | (14 | )% |

# * *

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# * *

***Net Revenues***

The following sets forth, for the periods indicated,our net revenues (in thousands, except percentages):
| ** **   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Net Revenues |       | $                                | 41,192     |                           | $          | 19,243 |   | 114 | % | $ | 77,017 |   | $ | 31,529 |   | 144 | % |
|              |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Netrevenues increased to $41.2 million and $77.0 million for the three and sixmonths ended June 30, 2006, respectively, as compared to $19.2 million and$31.5 million for the three and six months ended June 30, 2005, respectively.The $22.0 million or 114% increase for the three months ended June 30, 2006 andthe $45.5 million or 144% increase for the six months ended June 30, 2006 ascompared to the same periods in 2005 were primarily due to increased portshipments of broadband chipsets offset by decreases in average selling pricesper port of such chipsets, and revenue from the sales of products from the NPAacquisition, which was completed on February 17, 2006.  Net revenues for the three months endedJune 30, 2006 from the acquired ADI business were approximately 32% oftotal net revenues of which 24% is related to network processing and associatedADSL chipsets and the remainder is related to ADSL broadband only chipsets.

***Cost of Revenues***

The following sets forth, for the periods indicated,our cost of revenues (in thousands, except percentages):
| ** **       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **       | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Cost of revenues |       | $                                | 25,076     |                           | $          | 8,841 |   | 184 | % | $ | 43,636 |   | $ | 15,096 |   | 189 | % |
|                  |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our cost ofrevenues consists primarily of silicon wafers purchased from third-partyfoundries.  In addition, cost of revenuesincludes third-party costs associated with assembling, testing, and shipping ofour semiconductors and includes accruals for estimated warranty obligations andwrite-downs of excess, obsolete inventories, stock-based compensation expensesand amortization of acquisition-related intangibles. Cost of revenues increasedto $25.1 million for the three months ended June 30, 2006 as compared to $8.8million for the three months ended June 30, 2005, representing 60% and 46% ofnet revenues for those periods, respectively. Cost of revenues increased to$43.6 million for the six months ended June 30, 2006 as compared to $15.1million for the six months ended June 30, 2005, representing 57% and 48% of netrevenues for those periods, respectively. The $16.2 million or 184%increase and $28.5 million or 189% increase for the three and six months endedJune 30, 2006, respectively, compared to the same periods in 2005 wereprimarily due to higher volumes of products shipped including a full quarter ofcosts of products sold related to the NPA acquisition. Gross margin was 39% forthe three months ended June 30, 2006 as compared to 54% for the threemonths ended June 30, 2005 and 43% for the six months ended June 30, 2006 ascompared to 52% for the six months ended June 30, 2005. The decreases in grossmargin percentage are primarily from a product mix change as we began selling productsfrom the NPA acquisition in February 2006, as well as price decreases in excessof cost decreases on our broadband chipsets. In addition, in the three monthsended June 30, 2006, in connection with the NPA acquisition, we charged to costof revenues $1.7 million related to the amortization of intangibles, including$1.2 million related to the favorable supply agreement. We also charged to costof revenues $0.7 million related to the fair value adjustment to the acquiredinventory. Actual purchase price reductions from the favorable supply agreementamounted to $1.7 million. The $0.5 million difference has been capitalized onto inventory and will be charged to cost of revenues as the inventory is sold.

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***Research and Development***

The following setsforth, for the periods indicated, our research and development expenses (inthousands, except percentages):
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Research and  development |       | $                                | 13,429     |                           | $          | 6,853 |   | 96 | % | $ | 27,099 |   | $ | 13,423 |   | 102 | % |
|                           |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our research anddevelopment expenses consist primarily of payroll and related personnel costs,engineering services and support from third-party foundries and depreciation.In addition, there are substantial charges related to the amortization ofintangible assets related to the NPA acquisition and charges related tostock-based compensation. Research and development expenses increased to $13.4million for the three months ended June 30, 2006 as compared to $6.9 millionfor the three months ended June 30, 2005, representing approximately 33% and36% respectively, of net revenues for those periods. Personnel cost increasedby almost $2.0 million due to our growth, including the addition of personnelthat resulted from the NPA acquisition. Outside engineering service and supportcosts increased by $2.2 million, of which tapeout expenses were $1.4 million.Depreciation increased by approximately $0.6 million as our asset base grew. Inaddition, the amortization of intangibles related to the NPA acquisitionamounted to $0.2 million. Charges for stock-based compensation were $1.0million in the three months ended 2006 versus $1.1 million for the three monthsended 2005. Research and development expenses were $27.1 million for six monthsended June 30, 2006 versus $13.4 million for the six months ended June 30,2005. The 102% increase is attributable to higher personnel costs (approximately$4.0 million), higher outside engineering service and support costs(approximately $4.0 million, of which tapeout expenses were $2.8 million),higher facilities costs (approximately $0.8 million) and increased depreciation(approximately $1.0 million). In connection with the NPA acquisition in thefirst quarter of 2006, we expensed $2.9 million of IPR&D. We incurredstock-based compensation expense associated with research and developmentpersonnel of $1.9 million and $1.7 million in the six months endedJune 30, 2006 and 2005, respectively. The amortization of intangibles was$0.4 million for the six months ended June 30, 2006.

***Selling, General and Administrative***

The following setsforth, for the periods indicated, our selling, general and administrativeexpenses (in thousands, except percentages):
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Selling, general  and administrative |       | $                                | 6,131      |                           | $          | 4,075 |   | 50 | % | $ | 11,695 |   | $ | 7,506 |   | 56 | % |
|                                      |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling, generaland administrative expenses were $6.1 million for the three months ended June30, 2006 as compared to $4.1 million for the three months ended June 30, 2005,an increase of $2.0 million, or 50%. Payroll and related costs and outsideservices increased due to the effects of the NPA acquisition and normal growth.The amortization of intangibles was $1.0 million, but was somewhat offset bylower stock-based compensation charges. Stock-based compensation expenseassociated with sales, marketing and administrative personnel was $0.6 millionfor the three months ended June 30, 2006 as compared to $1.3 million for thethree months ended June 30, 2005. Expenses for the six months ended June 30,2006 were $11.7 million compared to $7.5 million for the six months ended June30, 2005. The 56% increase is attributable to higher payroll and related costsand higher costs related to both the NPA acquisition and our follow-onoffering, which occurred during the first quarter of 2006. The amortization ofthe NPA-related intangibles amounted to $1.6 million. Stock-based compensationcosts were $1.6 million for the six months ended June 30, 2006 versus $2.1million for the six months ended June 30, 2005.

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***Common Stock Offering Expense***

Common stock offering expenses for the three and sixmonths ended June 30, 2006 were $0 and $1.0 million compared to $0 for thecomparable 2005 periods. These expenses relate to the proportionate share ofexpenses incurred by us on behalf of the selling stockholders.

***Interest Income, net***

The following setsforth, for the periods indicated, our interest income, net  (in thousands, except percentages):
| ** **            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **            | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **            | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| Interest income,  net |       | $                                | 1,345      |                           | $          | 90 |   | 1,394 | % | $ | 2,304 |   | $ | 185 |   | 1,145 | % |
|                       |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest income, net consists primarily of interestincome earned on our cash, cash equivalents and short-term investments, whichis partially offset by interest expense. Interest income, net increased to $1.3million for the three months ended June 30, 2006 as compared to $0.1million for the three months ended June 30, 2005. Interest  income, net, increased to $2.3 million forthe six months ended June 30, 2006 as compared to $0.2 million for the sixmonths ended June 30, 2005. The increases for both periods were due to interestearned on higher average cash, cash equivalents and short term investmentbalances that resulted from our common stock offerings and cash provided byoperations. These increases were partially offset by cash paid for the NPAacquisition during the first quarter of 2006.

