Endwave 10Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2005


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

For the transition period from ______to ______

000-31635
(Commission file number)

ENDWAVE CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		95-4333817
(State of incorporation)		(I.R.S. Employer Identification No.)

776 Palomar Avenue, Sunnyvale, CA (Address of principal executive offices)		94085 (Zip code)

(408) 522-3100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ.

The number of shares of the registrant’s Common Stock outstanding as of November 2, 2005 was 11,313,323 shares.

ENDWAVE CORPORATION

INDEX


	Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements		3

Condensed Consolidated Balance Sheets as of September 30, 2005 (unaudited) and December 31, 2004		3

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2005 and 2004		4

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12

Item 3. Qualitative and Quantitative Disclosure about Market Risk		28

Item 4. Controls and Procedures		29

PART II. OTHER INFORMATION

Item 6. Exhibits		30

SIGNATURES		32

EXHIBITS		33
EXHIBIT 10.14
EXHIBIT 10.24
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)


	September 30,			December 31,
	2005			2004
ASSETS	(unaudited)				(1	)
Current assets:
Cash and cash equivalents	$	8,865		$	14,158
Restricted cash		25			—
Short-term investments		12,995			10,979
Accounts receivable, net		11,449			8,673
Accounts receivable from affiliate		10			15
Inventories		15,642			7,866
Other current assets		343			477

Total current assets		49,329			42,168
Property, plant and equipment, net		1,574			2,394
Other assets, net		105			125
Goodwill and intangible assets		4,948			5,407

	$	55,956		$	50,094


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:	��
Accounts payable	$	3,688		$	2,308
Accounts payable to affiliate		1,449			1,279
Accrued warranty		3,943			4,488
Accrued compensation		2,702			1,370
Restructuring liabilities, current		40			274
Other current liabilities		892			752

Total current liabilities		12,714			10,471
Other long-term liabilities		423			559

Total liabilities		13,137			11,030

Commitments and contingencies (Note 12)
Stockholders’ equity:
Common stock, $0.001 par value per share; 100,000,000 authorized, 11,277,811 and 10,499,944 issued and outstanding on September 30, 2005 and December 31, 2004, respectively		11			10
Additional paid-in capital		309,151			304,658
Treasury stock, at cost, 39,150 shares		(79	)		(79	)
Accumulated other comprehensive loss		(47	)		(30	)
Accumulated deficit		(266,217	)		(265,495	)

Total stockholders’ equity		42,819			39,064

	$	55,956		$	50,094


(1)		Derived from the Company’s audited financial statements as of December 31, 2004

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

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(unaudited)


	Three months ended						Nine months ended
	September 30,						September 30,
	2005			2004			2005			2004
Revenues:
Product revenues	$	13,523		$	7,377		$	34,367		$	21,118
Product revenues from affiliate		12			63			26			105
Development fees		785			154			1,269			564

Total revenues		14,320			7,594			35,662			21,787


Costs and expenses:
Cost of product revenues		9,668			5,395			23,800			14,607
Cost of product revenues from affiliate		1			12			3			28
Cost of product revenues, amortization of intangible assets		113			75			339			75
Research and development		1,708			1,395			4,819			3,452
Selling, general and administrative		2,386			2,204			7,119			5,738
Transaction costs		773			—			773			—
In-process research and development		—			320			—			320
Amortization of intangible assets		39			73			140			73
Restructuring charges, net		—			(4	)		(46	)		2,895
Recovery on building sublease		—			—			—			(359	)
Impairment of long-lived assets and other		—			389			—			389
Amortization of deferred stock compensation*		—			—			—			204


Total costs and expenses		14,688			9,859			36,947			27,422


Loss from operations		(368	)		(2,265	)		(1,285	)		(5,635	)
Interest and other income, net		175			231			563			993

Net loss	$	(193	)	$	(2,034	)	$	(722	)	$	(4,642	)


Basic and diluted net loss per share	$	(0.02	)	$	(0.21	)	$	(0.07	)	$	(0.48	)
Shares used in computing basic and diluted net loss per share		11,078,344			9,897,077			10,752,423			9,674,842


* Amortization of deferred stock compensation:
Cost of product revenues	$	—		$	—		$	—		$	109
Research and development		—			—			—			44
Selling, general and administrative		—			—			—			51

	$	—		$	—		$	—		$	204

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

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)


	Nine months ended
	September 30,
	2005			2004
Operating activities:
Net loss	$	(722	)	$	(4,642	)
Adjustments to reconcile net loss to net cash used in operating activities:
In-process research and development		—			320
Depreciation and amortization		1,145			1,232
Amortization of intangible assets		479			148
Impairment of long-lived assets and other		—			389
Amortization of deferred stock compensation		—			204
Restructuring charges, net		(46	)		(4	)
Gain on the sale of land and equipment		(121	)		(469	)
Recovery on building sublease		—			(359	)
Changes in operating assets and liabilities:
Accounts receivable, net		(2,771	)		1,737
Inventories		(7,776	)		851
Other assets		154			345
Accounts payable		1,550			(1,055	)
Accrued warranty		(545	)		(1,128	)
Accrued compensation and other current and long-term liabilities		1,263			(126	)

Net cash used in operating activities		(7,390	)		(2,557	)

Investing activities:
Cash paid in business combinations		(20	)		(6,067	)
Purchases of equipment		(349	)		(340	)
Proceeds on sales of property and equipment		30			5,056
Purchases of short term investments		(21,666	)		(13,037	)
Decrease (increase) in restricted cash		(25	)		778
Proceeds on maturities of short term investments		19,633			17,911

Net cash provided by (used in) investing activities		(2,397	)		4,301

Financing activities:
Payments on notes payable		—			(778	)
Proceeds from stock issuance		230			92
Proceeds from exercises of stock options		4,264			1,163

Net cash provided by financing activities		4,494			477


Net change in cash and cash equivalents		(5,293	)		2,221
Cash and cash equivalents at beginning of period		14,158			13,408

Cash and cash equivalents at end of period	$	8,865		$	15,629

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

ENDWAVE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Business and Basis of Presentation

Endwave Corporation and its wholly-owned subsidiary, Endwave Defense Systems Incorporated (together referred to as “Endwave” or the “Company”), design, manufacture and market radio frequency (“RF”) modules that enable the transmission, reception and processing of high frequency signals in telecommunication networks, defense electronics and homeland security systems. The Company’s RF modules are typically used in high-frequency applications and include:

		°	integrated transceivers – combinations of electronic devices that combine both the transmit and receive functions necessary or a bi-directional radio link;

		°	amplifiers — electronic devices used to increase the amplitude and power of an electronic signal;

		°	synthesizers — electronic devices that can be used to generate several different radio frequency signals from a single source;

		°	oscillators — electronic devices that generate alternating increasing and decreasing signals at specific intervals;

		°	up and down converters — electronic devices that shift the center frequency of a radio signal without altering the signal’s data modulation;

		°	frequency multipliers — electronic devices that increase the frequency of a radio signal in integer multiples; and

		°	microwave switch arrays — electronic devices that can switch the routing of a radio signal.

The accompanying unaudited condensed consolidated financial statements of Endwave have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the information contained herein reflects all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation of the results of the interim periods presented. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 or any future periods. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2004.

2. Warranty

The warranty periods for the Company’s products are generally between one and two years from date of shipment. The Company provides for estimated warranty expense at the time of shipment. While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of component suppliers, its warranty obligation is generally affected by product failure rates, replacement or repair costs and service delivery costs incurred in correcting product failures. Should these or other factors differ from the estimates, revisions to the estimated warranty accrual and related costs may be required.

In March 2005, the Company entered into a settlement and release agreement with Northrop Grumman Space & Mission Systems Corp. (“Northrop Grumman”) to settle all matters related to direct and indirect costs associated with a degraded semiconductor component originally provided by their foundry. Northrop Grumman reimbursed the Company’s customer for indirect costs associated with a recall of the product incorporating the degraded semiconductor component. Under the settlement and release agreement, the Company obtained the right to make a final purchase of additional wafers at preferable pricing, agreed to pay $300,000 for final reimbursement of such indirect costs, and assumed sole responsibility for any future product failures attributable to the semiconductor component. In April 2005, Endwave paid the $300,000 settlement fee and relieved the related warranty accrual. The amount is included in “warranties settled or reversed” in the table below.

During the second quarter of 2004, the Company determined that approximately $1.3 million of warranty accrual related to a possible pattern defect on a specific customer issue was no longer necessary. The amount is included in “warranties settled or reversed” in the table below. This decrease in the warranty accrual was partially offset by increases to the warranty accrual of $996,000 during the nine months ended September 30, 2004.

