Summary of Significant Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fiscal Year

The Company’s fiscal year ends on the last Saturday in December. The fiscal year ended December 29, 2012 includes 52 weeks, the fiscal years ended December 31, 2011 and December 25, 2010 include 53 and 52 weeks, respectively, and are referred to as fiscal years 2012, 2011 and 2010, respectively, herein.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, a majority owned (78)% subsidiary, Kowon Technology Co., Ltd. (Kowon), located in Korea, a majority owned (90)% subsidiary Kopin Tawain Corp (KTC) located in Taiwan, and a majority owned (51)% subsidiary Ikanos Consulting Ltd. (Ikanos), located in the United Kingdom (collectively the Company). All intercompany transactions and balances have been eliminated. Amounts of Kowon, KTC and Ikanos not attributable to the Company are referred to as noncontrolling interests in the consolidated statements of operations and consolidated statements of comprehensive (loss) income. Investment in business entities in which the Company does not have control but has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method.

Subsequent to year end, the Company paid $3.7 million to acquire an additional 15% ownership in its Kowon subsidiary. The Company plans to close its Kowon facility in 2013. As of December 29, 2012, the closure of this facility did not meet the criteria for assets held for sale.

Revenue Recognition

The Company recognizes revenue if four basic criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and services rendered; (3) the price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. The Company does not recognize revenue for products prior to customer acceptance unless it believes the product meets all customer specifications and the Company has a history of consistently achieving customer acceptance of the product. Provisions for product returns and allowances are recorded in the same period as the related revenues. The Company analyzes historical returns, current economic trends and changes in customer demand and acceptance of product when evaluating the adequacy of sales returns and other allowances. Certain product sales are made to distributors under agreements allowing for a limited right of return on unsold products. Sales to distributors are primarily made for sales to the distributor’s customers and not for their stocking of inventory. The Company delays revenue recognition for its estimate of distributor claims of right of return on unsold products based upon its historical experience with the Company’s products and specific analysis of amounts subject to return based upon discussions with the Company’s distributors or their customers.

The Company recognizes revenues from long-term research and development contracts on the percentage-of-completion method of accounting as work is performed, based upon the ratio of costs or hours already incurred to the estimated total cost of completion or hours of work to be performed. Revenue recognized at any point in time is limited to the amount funded by the U.S. government or contracting entity. The Company accounts for product development and research contracts that have established prices for distinct phases as if each phase were a separate contract. In some instances, the Company is contracted to create a deliverable which is anticipated to be qualified and go into full rate production stages. In those cases, the revenue recognition methodology will change from the percentage of completion method to the units-of-delivery method as new contracts are received after formal qualification has been completed.

The Company classifies amounts earned on contracts in progress that are in excess of amounts billed as unbilled receivables and classifies amounts received in excess of amounts earned as billings in excess of revenues earned. The Company invoices based on dates specified in the related agreement or in periodic installments based upon its invoicing cycle. The Company recognizes the entire amount of an estimated ultimate loss in its financial statements at the time the loss on a contract becomes known.

Research and Development Costs

Research and development expenses are incurred in support of internal display product development programs or programs funded by agencies or prime contractors of the U.S. government and commercial partners. Research and development costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication and packaging of experimental display products, and overhead, and are expensed immediately.

Cash and Equivalents and Marketable Securities

The Company considers all highly liquid, short-term debt instruments with original maturities of three months or less to be cash equivalents.

Marketable debt securities consist primarily of commercial paper, medium-term corporate notes, and United States government and agency backed securities. The Company classifies these marketable debt securities as available-for-sale at fair value in “Marketable debt securities, at fair value.” The investments in Advanced Wireless Semiconductor Company (AWSC) and WIN Semiconductor Corp. (WIN) are included in “Other assets” as available-for-sale and at fair value. The Company records the amortization of premium and accretion of discounts on marketable debt securities in the results of operations.

The Company uses the specific identification method as a basis for determining cost and calculating realized gains and losses with respect to marketable debt securities. The gross gains and losses realized related to sales of marketable debt securities were not material during fiscal years 2012, 2011 and 2010.

Inventory

Inventory is stated at the lower of cost (determined on the first-in, first-out or specific identification method) or market and consists of the following at December 29, 2012 and December 31, 2011:



	2012		2011
Raw materials	$	2,540,497	$	9,934,724
Work-in-process	1,880,202		5,220,353
Finished goods	1,369,054		5,313,435
	$	5,789,753	$	20,468,512

Property, plant and equipment

Property, plant and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, generally 3 to 10 years. Leasehold improvements and leased equipment are amortized over the shorter of the term of the lease or the useful life of the improvement or equipment. As discussed below, obligations for asset retirement are accrued at the time property, plant and equipment is initially purchased or as such obligations are generated from use.