***Income Tax Provision***

We recorded an income tax provision of $0.1 millionand $0 for the three months ended June 30, 2006 and 2005, respectively,representing effective tax rates of 5.2% and 0% respectively.  For the six months ended June 30, 2006 and2005, we recorded income tax provision of $0.2 million and $0, respectively,representing effective tax rates of 5.5% and 0%, respectively.  Our effective tax rate for the remainder of2006 may fluctuate based upon our operating results for each taxablejurisdiction in which we operate and the amount of statutory tax that we incurin each jurisdiction.

***Cumulative Effect of Change in AccountingPrinciple***

In the three and six months ended June 30, 2006the adoption of SFAS 123(R) resulted in a cumulative benefit from accountingchange of $638,000 net of tax, 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 andCapital Resources**

Cash, cashequivalents and short-term investments increased to $112.9 million at June 30,2006 from $ 93.9 million as of December 31, 2005,  an increase of $19.0 million. This increasewas primarily due to the $48.6 million of net proceeds raised in our follow-onoffering and $7.4 million generated from operations, and was partially offsetby the completion of the NPA acquisition for $32.7 million. We believe therewill be additional working capital requirements to fund and operate thenetworking processing and ADSL business we acquired from ADI as well asadditional requirements to fund and operate our existing business prior to theNPA Acquisition. We expect to finance our operations primarily throughoperating cash flows and existing cash balances.

We expect to growour operating expenses as we continue to execute our business strategy. Thisincrease in operating expenses may not result in an increase in our netrevenues and our anticipated net revenues may not be sufficient to supportthese increased expenditures. We anticipate that operating expenses and workingcapital will constitute a material use of our cash and cash equivalents.

As of June 30, 2006, wehave funded our operations primarily through cash from private and  public offerings of our common stock, thecollection of accounts receivable from our customers, and proceeds from theexercise of stock options and stock purchased under our employee stock purchaseplan. Our uses of cash include payroll and payroll-related expenses andoperating expenses such as tape outs and tape out related costs, marketingprograms, travel, professional services and facilities and related costs. Wehave also used cash to acquire businesses and technologies to expand ourproduct offerings.

***Operating Activities***

During the sixmonths ended June 30, 2006, we generated $7.4 million of net cash fromoperating activities as compared to net cash used by operating activities of$2.4 million during the six months ended June 30, 2005. The net cash generatedduring the six months ended June 30, 2006 resulted from a net loss of $3.6million that was offset by $3.6 million of non-cash charges for amortization ofstock-based compensation, $2.9 million for in-process research and development,$3.9 for amortization of purchased intangibles and $2.6 million fordepreciation of property and equipment. In addition, cash was used in operatingactivities to fund increases in accounts receivable of $11.9 million dueprimarily to the increase payment terms and higher revenues, which waspartially offset by an increase in accounts payable and accrued liabilities of$3.1 million due to timing of 

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inventory purchases. Weanticipate that accounts receivable, inventory and accounts payable willincrease. Our operating cash flows will also be impacted in the future based onthe timing of cash receipts from our customers and payments to our vendors bythe nature of vendor arrangements and management’s assessment of our cashinflows.

***Investing Activities***

Our investing activitiesused net cash of $86.8 million in the six months ended June 30, 2006 ascompared to $850,000 during the six months ended June 30, 2005. Cash used ininvesting activities in the six months ended June 30, 2006  relatedprimarily to the NPA acquisition of $32.7 million,  the purchase of property and equipment of$5.7 million and the net purchase of short-term investments totaling $48.4million. We anticipate that we will continue to purchase necessary property andequipment in the normal course of our business. The amount and timing of thesepurchases and the related cash outflows in future periods depend on a number offactors, including the hiring of employees, the rate of change of computerhardware and software used in our business, and our business outlook. We haveclassified our investment portfolio as “available for sale,” and our investmentobjectives are to preserve principal and provide liquidity while maximizingyields without significantly increasing risk. We may sell an investment at anytime if the quality rating of the investment declines, the yield on theinvestment is no longer attractive, or we are in need of cash. Because weinvest only in investment securities that are highly liquid with a readymarket, we believe that the purchase, maturity, or sale of our investments hasno 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***

Our financingactivities provided $50.1 million in the six months ended June 30, 2006 ascompared to $266,000 used in during the six months ended June 30, 2005. Cashgenerated by financing activities during the six months ended June 30, 2006 wasprimarily due to the completion of our follow-on offering in which we raised$48.6 million of net proceeds and we intend to use the balance of the netproceeds for working capital and general corporate purposes, which may includethe acquisition of businesses, products, product rights or technologies,strategic investments or purchases of common stock.

***Lineof Credit***

OnOctober 21, 2004, we entered into a loan and security agreement withSilicon Valley Bank that provides for an up to $5.0 million revolving lineof credit and a $2.0 million equipment financing facility. As of June 30,2006, we had no balance outstanding under the revolving line of credit and $1.1million outstanding under the equipment financing facility which bear interestrates from 6.0% to 6.3%.

The revolving lineof credit can be used to (1) borrow revolving loans for working capitalrequirements, (2) issue letters of credit, (3) enter into foreignexchange forward contracts and (4) support cash management services.Revolving loans will bear interest at a floating rate of interest equal toSilicon Valley Bank’s prime rate plus 0.5%. Equipment loans bear interest at afixed rate of interest equal to Silicon Valley Bank’s prime rate at the time ofborrowing plus 1.0%. So long as the amount of our unrestricted cash and cashequivalents less outstanding indebtedness under the loan and security agreementexceeds $35.0 million, a maximum of $5.0 million will be availablefor borrowing under the revolving line of credit. Otherwise, the maximum amountavailable for borrowing under the revolving line of credit is an amount equalto the lesser of $5.0 million or 80% of our accounts receivable eligibleunder the terms of the loan and security agreement.

OnOctober 21, 2006, the revolving line of credit matures and Silicon ValleyBank’s commitment to extend revolving loans terminates. Principal and intereston the equipment facility is payable monthly and bears interest at a fixedrate. The outstanding equipment facilities will be paid in full byFebruary 2007.

The revolving andequipment loans under the loan and security agreement are collateralized by afirst priority lien on substantially all of our assets, excluding intellectualproperty. The loan and security agreement requires us to maintain a profitabilitycovenant and a minimum quick ratio of not less than 1.15 to 1.00. Quick ratiomeans the 

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ratio of the sum ofunrestricted cash and cash equivalents and accounts receivable to currentliabilities. In addition, we are required to comply with covenants that limitour ability to, among other things, dispose of assets, make acquisitions, beacquired, incur indebtedness, grant liens, make investments, pay dividends orrepurchase stock.

The loan andsecurity agreement includes events of default that, include among other things,non-payment of principal, interest or fees, violation of covenants, inaccuracyof representations and warranties, cross-default to certain other indebtedness,bankruptcy and insolvency events, change of control and material judgments. Theoccurrence of an event of default could result in the acceleration of ourobligations under the loan and security agreement and foreclosure on thecollateral securing our obligations under the loan and security agreement. Wewere not in compliance with the minimum profitability financial covenant duringthe quarter ended March 31, 2005. Silicon Valley Bank agreed to forebearits rights to call the equipment financing facility as a result of thenon-compliance. This forbearance pertains to the covenant violation during thequarter ended March 31, 2005 in perpetuity; however, it does not extend toany future non-compliance with covenants. Based on expected future operatingresults, we believe we will continue to be in full compliance with the amendedcovenants for at least 12 months from the balance sheet date. Accordingly,we have classified the amounts due under the facility beyond 12 monthsfrom the balance sheet date as non-current.