Changes in the Company’s product warranty liability during the nine-month periods ended September 30, 2005 and 2004 are as follows:


	2005			2004
	(in thousands)
Balance at January 1	$	4,488		$	5,835
Warranties accrued		533			996
Warranties settled or reversed		(1,078	)		(1,800	)

Balance at September 30	$	3,943		$	5,031

3. Stock-Based Compensation

The Company has elected to use the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employee” (“APB 25”), as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), subsequently amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” to account for stock-based awards issued to its employees under its stock option plans and stock purchase plans. Deferred stock compensation is amortized using the graded vesting method over the vesting period of the related options, generally four years.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS 123, Emerging Issues Task Force Issue (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and Financial Accounting Standards Board Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”

For purposes of pro forma disclosures, the Company estimates the fair value of its stock-based awards to employees using a Black-Scholes option-pricing model.

Following is the pro forma effect on net loss and net loss per share for all periods presented had the Company applied SFAS 123’s fair value method of accounting for stock-based awards issued to its employees.


	Three months ended						Nine months ended
	September 30,						September 30,
	2005			2004			2005			2004
				(in thousands)
Net loss, as reported	$	(193	)	$	(2,034	)	$	(722	)	$	(4,642	)
Add: Stock-based employee compensation expense included in reported net loss		—			—			—			204

Deduct: Stock-based employee compensation expense determined under the fair value method for all awards		(1,265	)		(693	)		(3,270	)		(2,427	)

Net loss, pro forma	$	(1,458	)	$	(2,727	)	$	(3,992	)	$	(6,865	)


Basic and diluted net loss per share, as reported	$	(0.02	)	$	(0.21	)	$	(0.07	)	$	(0.48	)
Basic and diluted net loss per share, pro forma	$	(0.13	)	$	(0.28	)	$	(0.37	)	$	(0.71	)

4. Goodwill and Intangible Assets

Goodwill

At December 31, 2004, the Company had goodwill of $1,546,000 associated with the purchase of JCA Technology, Inc. (“JCA”). During the first quarter of 2005, the Company incurred an additional liability associated with the purchase of JCA and increased the goodwill balance by $20,000.

The Company conducted its 2005 annual goodwill impairment analysis in the third quarter of 2005 and no goodwill impairment was indicated.

Intangible Assets

The components of intangible assets as of September 30, 2005 are as follows (in thousands):


	Gross Carrying		Accumulated			Net Carrying Amount
	Amount		Amortization
Developed technology	$	2,250	$	(526	)	$	1,724
Tradename		1,060		—			1,060
Customer relationships		780		(182	)		598
Customer backlog		140		(140	)		—

Intangible assets	$	4,230	$	(848	)	$	3,382

The identifiable intangible assets are subject to amortization and have approximate original estimated weighted-average useful lives as follows: developed technology — five years, customer backlog — six months and customer relationships — five years.

The tradename has a gross carrying value of $1.1 million and is not subject to amortization and will be evaluated for impairment at least annually or more frequently if events and changes in circumstances suggest that the carrying amount may not be recoverable. The Company conducted its 2005 annual impairment analysis of the tradename in the third quarter of 2005 and no impairment was indicated.

The customer backlog was fully amortized as of January 2005. The amortization of the identifiable intangible assets was $152,000 and $148,000 during the three months ending September 30, 2005 and 2004, respectively. The amortization of the identifiable intangible assets was $479,000 and $148,000 during the nine months ended September 30, 2005 and 2004, respectively. The future amortization of the identifiable intangible assets is as follows (in thousands):


Years Ending December 31
2005 (October 1 – December 31)	$	151
2006		606
2007		606
2008		606
2009		353

	$	2,322

5. Inventories

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market and are comprised of the following (in thousands):


	September 30,		December 31,
	2005		2004
Raw materials	$	12,153	$	7,139
Work in process		1,915		432
Finished goods		1,574		295

	$	15,642	$	7,866

6. Restricted Cash

Restricted cash represents a certificate of deposit held by a financial institution as collateral for a letter of credit in connection with the Company’s building lease in Andover, Massachusetts. The restricted cash balance will be maintained by the Company for the term of the lease which terminates on November 30, 2008.

7. Restructuring Charges, Net

During the third quarter of 2004, in connection with the acquisition of JCA, the Company recorded a charge for restructuring of $431,000 (the “Third Quarter 2004 Plan”). The charge was included as part of the purchase price allocation in accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” The Company terminated a total of 39 employees, in order to eliminate duplicative activities and to reduce the cost structure of the combined company. These terminations primarily affected the manufacturing and operations group. The charge was for the related severance, benefits, payroll taxes and other associated costs. There were no remaining obligations as of September 30, 2005.


	Severance Benefits
Third Quarter 2004 Plan	(In thousands)
Accrual at December 31, 2004	$	193
Cash payments		(147	)
Restructuring charge adjustment		(46	)

Accrual at September 30, 2005	$	—

Effective January 2004, the Company executed several agreements related to the leasing arrangements for its Sunnyvale headquarters. Due to declining commercial real estate lease rates, the original lease executed in August 2001 was at an above market rate, and would have expired in July 2006. This lease was cancelled effective January 2004, and the Company exited the property. In consideration for the cancellation, the Company paid the landlord a settlement fee of approximately $3.0 million resulting in a net lease termination expense of $2.9 million. The Company also entered into a new lease for 16,000 square feet in Sunnyvale, California at a lower, at-market rate. The new lease will expire in August 2006.

8. Recovery on Building Sublease

During the first quarter of 2003, the Company subleased 12,700 square feet of its Sunnyvale, California headquarter building to an unrelated third party. The rental income for the lease period was less than the rental expense that would be incurred and, therefore, a loss at sublease inception of $662,000 was incurred. During the first quarter of 2004, $359,000 of this loss was reversed as the sublease was terminated prior to its expiration date.

9. Net Loss Per Share

The Company computes basic net loss per share by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock and potential common stock equivalents outstanding during the period, if dilutive. Potential common stock equivalents include incremental shares of common stock issuable upon the exercise of stock options.

Options to purchase 1,244,415 shares of common stock were outstanding at September 30, 2005 but were not included in the computation of diluted net loss per share for the three or nine month periods ended September 30, 2005 as the effect would be anti-dilutive. Options to purchase 1,893,060 shares of common stock were outstanding at September 30, 2004 but were not included in the computation of diluted net loss per share for the three and nine month periods ended September 30, 2004 as the effect would be anti-dilutive.

10. Comprehensive Income (Loss)

Comprehensive income (loss) generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized gain (loss) on available-for-sale securities of ($32,000) and $10,000 for the three months ended September 30, 2005 and 2004, was excluded from the net loss for the respective periods. Total comprehensive loss for the three months ended September 30, 2005 and 2004 was $225,000 and $2.0 million, respectively.

The Company’s unrealized loss on available-for-sale securities of $17,000 and $32,000 for the nine months ended September 30, 2005 and 2004, was excluded from the net loss for the respective periods. Total comprehensive loss for the nine months ended September 30, 2005 and 2004 was $739,000 and $4.7 million, respectively.

11. Segment Disclosures

The Company operates in a single segment. The Company’s product sales by geographic area (based on location of customer) for the three and nine months ended September 30, 2005 and 2004 were as follows (in thousands and as a percentage of total revenues):


	Three months ended September 30,
	2005				2004
United States	$	2,043	14.3	%	$	1,813	23.8	%
Finland		6,858	47.9	%		4,152	54.7	%
Italy		2,021	14.1	%		21	0.3	%
Norway		1,868	13.0	%		—	0.0	%
Other		1,530	10.7	%		1,608	21.2	%

Total	$	14,320	100.0	%	$	7,594	100.0	%


	Nine months ended September 30,
	2005				2004
United States	$	6,216	17.4	%	$	4,475	20.5	%
Finland		18,583	52.1	%		11,693	53.7	%
Italy		4,802	13.5	%		1,048	4.8	%
Norway		2,647	7.4	%		33	0.2	%
Other		3,414	9.6	%		4,538	20.8	%

Total	$	35,662	100.0	%	$	21,787	100.0	%

For the three months ended September 30, 2005, Nokia, Nera and Siemens accounted for 47%, 16% and 14%, respectively, of the Company’s total revenues. For the three months ended September 30, 2004, Nokia and PowerWave accounted for 55% and 10%, respectively, of the Company’s total revenues. For the periods presented, no other customer accounted for more than 10% of the Company’s total revenues.

For the nine months ended September 30, 2005, Nokia and Siemens accounted for 51% and 13%, respectively, of the Company’s total revenues. For the nine months ended September 30, 2004, Nokia accounted for 54% of the Company’s total revenues. For the periods presented, no other customer accounted for more than 10% of the Company’s total revenues.

12. Commitments and Contingencies

From time to time, the Company may be subject to legal proceedings and claims in the ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial and other resources. The Company is not currently aware of any legal proceedings or claims, and management does not believe that the Company is subject to other claims that would constitute material contingencies.