Intangible assets

Customer relationships represent the fair value of the underlying relationships and agreements with customers. Developed technology represents the fair value of technology as it exists in current products and has value through its continued use or reuse. The trademark represents the brand and name recognition associated with the marketing of products and was determined to have a finite life.

Identifiable intangible assets are amortized using the straight-line method over the estimated useful lives of the assets.

Product Warranty

The Company generally sells products with a limited warranty of product quality and a limited indemnification of customers against intellectual property infringement claims related to the Company’s products. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but unidentified issues based on historical activity. As of December 29, 2012 and December 31, 2011, the Company had warranty reserves of $0.7 million and $1.3 million. For the fiscal years 2012, 2011 and 2010 warranty claims and reversals were approximately $2.2 million, $1.4 million and $0.8 million, respectively.

Asset Retirement Obligations

The Company recorded asset retirement obligations (ARO) liabilities of $0.3 million and $1.3 million at December 29, 2012 and December 31, 2011, respectively. This represents the legal obligations associated with retirement of the Company’s assets when the timing and/or method of settling the obligation are conditional on a future event that may or may not be within the control of the Company. The Company also recorded accumulated depreciation charges of $0.6 million and $0.6 million, at December 29, 2012 and December 31, 2011, respectively, which represents the cumulative amortization of the capitalized long-lived asset associated with this obligation. The Company estimated the ARO using a discounted cash flow model that considered the Company’s cost of capital as well as increases in costs prior to settlement of the obligations and considered the probability that performance would be required.



	2012			2011
Beginning balance	$	1,295,670		$	944,617
Additions	32,360			309,119
Charges	(424,785		)	—
Accretion	43,211			41,934
Reclassified to noncurrent liabilities held for sale	(623,979		)	—
Ending balance	$	322,477		$	1,295,670

Income Taxes

The consolidated financial statements reflect provisions for federal, state, local and foreign income taxes. The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carryforwards. The Company measures deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company provides valuation allowances if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Foreign Currency

Assets and liabilities of non-U.S. operations where the functional currency is other than the U.S. dollar are translated from the functional currency into U.S. dollars at year end exchange rates, and revenues and expenses at average rates prevailing during the year. Resulting translation adjustments are accumulated as part of accumulated other comprehensive income. Transaction gains or losses are recognized in income or loss in the period in which they occur.

Net (Loss) Income Per Share

Basic net (loss) income per share is computed using the weighted-average number of shares of common stock outstanding during the period less any unvested restricted shares. Diluted earnings per common share is calculated using weighted-average shares outstanding and contingently issuable shares, less weighted-average shares reacquired during the period. The net outstanding shares are adjusted for the dilutive effect of shares issuable upon the assumed conversion of the Company’s common stock equivalents, which consist of outstanding stock options and unvested restricted stock units.

Weighted-average common shares outstanding used to calculate earnings per share, is as follows:



	2012	2011	2010
Weighted-average common shares outstanding—basic	63,617,680	64,405,776	66,019,847
Stock options and nonvested restricted common stock	—	828,436	691,654
Weighted-average common shares outstanding—diluted	63,617,680	65,234,212	66,711,501

The following were not included in weighted-average common shares outstanding- diluted because they are anti-dilutive or performance conditions have not been met at the end of the period.



	2012	2011	2010
Nonvested restricted common stock	2,283,048	613,934	229,159
Stock options	983,680	1,561,925	2,544,411
Total	3,266,728	2,175,859	2,773,570

Concentration of Credit Risk

The Company primarily invests its excess cash in government backed and corporate financial instruments management believes to be of high credit worthiness, which bear lower levels of relative credit risk. The Company relies on rating agencies to ascertain the credit worthiness of its marketable securities and, where applicable, guarantees by the Federal Deposit Insurance Company. The Company sells its products to customers worldwide and generally does not require collateral. The Company maintains a reserve for potential credit losses.

Fair Value of Financial Instruments

Financial instruments consist of current assets (except inventories, income tax receivables and prepaid assets) and certain current liabilities. Current assets (excluding marketable securities which are recorded at fair value) and current liabilities are carried at cost, which approximates fair value.

Stock-Based Compensation

The fair value of stock option awards is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. There were no stock options granted in fiscal years 2012, 2011 or 2010.

The fair value of nonvested restricted common stock awards is generally the market value of the Company’s equity shares on the date of grant. The nonvested restricted common stock awards require the employee to fulfill certain obligations, including remaining employed by the Company for one, two or four years (the vesting period) and in certain cases also require meeting either performance criteria or the Company’s stock achieving a certain price. The performance criteria primarily consist of the achievement of the Company’s annual incentive plan goals. For nonvested restricted common stock awards which solely require the recipient to remain employed with the Company, the stock compensation expense is amortized over the anticipated service period. For nonvested restricted common stock awards which require the achievement of performance criteria, the Company reviews the probability of achieving the performance goals on a periodic basis. If the Company determines that it is probable that the performance criteria will be achieved, the amount of compensation cost derived for the performance goal is amortized over the service period. If the performance criteria are not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. The Company recognizes compensation costs on a straight-line basis over the requisite service period for time vested awards.