The loan agreementwas amended on March 31, 2006. Pursuant to the Amendment, the provisionsof the loan and security agreement relating to the financial covenant regardingthe profitability of Ikanos was amended to exclude stock-based compensation andcertain expenses and charges resulting from the NPA acquisition for each of thequarters in 2006.

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 cash needsfor at least the next 12 months. Our future capital requirements willdepend on many factors including our rate of net revenues 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***

In February 2006,in connection with the NPA acquisition, we used approximately $32.7 million in cashas part of the consideration. In August 2006, in connection with the Doradusacquisition, we used approximately $2.5 million in cash as part of theconsideration. A portion of our cash may be further used to acquire or investin other businesses or products or to obtain the right to use othercomplementary technologies. From time to time, in the ordinary course ofbusiness, we may evaluate potential acquisitions of such businesses, products,or technologies. The nature of these transactions makes it difficult to predictthe amount and timing of such cash requirements.

***Contractual Commitments***

Welease certain office facilities and equipment under non-cancelable operatingleases. See Note 8 to the Condensed Consolidated Financial Statements inPart I, Item 1. of this Quarterly Report on Form 10-Q. The following tablesummarizes our contractual obligations at June 30, 2006 and the effect thoseobligations are expected to have on our liquidity and cash flow in futureperiods (in thousands):

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| ** **                      | ** ** | **Payment Due by Period** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | ** **                               | ** ** | ** ** | ** ** | **2007 and** | ** ** | **2009 and** | ** ** | **2011 and** | ** ** |
| ** **                      | ** ** | **Total**                                | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Operating lease  payments       |       | $                                        | 4,295      |   | $ | 510 |   | $ | 2,026 |   | $ | 1,591 |   | $ | 168 |   |
| Capital lease  obligations      |       | 2,378                                    |       | 560 |   | 1,631 |   | 187 |   | — |   |
| Notes payable                   |       | 1,082                                    |       | 354 |   | 728 |   | — |   | — |   |
| Inventory purchase  obligations |       | 8,086                                    |       | 8,086 |   | — |   | — |   | — |   |
| Other obligations               |       | 1,150                                    |       | 400 |   | 750 |   | — |   | — |   |
|                            |       | $                                        | 16,991     |   | $ | 9,910 |   | $ | 5,135 |   | $ | 1,778 |   | $ | 168 |   |

 

For the purpose ofthis table, purchase obligations for the purchase of goods or services aredefined as agreements that are enforceable and legally binding and that specifyall significant terms, including: fixed or minimum quantities to be purchased;fixed, minimum or variable price provisions; and the approximate timing of thetransaction. Our purchase orders are based on our current manufacturing needsand are fulfilled by our vendors within short time horizons. In addition, wehave 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.

On August 1, 2006,we completed the acquisition of Doradus pursuant to a merger agreement underwhich payment of $2.5 million in cash will be made in the third quarter of2006.

***Off-Balance SheetArrangements***

We donot use off-balance-sheet arrangements with unconsolidated entities or relatedparties, nor do we use other forms of off-balance-sheet arrangements such asspecial purpose entities and research and development arrangements.Accordingly, our liquidity and capital resources are not subject tooff-balance-sheet risks from unconsolidated entities. As of December 31,2005, we did not have any off-balance-sheet arrangements, as defined inItem 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 June 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 of June30, 2006 are detailed previously in “Liquidity and Capital Resources - *Contractual Commitments*”.

Inthe normal course of business, we provide indemnifications of varying scope tocustomers against claims of intellectual property infringement made by thirdparties arising from the use of our products. Historically, costs related tothese indemnification provisions have not been significant and we are unable toestimate the maximum potential impact of these indemnification provisions on ourfuture consolidated results of operations.

**ITEM 3.**                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET 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 June 30, 2006, we did nothold derivative financial instruments.

**InterestRate Risk**

Ourexposure to market risk for changes in interest rates relates primarily to ourinvestment portfolio. We do not use derivative financial instruments in ourinvestment portfolio. The primary objective of our investment activities is topreserve principal and meet liquidity needs, while maximizing yields andwithout significantly increasing risk. Our investment policy specifies creditquality standards for our investments and limits the amount of credit exposureto any single issue, issuer, or type of investment. Our investments consistprimarily of U.S. government notes and 

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bonds, auction ratesecurities and commercial paper. All investments are carried at market value,which approximates cost**.**

As ofJune 30, 2006 we had cash, cash equivalents and short term investments totaling$112.9 million. These amounts were invested primarily in money market funds andshort-term investments that are held for working capital purposes. We do notenter into investments for trading or speculative purposes. Due to theshort-term nature of these investments, we do not believe that a 10% change ininterest rates would have a material impact on our financial position andresults of operations. However, declines in interest rates will reduce futureinvestment income.

 On October 21, 2004, we entered into aloan and security agreement with Silicon Valley Bank that provides for an up to$5.0 million revolving line of credit and a $2.0 million equipmentfinancing facility. As of June 30, 2006, we had no balance outstanding under therevolving line of credit and $1.1 million outstanding under the equipmentfinancing facility which have fixed interest rates from 6.0% to 6.3%. Due tothe fixed nature of the equipment facility interest rates, we are not exposedto interest rate risk on our loan arrangements, at this time.

If we were toborrow in the future under the revolving line of credit, we would be exposed tointerest rate risks, as revolving loans will bear interest based on a floatingrate equal to Silicon Valley Bank’s prime rate plus 1.00%. The company has noplans to borrow against this line in the near future. On October 21, 2006,the revolving line of credit matures and Silicon Valley Bank’s commitment toextend revolving loans terminates

**ForeignCurrency Risk**

Our net revenuesand our costs, including subcontractor manufacturing expenses, are denominatedin U.S. dollars. An increase of the U.S. dollar relative to the currencies ofthe countries that our customers operate in would make our products moreexpensive to them and increase pricing pressure or reduce demand for ourproducts. We do not currently enter into forward exchange contracts to hedgeexposure denominated in foreign currencies or any other derivative financialinstruments for trading or speculative purposes. In the future, if we feel ourforeign currency exposure has increased, we may consider entering into hedgingtransactions to help mitigate that risk. We expect that our foreign currencyexposure will increase as our operations in India and other countries expand.

**ITEM 4. CONTROLSAND PROCEDURES**

*Evaluationof Disclosure Controls and Procedures.* Our managementevaluated, with the participation of our Chief Executive Officer and our ChiefFinancial Officer, the effectiveness of our disclosure controls and proceduresas of the end of the period covered by this Quarterly Report on Form 10-Q.Based on this evaluation, our Chief Executive Officer and our Chief FinancialOfficer have concluded that our disclosure controls and procedures areeffective 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.

*Changesin Internal Control over Financial Reporting.* There was nochange in our system of internal control over financial reporting during thethree months ended June 30, 2006 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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*Limitationson the effectiveness of controls.*  In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Additionally, in designing disclosure controlsand procedures, our management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

**PART II:  OTHERINFORMATION**

**ITEM1. LEGAL PROCEEDINGS**

From time to timewe are involved in legal proceedings and litigation arising in the ordinarycourse of business. We are not currently a party to any material litigation orother legal proceedings that we believe would have a material adverse effect onour business, financial condition, results of operations and cash flows.