13. Related Party Transactions

The Company maintains a supply agreement with Velocium, a business unit of Northrop Grumman, and a technology services agreement with Northrop Grumman. Northrop Grumman is a significant stockholder of Endwave. The supply agreement specifies volume and price commitments, as well as a description of a consigned inventory arrangement. Under this agreement, the Company purchased inventory of $2.3 million and $488,000 for the third quarter of 2005 and 2004, respectively, and $6.6 million and $1.8 million for the first nine months of 2005 and 2004, respectively. The $1.8 million of purchases made during the first nine months of 2004 is net of the reversal of a $793,000 liability pertaining to this agreement that was settled during the first quarter of fiscal 2004.

The Company also sells various products and services under purchase orders and agreements to Northrop Grumman, and recognized revenues of $12,000 and $63,000 for the third quarter of 2005 and 2004, respectively, and $26,000 and $105,000 for the first nine months of 2005 and 2004 respectively. The Company incurred costs related to this revenue of approximately $1,000 and $12,000 during the third quarter of 2005 and 2004, respectively, and $3,000 and $28,000 during the first nine months of 2005 and 2004, respectively.

At September 30, 2005, the Company had accounts receivable of $10,000 and accounts payable of $1.4 million, related to its customer and supplier relationships with Northrop Grumman.

At December 31, 2004, the Company had accounts receivable of $15,000 and accounts payable of $1.3 million related to its customer and supplier relationships with Northrop Grumman.

14. Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight and re-handling costs must be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of 2006, beginning on January 1, 2006. The Company is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material financial statement impact.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Non-monetary Assets — An Amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for non-monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Non-monetary Transactions,” and replaces it with the exception for exchanges that do not have commercial substance. SFAS 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006, beginning on January 1, 2006. The Company is currently evaluating the effect that the adoption of SFAS 153 will have on its consolidated results of operations and financial condition but does not expect it to have a material financial statement impact.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires the measurement of all share-based payments to employees, including grants of stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of operations. The accounting provisions of SFAS 123R were originally effective for all reporting periods beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. See “Stock-Based Compensation” above for the pro forma net income (loss) and net income (loss) per share amounts, as if the Company had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although the Company has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, it is evaluating the requirements under SFAS 123R and expects the adoption to have a significant adverse impact on the Company’s consolidated statements of operations and net loss per share.

In April 2005, the Securities and Exchange Commission approved a rule that delayed the effective date of SFAS 123R to the first annual reporting period beginning after June 15, 2005. SFAS123R will be effective for the Company beginning with the first quarter of 2006.

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

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements, related notes and “Risk Factors” section included elsewhere in this report on Form 10-Q, as well as the information contained under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2004. In addition to historical consolidated financial information, this discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those discussed in the forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements. In the past, our operating results have fluctuated and are likely to continue to fluctuate in the future.

The terms “we,” “us,” “our” and words of similar import below refer to Endwave Corporation and its wholly-owned subsidiary, Endwave Defense Systems Incorporated.

Overview

Revenues for the third quarter of 2005 were $14.3 million, representing an increase of $6.7 million, or 89%, from the third quarter of 2004, and an increase of $2.1 million, or 17%, from the second quarter of 2005. Revenues for the first nine months of 2005 were $35.7 million, representing an increase of $13.9 million, or 64%, from the first nine months of 2004 and have exceeded the total revenues we achieved in 2004. This pattern of revenue growth is due to increased demand from our telecommunications and defense electronics and homeland security customers. Based on our knowledge of our customers and overall market trends, we anticipate continued strong demand for our products during the fourth quarter of 2005. However, because the markets we serve are difficult to predict and the economic recovery has been inconsistent, we cannot assure you that a similar revenue growth rate will be realized during the fourth quarter of 2005.

For the three month period ended September 30, 2005, revenues from our defense electronics and homeland security customers comprised 16% of our total revenues. For the nine month period ended September 30, 2005, revenues from our defense electronics and homeland security customers comprised 19% of our total revenues. During all of 2004 revenues from our defense electronics and homeland security customers comprised 13% of our total revenues. We anticipate that the proportion of our revenues attributed to our defense electronics and homeland security customers during the remainder of 2005 will continue to be in excess of the 13% we achieved in 2004. In general, our defense electronics products are manufactured at our Diamond Springs, California location. As our defense electronics and homeland security related revenues increase, we are better able to leverage our fixed overhead costs associated with our Diamond Springs location which may result in improvements to our gross margins.

We continue to seek growth through enhancing our position as a leading merchant supplier of radio frequency (“RF”) modules, continued expansion into the defense electronics and homeland security markets, and strategic acquisitions.

During 2005, we have taken a number of steps in line with our growth strategy:

		°	In January 2005, we announced the formation of Endwave Defense Systems Incorporated (“EDSI”) to provide focus on the defense electronics and homeland security markets. The business consists of JCA Technology, Inc. (“JCA”), which we purchased in July 2004, and our legacy defense electronics business. We plan to continue to use the JCA tradename while providing highly integrated, value-added subsystem solutions for the defense electronics and homeland security markets.

		°	During 2005, we have continued to manufacture products based on our customers’ designs at the location of our offshore partner in Southeast Asia. We believe that this has allowed us to increase market share, establish relationships with new customers, increase revenues and absorb fixed costs.

Results of Operations

Three and nine months ended September 30, 2005 and 2004

The following table sets forth certain statement of operations data as a percentage of total revenues for the periods indicated:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
Total revenues		100.0	%		100.0	%		100.0	%		100.0	%

Cost of product revenues		67.5			71.2			66.7			67.2
Cost of product revenues, amortization of intangible assets		0.8			1.0			0.9			0.3
Research and development		11.9			18.4			13.5			15.8
Selling, general and administrative		16.7			29.0			20.0			26.3
Transaction costs		5.4			—			2.2			—
In-process research and development		—			4.2			—			1.5
Amortization of intangible assets		0.3			1.0			0.4			0.4
Restructuring charges, net		—			(0.1	)		(0.1	)		13.3
Recovery on building sublease		—			—			—			(1.6	)
Impairment of long-lived assets and other.		—			5.1			—			1.8
Amortization of deferred stock compensation		—			—			—			0.9

Total costs and expenses		102.6			129.8			103.6			125.9
Loss from operations		(2.6	)		(29.8	)		(3.6	)		(25.9	)
Interest and other income, net		1.3			3.0			1.6			4.6

Net loss		(1.3	)%		(26.8	)%		(2.0	)%		(21.3	)%

Revenues

Total revenues in the third quarter of 2005 were $14.3 million, an 89% increase from $7.6 million for the same period in 2004 and were comprised of product revenues and development fees. Total revenues for the nine months of 2005 were $35.7 million, a 64% increase from $21.8 million for the same period in 2004. Product revenues are attributable to sales of our RF modules. We generate development fees by developing product prototypes and custom products pursuant to development agreements that provide for payment of a portion of our research and development or other expenses. We typically enter into a development contract only if we perceive it to generate a significant opportunity for sales of our RF modules. We expect to enter into more development contracts in the future as we seek to further penetrate the defense electronics market, where development contracts are customary, but we do not expect development fees to represent a significant percentage of our total revenues for the foreseeable future.

Product revenues were $13.5 million in the third quarter of 2005, an 82% increase from $7.4 million for the same period in 2004. Product revenues were $34.4 million in the first nine months of 2005, a 62% increase from $21.2 million for the same period in 2004. The increase reflects stronger overall sales for our products in both our telecommunications networks market and defense electronics and homeland security market.

Development fees were $785,000 and $1.3 million for the three and nine month periods ended September 30, 2005, respectively, as compared to $154,000 and $564,000 for the three and nine month periods ended September 30, 2004. The increase in development fees is attributable to increased development of custom designed products for new and existing customers. During the fourth quarter 2005, we expect to generate additional revenues from these development agreements.

Cost and Expenses

Cost of product revenues.Cost of product revenues consists primarily of: costs of direct materials and labor utilized to assemble and test our products; equipment depreciation; costs associated with procurement, production control, quality assurance, and manufacturing engineering; costs associated with maintaining our manufacturing facilities; fees paid to our offshore manufacturing partner; reserves for potential excess or obsolete material; and accrued costs associated with potential warranty returns offset by the benefit of usage of materials that were previously written off.

Cost of product revenues was $9.7 million for the three months ended September 30, 2005, a 79% increase from $5.4 million for the same period in 2004. As a percentage of revenues, cost of product revenues decreased to 67.5% in the quarter ended September 30, 2005, from 71.2% for the same period in 2004. The percentage improvement was attributable to the benefit of increased absorption of our overhead costs due to increased production volume during the quarter and increased development fee revenue. The cost of product revenues was favorably impacted by the utilization of inventory that was previously written off amounting to approximately $110,000 during the third quarter of 2005 as compared to $114,000 during the third quarter of 2004.