In 2011, the Company granted compensation awards to its Chief Executive Officer that consisted of a grant of 260,000 shares of restricted stock and a grant of 380,000 shares of phantom stock to be settled in cash. The 260,000 shares of restricted stock and the 380,000 shares of phantom stock will vest at the end of the first 10 consecutive trading day period following the grant date during which the Company’s common stock trades at a price per share equal to or greater than $5.25, prior to September 12, 2016. The vesting of the awards upon achieving a closing stock price of $5.25 for 10 consecutive days is considered a market condition. The accounting for the 260,000 shares requires that the fair market value of the shares is determined on the grant day and then this fair market value is expensed straight-line over the derived service period. The accounting for the phantom stock award requires the Company to periodically assess the fair market value of the award, with increases or decrease in the fair market value being reflected in the statement of operations.

Comprehensive (Loss) Income

Comprehensive (loss) income is the total of net income and all other non-owner changes in equity including such items as unrealized holding gains (losses) on marketable equity and debt securities classified as available-for-sale and foreign currency translation adjustments.

The components of accumulated other comprehensive income are as follows:



	Cumulative Translation Adjustment			Unrealized Holding (Loss) Gain on Marketable Securities			Non-Credit Related Losses on Investments			Accumulated Other Comprehensive Income (Loss)
Balance as of December 26, 2009	$	554,361		$	5,040,629		$	(1,038,177	)	$	4,556,813
Changes during year	1,886,520			(1,243,327		)	785,339			1,428,532
Balance as of December 25, 2010	2,440,881			3,797,302			(252,838		)	5,985,345
Changes during year	(1,121,011		)	(971,148		)	252,838			(1,839,321		)
Balance as of December 31, 2011	1,319,870			2,826,154			—			4,146,024
Changes during year	2,222,234			144,534			—			2,366,768
Balance as of December 29, 2012	$	3,542,104		$	2,970,688		$	—		$	6,512,792

Immaterial Restatement with Reclassification of Discontinued Operations

During the second quarter of 2012, the Company identified an error in the calculation of intercompany profit elimination in inventory for prior periods. While the Company believes the correction of this error is not material to its previously issued historical consolidated financial statements, the Company has restated certain balances within the consolidated balance sheet as of December 31, 2011, and the consolidated statements of operations, comprehensive (loss) income, and statements of cash flows for the years ended December 31, 2011 and December 25, 2010. The amounts in the tables below do not cross foot due to rounding.

The effects of this restatement and the reclassification of certain amounts into discontinued operations on the consolidated statement of operations for the year ended December 31, 2011 and the year ended December 25, 2010 are as follows (in thousands):



	Fiscal year ended December 31, 2011
	As previously reported			Corrections			Reclassifications from Discontinued Operations			As reclassified and restated
Cost of product revenues	$	82,110		$	831		$	(48,282	)	$	34,659
Loss from operations	(769		)	(831		)	(5,950		)	(7,550		)
Income (loss) before benefit (provision) for income taxes, and equity losses in unconsolidated affiliate and net (income) loss of noncontrolling interest	1,015			(831		)	(5,916		)	(5,732		)
Tax benefit (provision)	3,541			256			(3,797		)	—
Income (loss) before equity losses in unconsolidated affiliate and net (income) loss of noncontrolling interest	4,556			(575		)	(9,713		)	(5,732		)
Net income (loss) from continuing operations *	4,260			(575		)	(9,713		)	(6,028		)
Net income from discontinued operations	—			—			9,713			9,713
Net (income) loss attributable to the noncontrolling interest	(662		)	57			—			(605		)
Net income (loss) attributable to the controlling interest	3,598			(518		)	—			3,079
Net income (loss) per share:
Basic
Continuing operations	$	0.06		$	(0.01	)	$	(0.15	)	$	(0.10	)
Discontinued operations	$	—		$	—		$	0.15		$	0.15
Diluted
Continuing operations	$	0.06		$	(0.01	)	$	(0.15	)	$	(0.10	)
Discontinued operations	$	—		$	—		$	0.15		$	0.15
Weighted average number of common shares:
Basic	64,406									64,406
Diluted	65,234									65,234

* In the prior year financial statement presentation, this line was titled net income (loss) as there were no discontinued operations.

This error resulted in a decrease to net income of ($0.6) million and changes in inventory of $0.8 million and prepaid expense and other current assets of ($0.3) million within the consolidated statements of cash flows for year-ended December 31, 2011. This error did not result in any changes to net cash flows from operating, investing or financing activities.