**ITEM 1A. RISK FACTORS**

*Investingin our common stock involves a high degree of risk. You should carefullyconsider the following risk factors, as well as the other information in thisQuarterly Report on Form 10-Q, and in our other filings with the SEC, includingour Annual Report on Form 10K for the year ended December 31, 2005 andsubsequent reports on Forms 10-Q and 8-K, before deciding whether to invest inshares of our common stock. Additional risks and uncertainties not presentlyknown to us or that we currently deem immaterial may also affect our business.If any of these known or unknown risks or uncertainties actually occurs withmaterial adverse effects on Ikanos, our business, financial condition andresults of operations could be seriously harmed. In that event, the marketprice for our common stock will likely decline and you may lose all or part ofyour investment.*

***Risks Related to Our Business***

**We havea 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 experiencedhigh growth rates in our net revenues in recent fiscal quarters. We do notexpect similar net revenues growth rates in future periods.**

We have a limitedoperating history which makes it difficult to evaluate our prospects. While ourcommercial operations began in 1999, we did not begin commercial shipments ofour products until the fourth quarter of 2002. Since then, our quarterly netrevenues and operating results have varied significantly and are likely tocontinue to vary from quarter to quarter due to a number of factors, many ofwhich are not within our control. For example, in the quarter endedMarch 31, 2005, our net revenues decreased by $6.2 million, or 33.4%,from the previous quarter, ended December 31, 2004, but then increased by$7.0 million, or 56.6%, in the next quarter, ended June 30, 2005.Quarterly fluctuations in revenue are typical in our industry, and are likelyto continue in the future. Quarterly fluctuations in net revenues arecharacteristic of our industry, as carriers purchase equipment based onexpected deployment and OEMs may occasionally manufacture equipment atrates higher than equipment is deployed. As a result, periodically and usuallywithout significant notice, carriers will reduce orders with OEMs for newequipment and OEMs in turn will reduce orders for our products, which willadversely impact the quarterly demand for our products, even when deploymentrates may be increasing.  Inaddition, our expenses are also subject to quarterly fluctuations resultingfrom factors including the costs related to new product releases. If ouroperating results do not meet the expectations of securities analysts orinvestors for any quarter or other reporting period, the market price of ourcommon stock may decline. Fluctuations in our operating resultsmay be due to a number of factors, including, but not limited to, changesin the mix of products we develop, acquire and sell as well as those identifiedthroughout this “Risk Factors” section. As a result, you should not rely onquarter to quarter comparisons of our operating results as an indicator offuture performance. In addition, in our last four fiscal quarters ended June30, 2006, our net revenues has grown 15%, 26%, 14% and 30% quarter overquarter. We do not expect similar net revenue growth rates in future periods.

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**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 is 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.

The net revenuesfrom the acquired business have been highly concentrated among customers. Wedid not have a prior relationship with many of these customers. The success ofour business is dependent in part upon our ability to develop strongrelationships with these customers and for the customers to continue to order networkprocessing products from us.

The NPA businessrelies on a limited number of suppliers for certain key components andmaterials. We are currently engaged in efforts to ensure a continuing supply ofcertain key components and materials from such suppliers and if these suppliersare unable to supply us with components and materials in the volumes werequire, at the costs we have budgeted or in the timeframes we have requested,our financial results will be negatively impacted. We recently have experiencedincreased costs inherited from the NPA business and this may continue. Further,if we do not obtain the components and materials as needed or the costs asbudgeted to meet customer demand, customer relationships may be harmed, andthis 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.

**We havea history of losses, and future losses may cause the market price of ourcommon stock to decline. We may not be able to generate sufficient netrevenues in the future to achieve or sustain profitability.**

Since inception,we have only been profitable in the third and fourth fiscal quarter of 2005. Weincurred significant net losses prior to such quarters, and we incurred asignificant loss our most recent quarter. As a result of the NPA acquisition,we expect to experience a net loss in 2006 primarily relating to non-cashacquisition-related charges. As of June 30, 2006, we had an accumulated deficitof $90.2 million. To achieve profitability again, we will need to generateand sustain higher net revenues while maintaining reasonable cost and expenselevels. We expect to increase expense levels to support increased research anddevelopment efforts related to new and existing product development, toincrease sales and marketing efforts, and to support administrative effortsrelated to costs of being a public company and managing an increasing complexbusiness, as well as to support the recently acquired NPA assets. Because manyof our expenses are fixed in the short term, or are incurred in advance ofanticipated sales, we may not be able to decrease our costs and expensesin a timely manner to offset any shortfall of sales. Although we have achievedprofitability in the last two quarters of 2005, we may not be able toachieve or sustain profitability on a quarterly or an annual basis in thefuture.

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

We currentlyexpect our chipsets to account for substantially all of our net revenues forthe foreseeable future. We began deriving revenues in the first quarter of 2006from products related to the NPA acquisition. If we are unable to develop newproducts or successfully integrate the newly acquired products to meet ourcustomers’ demand in a timely manner or demand for our chipsets declines orfails to grow as a result of competition or technological changes, it wouldharm our business. The markets for our products are characterized by frequentintroduction of new chipsets, short product life cycles and significant pricecompetition. If we or our OEM customers are unable to manage producttransitions in a timely and cost-effective manner, our net revenues 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.

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

The products wedevelop and sell are used for high volume applications and are subject to rapiddeclines in average selling prices. We have lowered our prices significantly attimes to gain market share, and we expect that we will continue to reduceprices in the future. Offering reduced prices to one customer could impact ouraverage selling prices to all customers. Our financial results will suffer ifwe are unable to offset any future reductions in our average selling prices byincreasing our sales volumes, or if we are unable to reduce our costs andexpenses or develop new or enhanced products on a timely basis with higherselling prices.

**Becausewe depend on a few significant customers for a substantial portion of our netrevenues, the loss of any of our key customers, our inability to continue tosell existing and new products to our key customers in significant quantitiesor our failure to attract new significant customers could adversely impact ournet revenues and harm our business.**

We derive asubstantial portion of our net revenues from sales to a relatively small numberof customers. 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 net revenues for any one of the periodsindicated. Sales made to these OEMs were made through the indicatedthird-party sales representatives:
| ** **                                        | ** ** | ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **OEM Customer**                             | ** ** | **Sales Representative**   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| NEC Corporation  (Magnus)                         |       | NEC Corporation (USA) |       | 19                                              | %          | 45                                            | %          | 22 | % | 44 | % |
| Sumitomo Electric Industries, Ltd. |       | Altima                          |       | 18                                              | %          | 34                                            | %          | 21 | % | 25 | % |
| Sagem                                             |       | Sagem                           |       | 25                                              | %          | n/a                                           |       | 18 | % | n/a |   |
| Dasan                                             |       | Uniquest                        |       | 9                                               | %          | 17                                            | %          | 14 | % | 21 | % |

 

We expect that asmall group of OEM customers, the composition of which has varied over time,will continue to account for a substantial portion of our net revenues in 2006and in the foreseeable future. In addition, we expect to continue to sell thenetwork processing and ADSL broadband products acquired in the NPA acquisitionto the existing customer base for these products. The SAFRAN Group of, whichSagem Communication is a subsidiary, represented 73% of net sales for the acquiredbusiness for the twelve months ended October 29, 2005. Accordingly, ourfuture operating results will continue to depend on the success of our largestOEM customers and on our ability to sell existing and new products to thesecustomers in significant quantities. Demand for our chipset products is basedon carrier demand for our OEM customers’ systems products. Accordingly, areduction in growth of carrier deployment of fiber-fast broadband serviceswould adversely affect our product sales and business.

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In addition, ourrelationships with some of our larger OEM customers may also deter otherpotential customers who compete with these customers from buying our products.To attract new customers or retain existing OEM customers, we have offered andmay continue to offer certain customers favorable prices on our products.If these prices are lower than the prices paid by our existing OEM customers,we may have to offer the same lower prices to certain of our customers. Inthat event, our average selling prices would decline. The loss of a keycustomer, a reduction in sales to any major customer or our inability toattract new significant customers could harm our business.