Cost of product revenues was $23.8 million for the nine months ended September 30, 2005, a 63% increase from $14.6 million for the same period in 2004. As a percentage of revenues, cost of product revenues decreased to 66.7% in the nine months ended September 30, 2005, compared to 67.2% for the same period in 2004. The decrease in cost of product revenues as a percentage of revenues was attributable to the benefit of increased absorption of our overhead costs due to increased overall revenue during the period partially offset by a first quarter of 2004 reversal of a $793,000 charge to cost of product revenues for a liability that was settled. There were no similar reversals during the first nine months of 2005. The cost of product revenues was favorably impacted by the utilization of inventory that was previously written off amounting to approximately $400,000 during the first nine months of 2005 as compared to $361,000 during the first nine months of 2004.

Research and development expenses. Research and development expenses were $1.7 million for the three months ended September 30, 2005, a 22% increase from $1.4 million for the same period in 2004. As a percentage of revenues, research and development expenses decreased to 11.9% in the quarter ended September 30, 2005, from 18.4% for the same period in 2004. The increase in absolute dollars was attributable to the increase in project related expenses of $220,000 that supported our increased development fee revenue and personnel-related expenses of $88,000 primarily resulting from added personnel from JCA which we acquired in the third quarter of 2004.

Research and development expenses were $4.8 million for the nine months ended September 30, 2005, a 40% increase from $3.5 million for the same period in 2004. As a percentage of revenues, research and development expenses decreased to 13.5% in the nine months ended September 30, 2005, from 15.8% for the same period in 2004. The increase in absolute dollars was attributable to the increase in personnel-related expenses of $845,000 primarily related to added personnel from JCA and increased project-related expenses of $107,000 to support increased development fee revenues.

During the fourth quarter of 2005, we expect a moderate increase to research and development expenses as we accelerate certain development programs and initiate new designs primarily related to our defense electronics and homeland security business. This increase could be more significant if we have an unexpected increase in new customer-specific development projects for which we could receive some development fees.

Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries and related expenses for executive, sales, marketing, finance, accounting, legal, information technology and human resources personnel, professional fees, facilities costs, promotional activities and costs related to the implementation of the requirements under Section 404 of the Sarbanes-Oxley Act of 2002. Selling, general and administrative expenses were $2.4 million for the three months ended September 30, 2005, an 8% increase from $2.2 million for the same period in 2004. As a percentage of revenues, selling, general and administrative expenses decreased to 16.7% in the quarter ended September 30, 2005, from 29.0% for the same period in 2004. The increase in absolute dollars was attributable to increased personnel-related expenses of $191,000 primarily related to added personnel from JCA and expenses due to the implementation of the requirements under Section 404 of the Sarbanes-Oxley Act of 2002.

Selling, general and administrative expenses were $7.1 million for the nine months ended September 30, 2005, a 24% increase from $5.7 million for the same period in 2004. As a percentage of revenues, selling, general and administrative expenses decreased to 20.0% in the nine months ended September 30, 2005, from 26.3% for the same period in 2004. As noted above, the increase in absolute dollars was attributable to increased personnel-related expenses of $953,000 primarily related to added personnel from JCA and the implementation of the requirements under Section 404 of the Sarbanes-Oxley Act of 2002.

During the fourth quarter of 2005, we anticipate an increase in selling, general and administrative expenses compared to prior year levels, as we continue the implementation of the requirements under Section 404 of the Sarbanes-Oxley Act of 2002.

Transaction costs. As part of a planned public offering of common stock pursuant to a registration statement filed with the Securities and Exchange Commission, we accumulated $773,000 of transaction costs in other current assets on our condensed consolidated balance sheet. During the third quarter of 2005, we postponed our proposed public offering indefinitely and as a result expensed the $773,000 in the third quarter of 2005.

In-process research and development. As part of the acquisition of JCA on July 21, 2004 we acquired $320,000 of in-process research and development (“IPR&D”). The value of the IPR&D was determined based on a valuation analysis from an independent appraiser. The amount of the purchase price for JCA allocated to IPR&D was determined through established valuation techniques accepted in the technology industry. The $320,000 allocated to the acquired IPR&D was immediately expensed in the period the acquisition was completed because the projects associated with the IPR&D had not yet reached technological feasibility and no future alternative uses existed for the technology. There was no such charge during 2005.

Amortization of intangible assets.As part of the acquisition of JCA on July 21, 2004, we acquired $4.2 million of identifiable intangible assets, including $2.3 million of core/developed technology, $1.1 million for the tradename, $780,000 for customer relationships and $140,000 for customer backlog. These assets are subject to amortization and have approximate original estimated weighted-average useful lives as follows: core/developed technology – 5 years, customer backlog – 6 months, customer relationships – 5 years. The tradename intangible asset is not subject to amortization and will be evaluated for impairment at least annually or more frequently if events and change in circumstances suggest that the carrying amount may not be recoverable.

The amortization associated with the developed technology is a charge to cost of product revenues. Amortization of developed technology charged to cost of product revenues was $113,000 and $339,000 during the three months and nine months ended September 30, 2005, respectively, as compared to $75,000 for both the three and nine month periods ended September 30, 2004.

The amortization associated with the customer backlog and the customer relationships is a charge to operating expenses. Amortization of customer backlog was $0 and $23,000 during the during the three months and nine month periods ended September 30, 2005, respectively, as compared to $47,000 for both the three and nine month periods ended September 30, 2004. The customer backlog was fully amortized during the first quarter of 2005. Amortization of customer relationships was $39,000 and $117,000 during the three and nine month periods ended September 30, 2005, respectively, as compared to $26,000 for both the three and nine month periods ended September 30, 2004.

Restructuring charges, net.During the second quarter of 2005, we incurred a net benefit to restructuring expense related to the reversal of $46,000 of charges from the Third Quarter of 2004 restructuring plan. The original estimates of the charges related to the restructuring plan were higher than the final payouts resulting in the $46,000 benefit in the second quarter of 2005.

During the first quarter of 2004, we incurred a net lease termination fee of $2.9 million related to the termination of the lease agreement for our corporate headquarters in Sunnyvale, California. During the first quarter of 2004, we finalized the terms of the lease termination, which resulted in a $3.0 million cash payment to our landlord in exchange for substantially reduced rent in a new location. This settlement was partially offset by a $101,000 benefit due to the reversal of deferred rent liability related to the previous lease agreement.

During the third quarter of 2003, we recorded a restructuring charge of $490,000, all of which was for severance payments. We eliminated 18 positions and made severance payments of $486,000. The remaining $4,000 was reversed during the third quarter of 2004.

Amortization of deferred stock compensation. Deferred stock compensation charges consist primarily of charges related to the difference between deemed fair market values for financial reporting purposes on the date of employee option grants and the option price for option awards prior to our initial public offering, as well as expenses attributable to the acceleration of options. During the first half of 2004, amortization of deferred stock compensation was $204,000. There were no such charges during 2005 or during the third quarter of 2004.

Recovery on building sublease.During the first quarter of 2003, we recorded a charge of $662,000 associated with the sublease of our Sunnyvale, California headquarter building for the excess of the remaining lease obligations over the anticipated sublease income. During the first quarter of 2004, $359,000 of this loss was reversed as the sublease was terminated prior to expiration date, as a part of lease termination noted above. There was no such charge or recovery during 2005.

Impairment of long-lived assets. During the third quarter of 2004, we recorded a charge of $389,000 to write off the remaining carrying value of equipment held-for-sale of $259,000 and to write off $130,000 associated with sales tax capitalized as part of our acquisition of Stellex Broadband Wireless in April 2001. The equipment held-for-sale was determined to have no value based on a current market review of similar assets and our inability to sell the assets despite our marketing efforts. The $130,000 of capitalized sales tax was related to equipment that had been fully depreciated or fully impaired previously, and as such was also fully written off. There were no such charges during 2005.

Interest and other income, net.Interest and other income, net consists primarily of interest income earned on our cash, cash equivalents and short-term investments and gains and losses on the sale of fixed assets, partially offset by interest expense on notes payable and capital equipment leases. Interest and other income, net was $175,000 for the three months ended September 30, 2005, a decrease from $231,000 for the same period in 2004. The decrease is primarily due to lower cash balances as we paid out $6.1 million during the third quarter of 2004 related to the acquisition of JCA.

Interest and other income, net was $563,000 for the nine months ended September 30, 2005, a decrease from $993,000 for the same period in 2004. The decrease was due primarily to the sale of land, fixed assets and assets held-for-sale during the first quarter of 2004, which resulted in a net gain of $473,000 during the period which was partially offset by interest expense on notes payable and capital lease equipment.

Liquidity and Capital Resources

We had cash, cash equivalents, restricted cash, and short-term investments at September 30, 2005 and December 31, 2004 of $21.9 million and $25.1 million, respectively.

During the first nine months of 2005, we used $7.4 million of cash in operating activities, as compared to $2.6 million in the same period of 2004. The use of $7.4 million of cash in the first nine months of 2005 was due primarily to an increase in inventory of $7.8 million and an increase in accounts receivable of $2.8 million, partially offset by a $1.6 million increase in accounts payable and $1.3 million increase in accrued compensation and other current and long-term liabilities. We believe the increase in inventory will be utilized to satisfy anticipated customer demand. The use of $2.6 million of cash in the first nine months of 2004 was due primarily to the net loss adjusted for non-cash items of $3.2 million, a $2.3 million decrease in accounts payable, accrued warranty and accrued compensation and other current and long-term liabilities, partially offset by a decrease in accounts receivable of $1.7 million, a decrease in inventory of $851,000 and a decrease in other assets of $345,000.