This error resulted in a ($0.6) million increase in comprehensive loss and comprehensive loss attributable to the controlling interest for the year-ended December 31, 2011.



	Fiscal year ended December 25, 2010
	As previously reported			Corrections			Reclassifications from Discontinued Operations			As reclassified and restated
Cost of product revenues	$	81,224		$	116		$	(45,743	)	$	35,597
Income (loss) from operations	4,591			(116		)	(7,400		)	(2,925		)
Income before benefit (provision) for income taxes, and equity losses in unconsolidated affiliate and net (income) loss of noncontrolling interest	9,808			(116		)	(7,606		)	2,086
Income before equity (losses) income in unconsolidated affiliate and net (income) loss of noncontrolling interest	9,556			(116		)	(7,300		)	2,140
Net income from continuing operations *	8,956			(116		)	(7,300		)	1,540
Net income from discontinued operations	—			—			7,300			7,300
Net (income) loss attributable to the noncontrolling interest	(22		)	11			—			(10		)
Net income attributable to the controlling interest	8,934			(105		)	—			8,829
Net income (loss) per share:
Basic
Continuing operations	$	0.14		$	—		$	(0.12	)	$	0.02
Discontinued operations	$	—		$	—		$	0.12		$	0.12
Diluted
Continuing operations	$	0.13		$	—		$	(0.11	)	$	0.02
Discontinued operations	$	—		$	—		$	0.11		$	0.11
Weighted average number of common shares:
Basic	66,020									66,020
Diluted	66,712									66,712

* In the prior year financial statement presentation, this line was titled net income (loss) as there were no discontinued operations.

This error resulted in a decrease to net income of ($0.1) million and changes in inventory of $0.1 million within the consolidated statements of cash flows for year-ended December 25, 2010. This error did not result in any changes to net cash flows from operating, investing or financing activities.

This error resulted in a ($0.1) million increase in comprehensive loss and comprehensive loss attributable to the controlling interest for the year-ended December 25, 2010.

The effects of this restatement on the consolidated balance sheet as of December 31, 2011 are as follows (in thousands):



	As previously reported			Corrections			As reclassified and restated
Inventory	$	21,416		$	(947	)	$	20,469
Prepaid taxes	412			256			668
Total current assets	146,428			(691		)	145,737
Total assets	194,564			(691		)	193,872
Accumulated deficit	(124,008		)	(623		)	(124,632		)
Noncontrolling interest	5,203			(68		)	5,135
Total stockholder's equity	170,788			(691		)	170,097
Total liabilities and stockholder's equity	194,564			(691		)	193,872

Assets Held for Sale

Assets and liabilities held for sale as of December 29, 2012 pertain to applicable assets and liabilities of the Company's III-V product line. The Company did not reclassify its presentation for the December 31, 2011 balance sheet.

Impairment of Long-Lived Assets

The Company periodically reviews the carrying value of our long-lived assets to determine if facts and circumstances suggest that they may be impaired or that the amortization or depreciation period may need to be changed. The carrying value of a long-lived asset is considered impaired when the anticipated identifiable undiscounted cash flows from such asset are less than its carrying value. For assets that are to be held and used, impairment is measured based upon the amount by which the carrying amount of the asset exceeds its fair value. The carrying value of the Company’s long-lived assets, excluding assets held for sale was $8.5 million at December 29, 2012.

Recently Adopted Accounting Pronouncements

Intangibles, Goodwill and Other

In December 2010 and September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-28 and ASU 2011-08 Intangibles—Goodwill and Other, respectively, which both modify the annual goodwill impairment testing procedures. ASU 2010-28 focuses on the carrying amount of goodwill for purposes of performing step one of the goodwill test and ASU 2011-08 focuses on allowing entities the ability to first assess the qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Both of these updates are effective for annual and interim reporting periods beginning after December 15, 2011 and early adoption is permitted. ASU 2010-28 requires retrospective application. The adoption did not have any impact on its financial position, results of operations of cash flows.

Fair Value Measurement

In May 2011, the FASB issued (ASU) 2011-04 Fair Value Measurement that modifies the fair value measurements and disclosure requirements in U.S. GAAP and IFRS. This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable inputs. This guidance is effective on a prospective basis for annual and interim reporting periods beginning after December 15, 2011. The adoption did not have any impact on its financial position, results of operations of cash flows.

Statement of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05 Statement of Comprehensive Income which (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The FASB has deferred the third requirement under this ASU. This amendment does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor does this amendment affect how earnings per share is calculated or presented. This guidance is required to be applied retrospectively and is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption did not have any impact on its financial position, results of operations of cash flows.

In February 2013, the FASB issued ASU 2013-02, Other Comprehensive Income. This update requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments are effective prospectively for reporting periods beginning after December 15, 2013, with early adoption permitted. The Company does not believe the adoption of this standard will have a material effect on its consolidated financial statements.