**Becauseof the rapid nature of technological development in our industry and the intensecompetition we face, our products become outmoded in a relatively short periodof time, which requires us to provide frequent updates and/or replacements toexisting products. If we do not successfully manage the transition process tonext generation chipset products, our operating results may be harmed.**

Our industry ischaracterized by rapid technological innovation and intense competition.Accordingly, our success depends in part on our ability to develop nextgeneration chipset products in a timely and cost-effective manner. Thedevelopment of new chipset products is expensive, complex and time consuming.If we do not rapidly develop our next generation chipset products ahead of ourcompetitors, we may lose both existing and potential customers to ourcompetitors. Conversely, even if we are successful in rapidly developing newchipset products ahead of our competitors and we do not cost-effectively manageour inventory levels of existing products when making the transition to the newchipset products, our financial results may be negatively affected by highlevels of obsolete inventory. If either of the foregoing were to occur, thenour operating results would be harmed.

**We relyon a limited number of independent subcontractors to manufacture, package andtest our current products, and our failure to secure and maintain sufficientcapacity with these subcontractors could impair our relationships withcustomers and decrease sales, which would negatively impact our market shareand operating results.**

We are a fablesssemiconductor company in that we do not own or operate a fabrication ormanufacturing facility. Seven outside factory subcontractors located in Taiwan,Austria, Malaysia, Singapore, Korea and China manufacture, assemble and testall of our semiconductor devices in current production, two of which are alsoour wafer foundries. In addition, in connection with the NPA acquisition, ADIdid not have any specific supply contracts, thus will need toform relationships with the suppliers of key components for networkprocessing and ADSL products. We do not have existing relationships with someof these suppliers and have no assurances from the suppliers that thesesuppliers will continue to provide manufacturing services under the same orsimilar terms as they had done prior to the NPA acquisition. In past periods ofhigh demand in the semiconductor market, we have experienced delays in meetingour capacity demand and as a result were unable to deliver products to ourcustomers on a timely basis. In addition, we have experienced similar delaysdue 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 qualify an alternativefacility in a timely manner in order to not disrupt our business. We typicallyrequire several months or more to qualify a new facility or process before wecan begin shipping products. If we cannot accomplish this qualification in atimely manner, we would experience a significant interruption in supply of theaffected products and our costs of revenues may increase. If we are unable tosecure sufficient capacity at our subcontractors’ existing facilities, or in theevent of a closure or significant delay at any of these facilities, ourrelationships with our customers would be harmed and our market share andoperating results would suffer as a result. In addition, we do not have formalpricing agreements with our subcontractors regarding the pricing for theproducts and services that they provide us. If their pricing for the productsand services they provide increases and we are unable to pass along suchincreases to our OEM customers, our operating results would be adverselyaffected.

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**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.**

The ability ofeach of our subcontractors’ manufacturing facilities to provide us withsemiconductors is limited by its available capacity and existing obligations.Although we have purchase order commitments to supply specified levels ofproducts to our OEM customers, we do not have a guaranteed level of productioncapacity from any of our subcontractors’ facilities that we depend on toproduce our semiconductors. Facility capacity may not be available when weneed it or at reasonable prices. We place our orders on the basis of our OEMcustomers’ 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 and the first nine months of 2004 as well as thesecond half of 2005 and the first half of 2006, general market conditions inthe semiconductor industry resulted in a significant increase in demand atthese facilities. The demand for our OEM customers’ products increasedsignificantly and we were asked to produce significantly higher quantities thanin the past and to deliver on short notice. In addition, our subcontractorshave also allocated capacity to the production of other companies’ products andreduced deliveries to us on short notice. It is possible that oursubcontractors’ other customers that are larger and better financed than weare, or that have long-term agreements with our subcontractors, may haveinduced our subcontractors to reallocate capacity to them. If this reallocationwere to occur again, it would impair our ability to deliver products on atimely basis.

Although we usetwo 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 these waferfoundries were unable to provide us with semiconductors as needed, we couldexperience 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.

In order to securesufficient manufacturing facility capacity when demand is high and mitigate therisks described in the foregoing paragraphs, we may enter into variousarrangements with subcontractors that could be costly and harm our operating results,including:

·                  optionpayments or other prepayments to a subcontractor;

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

·                  contractsthat commit us to purchase specified quantities of components over extended periods;

·                  purchaseof testing equipment for specific use at our subcontractors’ facilities;

·                  issuanceof our equity securities to a subcontractor; and

·                  othercontractual relationships with subcontractors.

We may not beable to make any such arrangements in a timely fashion or at all, and anyarrangements may be costly, reduce our financial flexibility and not be onterms favorable to us. Moreover, if we are able to secure facility capacity, wemay be obligated to use all of that capacity or incur penalties. Thesepenalties and obligations may be expensive and require significant capitaland could harm our business.

**In theevent 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.**

As indicated, weuse two independent wafer foundries to manufacture all of our semiconductorproducts, which exposes us to a substantial risk of delay, increased costs andcustomer dissatisfaction in the event that either one of these foundries wereunable to provide us with our semiconductor requirements. Particularly duringtimes when semiconductor capacity is limited, we may seek to qualifyadditional wafer foundries to meet our requirements. In order to bring thesenew foundries on-line, our customers would need to qualify the new facility,which process could take as long as several months. Once qualified, these newfoundries would then require an additional number of months to actually beginproducing semiconductors to meet our needs, by which time our perceived needfor additional capacity may have passed or the opportunities we previouslyidentified may have been lost to our competitors. Furthermore, even if thesenew foundries offer better pricing than our existing manufacturers, if theyprove to be less reliable than our existing manufacturers, we would not achievesome or all of our anticipated cost reductions.

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**If oursubcontractors’ manufacturing facilities do not achieve satisfactory yields orquality, our relationships with our customers and our reputation will be harmedand, if this were to occur, our net revenues and operating results coulddecline and our cost of revenue as a percentage of net revenues could increase.**

The fabrication ofsemiconductors is a complex and technically demanding process. Minor deviationsin the manufacturing process can cause substantial decreases in yields, and insome cases, cause production to be stopped or suspended. Although we workclosely with our subcontractors to minimize the likelihood of reducedmanufacturing yields, their facilities have from time to time experienced lowerthan anticipated manufacturing yields that have resulted in our inability tomeet our customer demand. It is not uncommon for yields in semiconductorfabrication facilities to decrease in times of high demand, in addition toreduced yields that may result from normal wafer lot loss due toworkmanship or operational problems at these facilities. When these eventsoccur, especially simultaneously, as happens from time to time, we may beunable to supply our customers’ demand. Many of these problems are difficult todetect at an early stage of the manufacturing process and may be timeconsuming and expensive to correct. In addition, because we purchase wafers,our exposure to low wafer yields from our subcontractors’ wafer foundries areincreased. Poor yields from the wafer foundries or defects, integration issuesor other performance problems in our products could cause us significantcustomer relations and business reputation problems, or force us to sell ourproducts at lower gross margins and therefore harm our financial results.Conversely, unexpected yield improvements could result in us holding excess inventorythat would also negatively impact our gross margins. In addition, manufacturingdefects may not be detected by the testing process performed by oursubcontractors. If defects are discovered after we have shipped our products,our reputation would be harmed and our net revenues and operating income coulddecline and our cost of revenue as a percentage of net revenues could increase.