Investing activities used $2.4 million of cash in the first nine months of 2005 due primarily to our increased investment in short-term securities. During the first nine months of 2004 investing activities provided $4.3 million of cash due primarily to $5.1 million proceeds on sales of buildings and land and $4.9 net cash provided by the maturity of short-term securities. This was partially offset by the use of $6.1 million for the purchase of JCA.

Financing activities provided cash of $4.5 million in the first nine months of 2005 as compared to $477,000 in the first nine months of 2004. The increase in cash from financing activities in the first nine months of 2005 and 2004 was primarily due to increased proceeds from the exercise of employee stock options and stock issuances.

We believe that our existing cash and investment balances will be sufficient to meet our working capital and capital expenditure requirements for the next 12 months and the foreseeable future thereafter. During the next 12 months, we expect to incur approximately $2.0 million in capital expenditures for manufacturing and development equipment in order to support our projected business. Our cash needs are dependent upon our rate of revenue growth, the level of our marketing and sales activities and expansion of our customer base, the pursuit of future acquisitions, the timing and extent of spending to support research and development efforts, expansion into new markets and the timing of introductions of new products. With the exception of operating leases, we have not entered into any off-balance sheet financing arrangements, we have not established or invested in any variable interest entities and we do not have any unconditional purchase obligations, nor do we have non-cancelable commitments for capital expenditures. We have not guaranteed the debt or obligations of other entities or entered into options on non-financial assets.

The following table summarizes our future payment obligations for operating leases (excluding interest):


	Operating
	Leases
Years Ending December 31,	(in thousands)
2005 (October 1 – December 31)	$	176
2006		422
2007		300
2008		300
2009		105

Total minimum payments required	$	1,303

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight and re-handling costs must be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by us in the first quarter of 2006, beginning on January 1, 2006. We are currently evaluating the effect that the adoption of SFAS 151 will have on our consolidated results of operations and financial condition but do not expect SFAS 151 to have a material financial statement impact.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Non-monetary Assets — An Amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for non-monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Non-monetary Transactions,” and replaces it with the exception for exchanges that do not have commercial substance. SFAS 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by us in the first quarter of fiscal 2006, beginning on January 1, 2006. We are currently evaluating the effect that the adoption of SFAS 153 will have on our consolidated results of operations and financial condition but do not expect it to have a material financial statement impact.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires the measurement of all share-based payments to employees, including grants of stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of operations. The accounting provisions of SFAS 123R were originally effective for all reporting periods beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. See Note 3 to the unaudited condensed consolidated financial statements above for the pro forma net income (loss) and net income (loss) per share amounts, as if we had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123R and expect the adoption to have a significant adverse impact on our consolidated statements of operations and net loss per share.

In April 2005, the Securities and Exchange Commission approved a rule that delayed the effective date of SFAS 123R to the first annual reporting period beginning after June 15, 2005. SFAS 123R will be effective for us beginning with the first quarter of 2006.

RISK FACTORS

You should consider carefully the following risk factors as well as other information in this report and the documents incorporated by reference herein or therein, before investing any of our securities. If any of the following risks actually occur, our business, operating results and financial condition could be adversely affected. This could cause the market price of our common stock to decline, and you may lose all or part of your investment.

Risks Relating to Our Business

We have had a history of losses and may not be profitable in the future.

We have had a history of losses. We had a net loss of $722,000 during the first nine months of 2005. We also had net losses of $31.0 million, $7.9 million and $4.4 million for the years ended December 31, 2002, 2003 and 2004 respectively. There is no guarantee that we will achieve or maintain profitability in the future.

We depend on a small number of key customers in the telecommunications industry for a large portion of our revenues. If we lose any of our major customers, particularly Nokia, or there is any material reduction in orders for our products from any of these customers, our business, financial condition and results of operations would be adversely affected.

We depend, and expect to continue to depend, on a relatively small number of telecommunications network original equipment manufacturers and systems integrators, collectively referred to in this report as telecom OEMs, for a large portion of our revenues. The loss of any of our major customers, particularly Nokia, or any material reduction in orders from any of such customers would have a material adverse effect on our business, financial condition and results of operations. In 2002, 2003, 2004 and the first nine months of 2005 revenues from Nokia accounted for 71%, 59%, 55% and 51% of our total revenues, respectively. Revenues from Siemens accounted for 13% of our total revenues for the first nine months of 2005. Revenues from Nera ASA accounted for 10% of our total revenues for 2004. Revenues from Stratex Networks, Inc. accounted for 13% of our total revenues for 2003. We had no other customers individually representing more than 10% of our total revenues for 2002, 2003, 2004 or the first nine months of 2005. Most of our customer agreements are in the form of purchase orders and are not pursuant to a formal agreement. As a result, none of our major customers is under any long-term commitment to purchase products from us, and there is no guarantee that any of them will continue to do business with us.

We depend on the telecommunications industry for most of our revenues. If this industry suffers another downturn or fails to grow as anticipated, our revenues could decrease and our profitability could suffer. In addition, consolidation in this industry could result in delays or cancellations of orders for our products, adversely impacting our results of operations.

We depend, and expect to remain dependent, on the telecommunications industry for most of our revenues. Revenues from all of our telecom OEM customers comprised 86% of our total revenues in 2004 and 81% of our total revenues in the first nine months of 2005.

The telecommunications industry suffered a significant worldwide downturn beginning in 2000, and has only recently begun to grow again. In connection with this downturn, there were worldwide reductions in telecommunications network projects that resulted in the loss of some of our key customers and reduced revenues from our remaining customers. We also were forced to undertake significant cost reduction measures as a result. The telecommunications industry has only recently begun to grow again. Our revenues are dependent, in part, on growth of wireless telephony, increasing data-intensive cellular traffic, deployment of third-generation, or “3G”, networks and the introduction of other high capacity data-only telecommunications networks. If similar downturns reoccur, or if the telecommunications industry fails to grow as we anticipate, our revenues may remain flat or decrease. Significantly lower revenues would likely force us to make provisions for excess inventory and abandoned or obsolete equipment and reduce our operating expenses. To reduce our operating expenses, we could be required to reduce the size of our workforce and consolidate facilities. We cannot guarantee that we would be able to reduce operating expenses to a level commensurate with the lower revenues resulting from such an industry downturn.

The telecommunications industry has undergone significant consolidation in the past few years and we expect that consolidation to continue. The acquisition of one of our major customers in this market, or one of the communications service providers supplied by one of our major customers, could result in delays or cancellations of orders of our products and, accordingly, delays or reductions in our anticipated revenues and reduced profitability or increased net losses.

Our future success depends in part on our ability to further penetrate into new markets, such as defense electronics and homeland security, and we may be unable to do so.

Historically, all or a large majority of our revenues have been attributable to sales of our RF modules to telecom OEMs such as Nokia. Part of our growth strategy is to design and sell high-frequency RF modules for and to OEMs and systems integrators in new markets, particularly defense electronics and homeland security. To date, only a small percentage of our revenues has been attributable to sales of RF modules to defense systems integrators. We have only recently begun to design and sell products for the recently emerging homeland security market. The potential size of this market is unclear and we cannot predict how the market will evolve. If increased demand for high-frequency RF modules in the defense electronics and homeland security markets does not materialize, we fail to secure new design wins in these markets or we are unable to design readily manufacturable products for these new markets, our growth and revenues could be adversely impacted, thereby decreasing our profitability or increasing our net losses.

Our operating results fluctuate significantly based on seasonal factors in the telecommunications network market.

In the past, our operating results have reflected lower revenues in the first and third calendar quarters due to seasonality in the telecommunications network market. Revenues attributable to telecom OEMs typically contract in the first quarter due to delays in purchasing resulting from wireless carriers’ budgeting processes. The third quarter is generally slow in our telecommunications network market as many of our European telecom OEM customers shut down their factories for a portion of the summer months. The fourth quarter historically has been our strongest quarter as the wireless carriers expend their remaining capital budgets for the year. The third quarter of 2005 did not reflect this historical pattern, and we believe the sequential increase in revenues we generally see from the third quarter to the fourth quarter may not be as significant, as we have experienced in the past, but we cannot assure you that will be the case.

Because of the shortages of some components and our dependence on single source suppliers and custom components, we may be unable to obtain an adequate supply of components of sufficient quality in a timely fashion, or we may be required to pay higher prices or to purchase components of lesser quality.

Many of our products are customized and must be qualified with our customers. This means that we cannot change components in our products easily without delays associated with requalification. Accordingly, while a number of the components we use in our products are made by multiple suppliers, we may effectively have single source suppliers for some of these components.

In addition, we currently purchase a number of components, some from single source suppliers, including, but not limited to:

	•		semiconductor devices;

	•		application-specific monolithic microwave integrated circuits;

	•		voltage-controlled oscillators;

	•		voltage regulators;

	•		lead-free surface mount components;

	•		high-frequency circuit boards;

	•		custom connectors;

	•		electromagnetic housings;

	•		yttrium iron garnet components; and

	•		magnetic components.

Any delay or interruption in the supply of these or other components could impair our ability to manufacture and deliver our products, harm our reputation and cause a reduction in our revenues. In addition, any increase in the cost of the components that we use in our products could make our products less competitive and lower our margins. Recently, we suffered from a shortage of and quality issues with various components, including voltage-controlled oscillators, voltage regulators and certain high-frequency circuit boards. These shortages and quality issues have adversely impacted our product revenues in each of the last three quarters and may further reduce product revenues in the future. Our single source suppliers could enter into exclusive agreements with or be acquired by one of our competitors, increase their prices, refuse to sell their products to us, discontinue products or go out of business. Even to the extent alternative suppliers are available to us and their components are qualified with our customers on a timely basis, identifying them and entering into arrangements with them may be difficult and time consuming, and they may not meet our quality standards. We may not be able to obtain sufficient quantities of required components on the same or substantially the same terms.

Our cash requirements will be impacted by our need to increase inventories.

As part of our expansion in the telecommunications market and our increased emphasis on the defense electronics and homeland security markets, we have increased the number of our products by over three times during 2005. The products we manufacture require hundreds to thousands of components obtained from a wide variety of suppliers and we have faced component shortages and quality issues from our suppliers. In addition, in order to maintain and enhance our competitive position, we must be able to satisfy our customers’ rapidly-changing needs. As a result of these challenges, we have significantly increased our raw materials inventory and added more finished products to our key customers’ consignment stocks so that they will be better-positioned to meet their own customers’ demand. These increases in raw materials and finished goods have significantly increased our working capital needs.

We rely heavily on a Thailand facility of HANA Microelectronics Co., Ltd., a contract manufacturer, to produce our RF modules. If HANA is unable to produce these modules in sufficient quantities or with adequate quality, or it chooses to terminate our manufacturing arrangement, we will be forced to find an alternative manufacturer and may not be able to fulfill our production commitments to our customers, which could cause sales to be delayed or lost and could harm our reputation.

We outsource the assembly and testing of most of our products to a Thailand facility of HANA Microelectronics Co., Ltd., or HANA, a contract manufacturer. We plan to continue this arrangement as a key element of our operating strategy. If HANA does not provide us with high quality products and services in a timely manner, or terminates its relationship with us, we may be unable to obtain a satisfactory replacement to fulfill customer orders on a timely basis. In the event of an interruption of supply from HANA, sales of our products could be delayed or lost and our reputation could be harmed. Our manufacturing agreement with HANA currently expires in July 2006 but will renew automatically for a one-year period unless either party notifies the other of its desire to terminate the agreement at least 90 days prior to the expiration of the term. In addition, either party may terminate the agreement without cause upon 120 days prior written notice to the other party, and either party may terminate the agreement if the non-terminating party is in breach and does not cure the breach within 30 days after notice of the breach is given by the terminating party. There can be no guarantee that HANA will not seek to terminate its agreement with us.

We rely on Velocium and other third-party semiconductor foundries to manufacture the semiconductors contained in our products. The loss of our relationship with any of these foundries, particularly Velocium, without adequate notice would adversely impact our ability to fill customer orders and could damage our customer relationships.

We design semiconductor devices. However, we do not own or operate a semiconductor fabrication facility, or foundry, and rely on a limited number of third parties to produce these components. Our primary semiconductor foundry is Velocium, a business unit of Northrop Grumman Space & Mission Systems Corp., which was the holder of approximately 11.9% of our common stock as of November 2, 2005, and a wholly-owned subsidiary of Northrop Grumman Corporation. In this report, we refer to the Northrop Grumman Space & Mission Systems Corp. foundry by its tradename, Velocium. Velocium produced over 85% of our semiconductors in 2004. We also use other suppliers for some of our products. The loss of our relationship with or our access to any of the semiconductor foundries we currently use, particularly Velocium, and any resulting delay or reduction in the supply of semiconductor devices to us, would severely impact our ability to fulfill customer orders and could damage our relationships with our customers.

Our current supply agreement with Velocium expires in December 2005. We are currently in contract renewal negotiations but may not be able to negotiate an extension to this agreement on favorable terms, if at all. We also may not be successful in forming alternative supply arrangements that provide us with a sufficient supply of gallium arsenide devices. Because there is a limited number of semiconductor foundries that use the particular process technologies we select for our products and have sufficient capacity to meet our needs, using alternative or additional semiconductor foundries would require an extensive qualification process that could prevent or delay product shipments and revenues. We estimate that it may take up to six months to shift production of a given semiconductor circuit design to a new foundry.

Implementing our acquisition strategy could result in dilution to our stockholders and operating difficulties leading to a decline in revenues and operating profit.

One of our strategies is to grow through acquisitions. To that end, we have completed five acquisitions since our initial public offering and intend to pursue attractive acquisitions in our market as appropriate. The process of investigating, acquiring and integrating any business into our business and operations is risky and may create unforeseen operating difficulties and expenditures. The areas in which we may face difficulties include:

	•		diversion of our management from the operation of our core business;

	•		assimilating the acquired operations and personnel;

	•		integrating information technology and reporting systems;

	•		retention of key personnel;

	•		retention of acquired customers; and

	•		implementation of controls, procedures and policies in the acquired business.

For example, it took us longer to integrate JCA Technology into our operations at our Diamond Springs facilities than we originally anticipated. Additionally, the JCA acquisition required us to devote efforts to standardize the product design and manufacturing process to reduce dependence on specific personnel. As a result of these difficulties, our ability to deliver our defense electronics products to our customers in a timely manner was temporarily adversely affected.

In addition to the factors set forth above, we may encounter other unforeseen problems with acquisitions that we may not be able to overcome. Future acquisitions may require us to issue shares of our stock or other securities that dilute our other stockholders, expend cash, incur debt, assume liabilities, including contingent or unknown liabilities, or create additional expenses related to write-offs or amortization of intangible assets with estimated useful lives, any of which could materially adversely affect our revenues and our operating profits.

Our products may contain component, manufacturing or design defects or may not meet our customers’ performance criteria, which could cause us to incur significant repair expenses, harm our customer relationships and industry reputation, and reduce our revenues and profitability.

We have experienced manufacturing quality problems with our products in the past and may have similar problems in the future. As a result of these problems, we have replaced components in some products, or replaced the product, in accordance with our product warranties. Our product warranties typically last one to two years. As a result of component, manufacturing or design defects, we may be required to repair or replace a substantial number of products under our product warranties, incurring significant expenses as a result. Further, our customers may discover latent defects in our products that were not apparent when the warranty period expired. These defects may cause us to incur significant repair or replacement expenses beyond the normal warranty period. In addition, any component, manufacturing or design defect could cause us to lose customers or revenues or damage our customer relationships and industry reputation.

For example, some radios incorporating our transceivers that are manufactured and shipped by one of our customers have experienced degraded performance after installation in the field. The cause of the degradation was identified to be a faulty semiconductor component originally developed and supplied by TRW Inc. that was incorporated in the transceiver. TRW was later acquired by Northrop Grumman Corporation and renamed Northrop Grumman Space & Mission Systems Corp., and its foundry is referred to by its tradename, Velocium. Pursuant to a settlement agreement between TRW and us, we are responsible for the direct costs associated with the repair and replacement of the degraded transceivers produced under our supply agreement with the customer. Northrop Grumman Space & Mission Systems Corp., as successor to TRW, compensated our customer for the indirect costs associated with the repair and replacement of the degraded radios and transceivers. These indirect costs include the costs associated with removing and replacing the radios in the field as well as removing and replacing the transceiver module in each returned radio. During 2001, we reserved $4.6 million for warranty charges to cover the actual repair of the transceivers containing these faulty components, of which $1.8 million had been used through September 30, 2005.

Under an agreement we entered into with Northrop Grumman Space & Mission Systems Corp. (“Northrop Grumman”) in March 2005, we agreed to pay $300,000 to Northrop Grumman Space & Mission Systems Corp. as final reimbursement for these indirect costs and to assume sole responsibility for any future product failures attributable to the semiconductor component. In April 2005, Endwave paid the $300,000 settlement fee to Northrop Grumman. We are in the process of designing a replacement component, which will be fabricated by an alternate supplier that we believe will eliminate the degradation of performance in future production units. We expect to complete the design and qualification of this replacement component by the end of 2005 at a cost to us of approximately $120,000.

We depend on our key personnel. Skilled personnel in our industry can be in short supply. If we are unable to retain our current personnel or hire additional qualified personnel, our ability to develop and successfully market our products would be harmed.