**We baseorders for inventory on our forecasts of our OEM customers’ demand and if ourforecasts are inaccurate, our financial condition and liquidity would suffer.**

We place orderswith our suppliers based on our forecasts of our OEM customers’ demand. Ourforecasts are based on multiple assumptions, each of which may introduceerrors into our estimates. In the past, when the demand for our OEM customers’products increased significantly, we were not able to meet demand on a timelybasis, and we expended a significant amount of time working with our customersto allocate limited supply and maintain positive customer relations. If weunderestimate customer demand, we may forego revenue opportunities, losemarket share and damage our customer relationships. Conversely, if weoverestimate customer demand, we may allocate resources to manufacturingproducts that we may not be able to sell when we expect to or at all. As aresult, we would have excess or obsolete inventory, resulting in a decline inthe value of our inventory, which would increase our cost of revenue and createa drain on our liquidity. Our failure to accurately manage inventory againstdemand 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.**

We periodicallyevaluate the benefits, on a product-by-product basis, of migrating to smallerchips, which are measured in microns and referred to as geometry processes. Wehave designed our products to be manufactured in 0.8 micron, 0.25 micron, 0.18micron and 0.13 micron geometry processes. We are currently migrating some ofour products to even smaller 90-nanometer geometry process technology, and overtime, we are likely to migrate to even smaller geometries. The smaller chipsize reduces our production and packaging costs, which enables us to becompetitive in our pricing. The transition to smaller geometries requires us towork with our subcontractors to modify the manufacturing processes for ourproducts and to redesign some products. In the past, we have experienced somedifficulties in shifting to smaller geometry process technologies or newmanufacturing processes, which resulted in reduced manufacturing yields, delaysin product deliveries and increased expenses. We may face similardifficulties, delays and expenses as we continue to transition our products tosmaller geometry 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.

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**We faceintense competition in the semiconductor industry and the broadbandcommunications markets, which could reduce our market share and negativelyimpact our net revenues.**

The semiconductorindustry and the broadband communications markets are intensely competitive. Wecurrently compete or expect to compete with, among others, BroadcomCorporation, Centillium Communications, Inc., Conexant Systems, Inc.,Infineon Technologies A.G., Marvell Technology Group Ltd.,Metalink Ltd., STMicroelectronics N.V. and Texas Instruments Incorporated,which companies, we believe, have experience in very-high-bit-rate-digitalsubscriber line, or VDSL, or VDSL-like, technology. We also expect to competewith Freescale Semiconductor, Inc., Intel Corporation, Marvell TechnologyGroup Ltd., PMC-Sierra, Inc. and Realtek Semiconductor Corp., in thenetwork processing market. We expect competition to continue to increase.Competition has resulted and may continue to result in declining averageselling prices for our products and market share.

We consider othercompanies that have access to discrete multi-tone, or DMT, technology aspotential competitors in the future, and we also may face competition fromnewly established competitors, suppliers of products based on new or emergingtechnologies and customers who choose to develop their own chipsets. To remaincompetitive, we need to provide products that are designed to meet ourcustomers’ needs. Our products must:

·                  achieveoptimal product performance;

·                  complywith industry standards;

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

·                  meetfunctional specifications;

·                  beintroduced timely to the market; and

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

Many of ourcompetitors 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 toincorporate fiber-fast broadband or network processing technologies into a moreattractive product line than ours. Many of them also have longer operatinghistories, greater name recognition, larger customer bases, and significantlygreater financial, sales and marketing, manufacturing, distribution, technicaland other resources than we do. These competitors may be able to adaptmore quickly to new or emerging technologies and changes in customerrequirements. In addition, current and potential competitors have establishedor may establish financial or strategic relationships among themselves orwith existing or potential customers, resellers or other third parties.Accordingly, new competitors or alliances among competitors could emerge andrapidly acquire significant market share. Existing or new competitorsmay also develop technologies that more effectively address our marketswith products that offer enhanced features and functionality, lower powerrequirements, greater levels of semiconductor integration or lower cost. Wecannot assure you that we will be able to compete successfully against currentor new competitors, in which case we may lose market share in our existingmarkets and our net revenues may fail to increase or may decline.

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

Our net revenuesare 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.

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

We rely on thirdparties for technologies that are integrated into some of our products,including memory cells, input/output cells and core processor logic. If we areunable to continue to use or license these technologies on reasonable terms, orif these technologies fail to operate properly, we may not be able tosecure alternatives in a timely manner and our ability to remain competitivewould be harmed. In addition, if we are unable to successfully licensetechnology from third parties to develop future products, we may not beable to develop such products in a timely manner or at all.

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**Wemay be unable to attract, retain and motivate key senior management andtechnical personnel, which could harm our development of technology and abilityto be competitive.**

Our future successdepends to a significant extent upon the continued service of our keypersonnel, including our President and Chief Executive Officer, Rajesh Vashist,and our other senior executives and key technical personnel. Except forMr. Vashist, we do not have employment agreements with any of theseexecutives or any other key employees that govern the length of their service.The loss of the services of Mr. Vashist or other senior management ortechnical personnel could harm our business. Furthermore, our future successdepends on our ability to continue to attract, retain and motivate other seniormanagement and qualified technical personnel, particularly software engineers,digital circuit designers, mixed-signal circuit designers and systems andalgorithms engineers, and we are currently in the process of trying to hire ageneral manager. Competition for these employees is intense. Stock options andother equity incentives generally comprise a significant portion of ourcompensation packages for all employees, and the expected volatility in theprice of our common stock may make it more difficult for us to attract andretain key employees, which could harm our ability to provide technologicallycompetitive products.

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

Our future successdepends on our ability to develop new chipset products and transition to newproducts, introduce these products in a cost-effective and timely manner andconvince OEMs to select our products for design into their new systems. Ourhistorical quarterly results have been, and we expect that our future resultswill continue to be, dependent on the introduction of a relatively small numberof new products and the timely completion and delivery of those products tocustomers. The development of new chipset products is complex, and from time totime we have experienced delays in completing the development and introductionof new products. We have in the past invested substantial resources in emergingtechnologies that did not achieve the market acceptance that we had expected.Our ability to develop and deliver new chipset products successfully willdepend on various 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;

·                  timelycomplete and introduce new product designs;

·                  timelyqualify and obtain industry interoperability certification of our products andthe equipment into which our products will be incorporated;

·                  ensurethat our subcontractors have sufficient foundry capacity and packagingmaterials and achieve acceptable manufacturing yields;

·                  shiftour products 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 we are unableto 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.**

Our products aregenerally incorporated into our OEMs customers’ systems at the design stage. Asa result, we rely on OEMs to select our products to be designed into theirsystems, which we refer to as a design win. We often incur significantexpenditures on the development of a new product without any assurance that anOEM will select our product for design into its own system. Additionally, insome instances, we are dependent on third parties to 

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obtain or provideinformation that we need to achieve a design win. Some of these third partiesmay not supply this information to us on a timely basis, if at all.Furthermore, even if an OEM designs one of our products into its systemoffering, we cannot be assured that its equipment will be commerciallysuccessful or that we will receive any net revenue as a result of that designwin. Our OEM customers are typically not obligated to purchase our products andcan choose 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 net 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.**

We intend tocontinue to actively pursue acquisitions, strategic partnerships and jointventures that we believe may allow us to complement our growth strategy,increase market share in our current markets and expand into adjacent markets,broaden our technology and intellectual property and strengthen ourrelationships with carriers and OEMs. For example, in August 2006 we acquiredDoradus, a developer of advanced signal processing products for communicationsand consumer applications for approximately $2.5 million in cash and theassumption of approximately 177,000 options to purchase Ikanos common stock andapproximately 178,000 shares of restricted stock. Any future acquisition,partnership joint venture or investment may require that we paysignificant 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 commitmentsmay impair the operation of our business. Furthermore, acquired businessesmay not be effectively integrated, may be unable to maintain keypre-acquisition business relationships, may contribute to increased fixedcosts and may expose us to unanticipated liabilities and otherwise harmour operating results.