We believe that our future success depends upon our ability to attract, integrate and retain highly skilled managerial, research and development, manufacturing and sales and marketing personnel. Skilled personnel in our industry can be in short supply. As a result, our employees are highly sought after by competing companies and our ability to attract skilled personnel is limited. To attract and retain qualified personnel, we may be required to grant large stock option or other stock-based incentive awards, which may harm our operating results or be dilutive to our other stockholders. We may also be required to pay significant base salaries and cash bonuses, which could harm our operating results.

Due to our relatively small number of employees and the limited number of individuals with the skill set needed to work in our industry, we are particularly dependent on the continued employment of our senior management team and other key personnel. If one or more members of our senior management team or other key personnel were unable or unwilling to continue in their present positions, these persons would be very difficult to replace, and our ability to conduct our business successfully could be seriously harmed. We do not maintain key person life insurance policies.

Competitive conditions may require us to reduce prices in the future and, as a result, we may need to reduce our costs in order to be profitable.

Over the past year, we have reduced our prices by 10% to 15% in order to remain competitive and we expect market conditions will cause us to reduce our prices in the future. In order to reduce our per-unit cost of product revenues, we must continue to design and re-design products to require lower cost materials, improve our manufacturing efficiencies and successfully move production to low-cost, offshore locations. The combined effects of these actions may be insufficient to achieve the cost reductions needed to be profitable.

The length of our sales cycle requires us to invest substantial financial and technical resources in a potential sale before we know whether the sale will occur. There is no guarantee that the sale will ever occur and if we are unsuccessful in designing a high-frequency RF module for a particular generation of a customer’s products, we may need to wait until the next generation of that product to sell our products to that particular customer.

Our products are highly technical and the sales cycle can be long. Our sales efforts involve a collaborative and iterative process with our customers to determine their specific requirements either in order to design an appropriate solution or to transfer the product efficiently to our offshore contract manufacturer. Depending on the product, the sales cycle can take anywhere from 2 to 12 months, and we incur significant expenses as part of this process without any assurance of resulting revenues. We generate revenues only if our product is selected for incorporation into a customer’s system and that system is accepted in the marketplace. If our product is not selected, or the customer’s development program is discontinued, we generally will not have an opportunity to sell our product to that customer until that customer develops a new generation of its system. There is no guarantee that our product will be selected for that new generation of its system. In the past, we have had difficulty meeting some of our major customers’ stated volume and cost requirements. The length of our product development and sales cycle makes us particularly vulnerable to the loss of a significant customer or a significant reduction in orders by a customer because we may be unable to quickly replace the lost or reduced sales.

We may not be able to design our products as quickly as our customers require, which could cause us to lose sales and may harm our reputation.

Existing and potential customers typically demand that we design products for them under difficult time constraints. In the current market environment, the need to respond quickly is particularly important. If we are unable to commit the necessary resources to complete a project for a potential customer within the requested timeframe, we may lose a potential sale. Our ability to design products within the time constraints demanded by a customer will depend on the number of product design professionals who are available to focus on that customer’s project and the availability of professionals with the requisite level of expertise is limited.

Each of our telecommunications network products is designed for a specific range of frequencies. Because different national governments license different portions of the frequency spectrum for the telecommunications network market, and because communications service providers license specific frequencies as they become available, in order to remain competitive we must adapt our products rapidly to use a wide range of different frequencies. This may require the design of products at a number of different frequencies simultaneously. This design process can be difficult and time consuming, could increase our costs and could cause delays in the delivery of products to our customers, which may harm our reputation and delay or cause us to lose revenues.

In our other markets, our customers have specific requirements that can be at the forefront of technological development and therefore difficult and expensive to develop. If we are not able to devote sufficient resources to these products, or we experience development difficulties or delays, we could lose sales and damage our reputation with those customers.

We may not be able to manufacture and deliver our products as quickly as our customers require, which could cause us to lose sales and would harm our reputation.

In the fourth quarter of 2004 and the first nine months of 2005, we have been unable to manufacture products in the volume requested by our customers. In the future, we may not be able to manufacture products and deliver them to our customers at the times and in the volumes they require. Manufacturing delays and interruptions can occur for many reasons, including, but not limited to:

	•		the failure of a supplier to deliver needed components on a timely basis or with acceptable quality;

	•		lack of sufficient capacity;

	•		poor manufacturing yields;

	•		equipment failures;

	•		manufacturing personnel shortages;

	•		labor disputes;

	•		transportation disruptions;

	•		changes in import/export regulations;

	•		infrastructure failures at the facilities of our offshore contract manufacturer;

	•		natural disasters;

	•		acts of terrorism; and

	•		political instability.

Manufacturing our products is complex. The yield, or percentage of products manufactured that conform to required specifications, can decrease for many reasons, including materials containing impurities, equipment not functioning in accordance with requirements or human error. If our yield is lower than we expect, we may not be able to deliver products on time. For example, in the past, we have on occasion experienced poor yields on certain products that have prevented us from delivering products on time and have resulted in lost sales. If we fail to manufacture and deliver products in a timely fashion, our reputation may be harmed, we may jeopardize existing orders and lose potential future sales, and we may be forced to pay penalties to our customers.

As part of our strategy, we may expand our domestic manufacturing capacity beyond the level required for our current sales in order to accommodate anticipated increases in our defense electronics business. As a result, our domestic manufacturing facilities may be underutilized from time to time. Conversely, if we do not maintain adequate manufacturing capacity to meet demand for our defense electronic products, we may lose opportunities for additional sales. Any failure to have sufficient manufacturing capacity to meet demand could cause us to lose revenues, thereby reducing our profitability, or increasing our net losses, and could harm our reputation with customers.

Because we do not have long-term commitments from many of our customers, we must estimate customer demand, and errors in our estimates could have negative effects on our inventory levels and revenues.

Our sales are generally made on the basis of formal agreements and purchase orders, which may be later modified or canceled by the customer, rather than firm long-term purchase commitments. We have historically been required to place firm orders for products and manufacturing equipment with our suppliers up to six months prior to the anticipated delivery date and, on occasion, prior to receiving an order for the product, based on our forecasts of customer demands. Our sales process requires us to make multiple demand forecast assumptions, each of which may introduce error into our estimates, causing excess inventory to accumulate or a lack of manufacturing capacity when needed. If we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell when we expect or at all. As a result, we would have excess inventory, which would harm our financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity were available, we would lose revenue opportunities, market share and damage our customer relationships. On occasion, we have been unable to adequately respond to unexpected increases in customer purchase orders and were unable to benefit from this increased demand. There is no guarantee that we will be able to adequately respond to unexpected increases in customer purchase orders in the future, in which case we may lose the revenues associated with those additional purchase orders and our customer relationships and reputation may suffer.

Some of our customer contracts require us to manufacture products designed by our customers. While we intend to convert these products to products of our own design, such transitions may be difficult to implement and delays or difficulties in doing so could harm our operating results.

Some of our customer contracts are based on the transfer of product manufacturing from our customers’ factories to our own. Under these contracts, we may be required to manufacture the products in a manner similar to the way our customers previously manufactured them until we are able to convert these products to products of our own design. The objective of converting a product to one of our own design is to improve manufacturability and lower costs. If we encounter difficulties or delays in transitioning a customer’s product to our manufacturing facilities, revenues attributable to that product could be delayed or lost. The cost of manufacturing a customer-designed product is typically higher than the cost of manufacturing a product of our own design. In the short term, while we are manufacturing a customer-designed product, our profit margins will be adversely impacted. Similarly, difficulties and delays in transitioning a product to a product of our own design will result in reduced profitability over the long-term.

Any failure to protect our intellectual property appropriately could reduce or eliminate any competitive advantage we have.

Our success depends, in part, on our ability to protect our intellectual property. We rely primarily on a combination of patent, copyright, trademark and trade secret laws to protect our proprietary technologies and processes. As of September 30, 2005, we had 38 United States patents issued, many with associated foreign filings and patents. Our issued patents include those relating to basic circuit and device designs, semiconductors, Multilithic Microsystem technology and system designs. Our issued United States patents expire between 2007 and 2020. We maintain a vigorous technology development program that routinely generates potentially patentable intellectual property. Our decision as to whether to seek formal patent protection is done on a patent by patent basis and is based on the economic value of the intellectual property, the anticipated strength of the resulting patent, the cost of pursuing the patent and an assessment of using a patent as a strategy to protect the intellectual property.

To protect our intellectual property, we enter into confidentiality and assignment of rights to inventions agreements with our employees, and confidentiality and non-disclosure agreements with third parties, and generally control access to and distribution of our documentation and other proprietary information. These measures may not be adequate in all cases to safeguard the proprietary technology underlying our products. It may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited outside of the United States, Europe and Japan. We may not be able to obtain any meaningful intellectual property protection in other countries and territories. Additionally, we may, for a variety of reasons, decide not to file for patent, copyright, or trademark protection outside of the United States. We occasionally agree to incorporate a customer’s or supplier’s intellectual property into our designs, in which case we have obligations with respect to the non-use and non-disclosure of that intellectual property. We also license technology from other companies, including Northrop Grumman Corporation. There are no limitations on our rights to make, use or sell products we may develop in the future using the technology licensed to us by Northrop Grumman Corporation, provided that the products are for commercial customers and non-satellite applications. Steps taken by us to prevent misappropriation or infringement of our intellectual property or the intellectual property of our customers may not be successful. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary rights of others, including our customers. Litigation of this type could result in substantial costs and diversion of our resources.