**We relyon third-party sales representatives to assist in selling our products, and thefailure of these representatives to perform as expected could reduce ourfuture sales.**

We sell ourproducts 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 sales and operating results could beharmed.

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

We design ourproducts to conform to regulations established by governments and tostandards set by industry standards bodies such as The American NationalStandards Institute and The Committee T1E1.4 in North America, EuropeanTelecommunications Standards Institute in Europe and ITU-T and the Institute ofElectrical and Electronics Engineers, Inc. worldwide. Because our productsare designed to conform to current specific industry standards, ifcompeting standards emerge that are preferred by our customers, we would haveto make significant expenditures to develop new products. If our customers adoptnew or competing industry standards with which our products are not compatible,or the industry groups adopt standards or governments issue regulations withwhich our products are not compatible, our existing products would become lessdesirable to our customers and our sales and operating results would suffer.

**If wefail to secure or protect our intellectual property rights, competitorsmay be able to use our technologies, which could weaken our competitiveposition, reduce our net revenue or increase our costs.**

Our success willdepend, in part, on our ability to protect our intellectual property. We relyon a combination of patent, copyright, trademark and trade secret laws,confidentiality procedures and licensing arrangements to 

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establish and protect ourproprietary rights in the United States. We do not currently have anyapplications on file in any foreign jurisdictions with respect to ourintellectual property notwithstanding the fact that a significant portion ofour net revenue is generated abroad. Our pending patent applicationsmay not result in issued patents, and our existing and future patentsmay not be sufficiently broad to protect our proprietary technologies ormay be held invalid or unenforceable in court. While we are not currentlyaware of misappropriation of our existing technology, policing unauthorized useof our technology is difficult and we cannot be certain that the steps we havetaken will prevent the misappropriation or unauthorized use of ourtechnologies, particularly in foreign countries where we have not applied forpatent protections and, even if such protections were available, the lawsmay not protect our proprietary rights as fully as U.S. law. The patentswe have obtained or licensed, or may obtain or license in the future,may not be 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 net 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 costs and diversionof our resources.**

Companies in thesemiconductor industry often aggressively protect and pursue their intellectualproperty rights. From time to time, we receive, and may continue toreceive in the future, notices that claim we have infringed upon,misappropriated or misused other parties’ proprietary rights. While we are notaware that we are currently infringing on the proprietary rights of thirdparties, we may in the future be engaged in litigation with parties whoclaim that we have infringed their patents or misappropriated or misused theirtrade secrets or who may seek to invalidate one or more of our patents,and it is possible that we would not prevail in any future lawsuits. An adversedetermination in any of these types of claims could prevent us frommanufacturing or selling some of our products, could increase our costs ofproducts 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 ouroperating results to fluctuate and result in volatility in the price of ourcommon stock. An OEM customer or a carrier may decide to cancel or changeits product plans, 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 

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incorporates our product.Due to this lengthy sales cycle, we may experience significant delays fromthe time we increase our operating expenses and make investments in inventoryuntil the time that we generate net revenue from these products. It is possiblethat we may never generate any net revenue from these products afterincurring these expenditures and investments. Even if an OEM customer selectsour product to incorporate into its equipment, we have no assurances that thecustomer will ultimately market and sell its equipment or that such efforts byour customer will be successful. The delays inherent in our lengthy sales cycleincreases the risk that an OEM customer or carrier will decide to cancel orchange its product plans. From time to time, we have experienced changes andcancellations in the purchase plans of our OEM customers. A cancellation orchange in plans by an OEM customer or carrier could cause us to not achieveanticipated net revenue and result in volatility of the price of our commonstock. In addition, our anticipated sales could be lost or substantiallyreduced if a significant OEM customer or carrier reduces or delays ordersduring our sales cycle or chooses not to release equipment that contains ourproducts.

**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, 98% of our net revenue for the three monthsended June 30, 2006 and 99% of our net revenue for the three months ended June30, 2005 was derived from sales to customers outside the United States.Additionally, 99% of the net sales for the twelve-month period endedOctober 29, 2005 of the network processing business we acquired in the NPAacquisition were derived from sales to customers outside of the United States.We have expanded our international business activities and may open otherdesign and operational centers abroad. International operations are subject tomany other inherent risks, including but not limited to:

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

·                  exposureto different legal standards, particularly with respect to intellectualproperty;

·                  naturaldisasters and public health emergencies;

·                  tradeand travel restrictions;

·                  theimposition of governmental controls and restrictions or unexpected changes inregulatory requirements;

·                  burdensof complying with a variety of foreign laws;

·                  importand export license requirements and restrictions of the United States and eachother country in which we operate;

·                  foreigntechnical standards;

·                  changesin tariffs;

·                  difficultiesin staffing and managing international operations;

·                  fluctuationsin currency exchange rates;

·                  difficultiesin collecting receivables 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 69% of our net revenue for the three months endedJune 30, 2006 and 98% for the three months ended June 30, 2005. Our sales havebeen dependent on the continuous growth of new fiber extension over copper andbroadband over copper subscribers in Asia. Fluctuations in or a plateau of newsubscribers in Asia could impact our net revenues and a sustained slow down ingrowth of fiber extension over copper and broadband over copper subscribers inAsia may cause our net revenues to decline.

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**We arein the process of implementing a new ERP system, which could disrupt ouroperations, negatively impact our sales volume and net revenue and adverselyaffect our 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, and subsequent enhancements to this new system could disrupt our operations.We are currently in the process of implementing the second phase of the ERPinformation system, which we expect to complete in the third quarter of 2006.We have experienced difficulties in the past in implementing new informationsystems. The process of implementing new information systems could alsoadversely impact our ability to do the following in a timely manner:

·                  reportfinancial results;

·                  accuratelyreflect inventory costs;

·                  acceptand process customer orders;

·                  receiveinventory and ship products;

·                  invoiceand collect receivables;

·                  placepurchase orders and pay invoices; 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 our operatingresults.**

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 denominated inU.S. dollars and an increase in the U.S. dollar relative to the currencies ofthe countries 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 net revenues from Asia, andwith the NPA acquisition, a majority of our network processing revenue from asingle customer in Europe. If we fail to diversify the geographic sources andcustomer base of our net revenue in the future, our operating results could beharmed.**

A substantialportion of our net revenue is derived from sales into Japan, Korea and France,and our net revenues has been heavily dependent on developments in thesemarkets. As a result, our sales are subject to economic downturns, decrease indemand and overall negative market conditions in Asia and France. Whilepart of our 

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strategy is to continueto diversify the geographic sources and customer base of our net revenue, ourfailure to successfully penetrate markets outside of Japan, Korea and France,and to successfully diversify our customer base could harm our business andoperating 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,particularly when they are first introduced or as new versions are released. Inthe past we have experienced, and may in the future experience, defectsand bugs in our products. If any of our products contains defects or bugs, orhave reliability, 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 Union bansthe use of lead and other heavy metals in electrical and electronic equipmentafter July 1, 2006. As a result, in advance of this deadline, some of ourcustomers selling products in Europe have begun demanding product fromcomponent manufacturers that do not contain these banned substances. Becausemost of our existing assembly processes (as well as those of most othermanufacturers) utilize a tin-lead alloy as a soldering material in themanufacturing process, we must redesign many of our products if we are to meetcustomer demand. This redesign may result in increased research anddevelopment and manufacturing and quality control costs. In addition, theproducts that we manufacture that comply with the new regulatory standardsmay not perform as well as our current products. Moreover, if we areunable to successfully and timely redesign existing products and introduce newproducts that meet the standards set by environmental regulation and ourcustomers, sales of our products could decline, which could materiallyadversely affect our business, financial condition and results of operations.

**We haveincurred increased costs as a result of being a 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.

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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 need to attract and retain keyemployees in our finance department. If we fail to do so our ability to meet reporting and complianceregulations could be affected.**

In the second quarter of2006, the employment of several key employees in our finance department terminated.We are currently in the process of hiring key financial personnel. Withoutgaining additional key employees in our finance department our ability to meetreporting and compliance regulations may be negatively impacted, which couldharm the ability to operate our business as a public company and investors’ maylose confidence in our ability to operate in compliance with existing internalcontrols rules and regulations, either of which could result in a decline inour 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 net 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 broadbandcommunications markets to fully recover from downturns could harm our business.The semiconductor industry also periodically experiences increased demand andproduction capacity constraints, which may affect our ability to shipproducts. Accordingly, our operating results may vary significantly as aresult of the general conditions in the semiconductor or broadbandcommunications industry, which could 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, which wouldhave 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.

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**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 in responseto various factors, many of which we cannot control, including:

·                  quarter-to-quartervariations in our operating results;

·                  changesin accounting rules, particularly those related to the expensing of stockoptions;

·                  announcementsof changes in our senior management;

·                  thegain or loss of one or more significant customers or suppliers;

·                  announcementsof technological innovations or new products by our competitors, customers orus;

·                  thegain or loss of market share in any of our markets;

·                  generaleconomic and political conditions and specific conditions in the semiconductorindustry and broadband technology    markets, includingseasonality in sales of consumer products into which our products areincorporated;

·                  continuinginternational conflicts and acts of terrorism;

·                  changesin earnings estimates or investment recommendations by analysts;

·                  changesin investor perceptions; or

·                  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.In the past, we and other companies that have experienced volatility in themarket price of their securities have been, and in the future we may be,the subject of securities class action litigation.

**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 the past,securities class action litigation often has been brought against acompany following periods of volatility in the market price of its securities.Companies such as ours in the semiconductor industry and other technologyindustries are particularly vulnerable to this kind of litigation due to thehigh volatility of their stock prices. While we are not aware of any suchcontemplated class action litigation against us, we may in the futurebe the target of securities litigation. Any securities litigation could resultin substantial costs and could divert the attention and resources of ourmanagement.

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**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 June 30,2006, we had approximately 27,239,000 shares of common stock outstanding. Ofthese 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 couldoccur at any time. These sales could reduce the market price of our commonstock.

**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:

·                  theright of the board of directors to elect a director to fill a vacancy createdby the expansion of the board of directors;

·                  theestablishment of a classified board of directors requiring that not all membersof the board be elected at one time;

·                  theprohibition of cumulative voting in the election of directors which wouldotherwise allow less than a majority of stockholders to elect directorcandidates;

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·                  therequirement for advance notice for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at a stockholders’meeting;

·                  theability of the board of directors to alter our bylaws without obtainingstockholder approval;

·                  theability of the board of directors to issue, without stockholder approval, up to5,000,000 shares of preferred stock with terms set by the board of directors,which rights could be senior to those of common stock;

·                  therequired approval of holders of at least two-thirds of the shares entitled tovote at an election of directors to adopt, amend or repeal our bylaws or amendor repeal the provisions of our certificate of incorporation regarding theelection and removal of directors and the ability of stockholders to takeaction;

·                  therequired approval of holders of a majority of the shares entitled to vote at anelection of directors to remove directors 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. Todate, we estimate that we have used approximately $32.7 million of the proceedsfor NPA acquisition. The remainder of the net proceeds of theoffering has been applied to temporary investments.

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 common stock were sold in the offering at $20.75per share. 2,500,000 of the shares of common stock were sold by us and3,250,000 of the shares of common stock were sold by selling stockholders. Theoffering terminated after the sale of all of the securities registered on the registrationstatement. After deducting the underwriters’ commission and the estimatedoffering costs, we received net proceeds of $48.6 million from the offering.None of the expenses were paid, directly or indirectly, to directors, officersor persons owning 10% or more. To date, we used approximately $2.5 million ofthe net proceeds of the offering to fund Doradus acquisition, and the remainderof the net proceeds has been applied to temporary investments.

**ITEM 4. **                 SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

     Thefollowing matters were submitted to the stockholders at our Annual Meeting ofStockholders held on June 13, 2006. Votes were cast representing 19,460,299shares out of 26,993,723 outstanding shares. This represents 72% participation.Each of the matters was approved by the requisite vote.

(a)          The followingindividuals were re-elected to the Board of Director for three-year terms asClass I directors:

|                | ** ** | **Votes**  | ** ** | **Votes**    | ** ** |
|----------------|------------|------------|------------|--------------|------------|
| ** **     | ** ** | **For**    | ** ** | **Withheld** | ** ** |
| Michael Goguen |       | 18,758,247 |       | 702,052      |       |
| G. Venkatesh   |       | 18,714,978 |       | 745,321      |       |

 

Our board ofdirectors currently consists of six members, who are Danial Faizullabhoy,Michael Goguen, Michael Gulett, Paul Hansen, Rajesh Vashist and G. Venkatesh.Our Board of Directors is divided into 

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three classes,with each director serving a three-year term and one class being elected ateach year’s annual meeting of stockholders. Messrs. Faizullabhoy and Gulett are‘‘Class II’’ directors whose term expires at our annual meeting of stockholdersin 2007. Messrs. Vashist and Hansen are ‘‘Class III’’ directors whose termexpires at our annual meeting of stockholders in 2008.

(b)         To ratify the appointmentof PricewaterhouseCoopers LLP as our independent registered public accountingfirm for the year ending December 31, 2006.

| Affirmative Votes |   | 19,440,399 |   |
|-------------------|--------|------------|--------|
| Negative Votes    |   | 14,550     |   |
| Votes Abstain     |   | 5,350      |   |
| Broker Non-Votes  |   | —     |   |

 

**ITEM 6.**                    EXHIBITS

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

**ITEMS 3 and 5 arenot applicable and have been omitted.**

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934 theCompany has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                 |   | **IKANOS COMMUNICAITONS,  INC.**                          | ** ** |
|-----------------|--------|-----------------------------------------------------------|------------|
| ** **      |   | ** **                                                | ** ** |
| August 16, 2006 |   | /s/   Rajesh  Vashist                      |       |
|            |   | Rajesh Vashist                                            |       |
| * *        |   | *President, Executive Officer  and Chairman of the Board* | * *   |
| * *        |   | *(Principal Executive Officer)*                           | * *   |
| * *        |   | * *                                                  | * *   |
| August 16, 2006 |   | /s/   Daniel  K. Atler                     |       |
|            |   | Daniel K. Alter                                           |       |
| * *        |   | *Vice President and Chief  Financial Officer*             | * *   |
| * *        |   | *(Principal Financial Officer)*                           | * *   |

 

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**IKANOSCOMMUNICATIONS, INC.**

**EXHIBITS TO FORM 10-Q QUARTERLY REPORT**

**Forthe Quarter Ended June 30, 2006**

 

 
| **Exhibit No.** | ** ** | ** **                                                                                                                                                                                                                    | **Description** | ** ** | ** ** |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|------------|------------|
| 10.1*                |       | Amended and Restated  1999 Stock Option Plan.                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                          |
| 10.2*†          |       | Amendment to 2006 Sales  Compensation Plan for Vice President of Worldwide Sales.                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                          |
| 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), 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.                                                                              |
|                 |       |                                                                                                                                                                                                                          |
| 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.                                           |

 

*                    Filedherewith.

†                     Confidentialtreatment has been requested as to certain portions of this exhibit.

 

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