We may receive in the future, notices of claims of infringement of other parties’ proprietary rights. In addition, the invalidity of our patents may be asserted or prosecuted against us. Furthermore, in a patent or trade secret action, we could be required to withdraw the product or products as to which infringement was claimed from the market or redesign products offered for sale or under development. We have also at times agreed to indemnification obligations in favor of our customers and other third parties that could be triggered upon an allegation or finding of our infringement of other parties’ proprietary rights. These indemnification obligations would be triggered for reasons including our sale or supply to a customer or other third parties of a product which was later discovered to infringe upon another party’s proprietary rights. Irrespective of the validity or successful assertion of such claims we would likely incur significant costs and diversion of our resources with respect to the defense of such claims. To address any potential claims or actions asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. However, in such an instance, a license may not be available on commercially reasonable terms, if at all.

With regard to our pending patent applications, it is possible that no patents may be issued as a result of these or any future applications or the allowed patent claims may be of reduced value and importance. If they are issued, any patent claims allowed may not be sufficiently broad to protect our technology. Further, any existing or future patents may be challenged, invalidated or circumvented thus reducing or eliminating their commercial value. The failure of any patents to provide protection to our technology might make it easier for our competitors to offer similar products and use similar manufacturing techniques.

Risks Relating to Our Industry

Our acquisition of JCA Technology and our own marketing and sales efforts have increased the volume of our products used by the United States government. Our revenues in this market largely depend upon the funding and implementation decisions of Congress and United States government agencies. These decisions could change abruptly and without notice, unexpectedly reducing our current or future revenues in this market.

Our growth is partially dependent on growth in sales to defense electronics and homeland security prime contractors as a first-tier subcontractor. Government appropriations and prime contractor reactions to changing levels of contract funding availability can cause re-programming of first-tier subcontractor requirements by prime contractors in a way that reduces our current revenues or future revenue forecasts. These funding and implementation decisions are difficult to predict and may change abruptly. If they change in a manner unfavorable to us, we could find that previously expected and forecasted revenues do not materialize.

Our failure to compete effectively could reduce our revenues and margins.

Among merchant suppliers in the telecommunications network market, we primarily compete with Eyal Microwave Industry, Filtronics plc, the Forem division of Andrew Corporation, Linkra Srl, Microelectronics Technology Inc., REMEC, Inc., Teledyne Technologies Incorporated, Thales Group SA and Xytrans Inc. In addition to these companies, there are telecom OEMs, such as Ericsson and NEC Corporation, that use their own captive resources for the design and manufacture of their high-frequency RF transceiver modules, rather than use merchant suppliers like us. We believe that approximately one-half of the high-frequency RF transceiver modules manufactured today are being produced by these captive resources. To the extent that telecom OEMs presently, or may in the future, produce their own RF transceiver modules, we lose the opportunity to gain a customer and the potential related sales. In the defense electronics and homeland security markets, we primarily compete with Aeroflex Incorporated, AML Communications Inc., Chelton, Ltd., CTT Inc., Herley Industries, Inc., KMIC Technology, Inc. and Teledyne Technologies Incorporated.

Many of our current and potential competitors are substantially larger than us and have greater financial, technical, manufacturing and marketing resources. In addition, we have only recently begun to design and sell products for homeland security applications as the market for homeland security is only now emerging. If we were unable to compete successfully, our future operations and financial results would be harmed.

Our failure to comply with any applicable environmental regulations could result in a range of consequences, including fines, suspension of production, excess inventory, sales limitations and criminal and civil liabilities.

Due to environmental concerns, the need for lead-free solutions in electronic components and systems is receiving increasing attention within the electronics industry as companies are moving towards becoming compliant with the Restriction of Hazardous Substances Directive, or RoHS Directive. The RoHS Directive is European legislation that restricts the use of a number of substances, including lead, effective July 2006. We believe that our products will be compliant with the RoHS Directive and that materials will be available to meet these emerging regulations. However, it is possible that unanticipated supply shortages or delays or excess non-compliant inventory may occur as a result of these new regulations. Failure to comply with any applicable environmental regulations could result in a range of consequences, including loss of sales, fines, suspension of production, excess inventory, and criminal and civil liabilities.

Government regulation of the communications industry could limit the growth of the markets that we serve or could require costly alterations of our current or future products.

The markets that we serve are highly regulated. Communications service providers must obtain regulatory approvals to operate broadband wireless access networks within specified licensed bands of the frequency spectrum. For example, the Indian government’s unexpected decision to award a license to a carrier in an alternative frequency band for which we did not then supply RF modules adversely impacted our revenues for the first quarter of 2004. Further, the Federal Communications Commission and foreign regulatory agencies have adopted regulations that impose stringent RF emissions standards on the communications industry. In response to the new environmental regulations on health and safety in Europe and China, we are required to design and build a lead-free product. Changes to these regulations may require that we alter the performance of our products.

Risks Relating to Ownership of Our Stock

The assets of Wood River Partners, L.P. and certain of its affiliates, the holders of approximately 37.9% of our outstanding common stock as of November 3, 2005, have been placed into receivership by the Securities and Exchange Commission, and the receiver may dispose of the shares of our common stock held by Wood River Partners, L.P. and its affiliates in a manner that adversely affects the trading price of our common stock.

Based on filings made with the Securities and Exchange Commission, as of November 2, 2005, Wood River Partners, L.P. and certain of its affiliates own approximately 37.9% of our outstanding common stock. On October 13, 2005, the Securities and Exchange Commission filed an emergency action against Wood River Partners, L.P and these affiliates (together, “Wood River”), and, concurrently with the filing of the action, an order was entered placing all assets of Wood River into the receivership of Arthur Steinberg, Esq. The receiver may be required to liquidate the assets of Wood River in order to satisfy claims against Wood River, or may otherwise determine that the liquidation of Wood River’s position in Endwave is in the best interests of the investors in Wood River. Such disposition of Endwave shares may have the effect of reducing the trading price of our common stock.

The market price of our common stock has historically fluctuated and is likely to fluctuate in the future.

The price of our common stock has fluctuated widely since our initial public offering in October 2000. For example, in the first nine months of 2005, the lowest bid price for our common stock was $12.30 and the highest bid price for our common stock was $55.41, and in 2004, the lowest bid price for our common stock was $5.50 and the highest bid price for our common stock was $19.20. The market price of our common stock can fluctuate significantly for many reasons, including, but not limited to:

	•		our financial performance or the performance of our competitors;

	•		the sale of common stock by Wood River, Northrop Grumman or other stockholders;

	•		technological innovations or other trends or changes in the telecommunications network, defense electronics or homeland security markets;

	•		successes or failures at significant product evaluations or site demonstrations;

	•		the introduction of new products by us or our competitors;

	•		acquisitions, strategic alliances or joint ventures involving us or our competitors;

	•		decisions by major participants in the communications industry not to purchase products from us or to pursue alternative technologies;

	•		decisions by investors to de-emphasize investment categories, groups or strategies that include our company or industry;

	•		market conditions in the industry, the financial markets and the economy as a whole; and

	•		low trading volume of our common stock.

It is likely that our operating results in one or more future quarters may be below the expectations of security analysts and investors. In that event, the trading price of our common stock would likely decline. In addition, the stock market has experienced extreme price and volume fluctuations. These market fluctuations can be unrelated to the operating performance of particular companies and the market prices for securities of technology companies have been especially volatile. Future sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock. Additionally, future stock price volatility for our common stock could provoke the initiation of securities litigation, which may divert substantial management resources and have an adverse effect on our business, operating results and financial condition. Our existing insurance coverage may not sufficiently cover all costs and claims that could arise out of any such securities litigation. We anticipate that prices for our common stock will continue to be volatile.

Wood River and Northrop Grumman control a large percentage of our common stock and are able to significantly affect the outcome of matters requiring stockholder approval.

As of November 2, 2005, Wood River and Northrop Grumman beneficially owned approximately 37.9 % and 11.9%, respectively, of our outstanding common stock. Because most matters requiring approval of our stockholders require the approval of the holders of a majority of the shares of our outstanding common stock, the significant beneficial ownership interest of Wood River and Northrop Grumman allows them to significantly affect the election of our directors and the outcome of most corporate actions requiring stockholder approval and to significantly affect our corporate actions in a manner that could conflict with the interests of our other stockholders. As of that date, our directors and executive officers owned, or had the right to acquire within 60 days thereafter, approximately 10% of our outstanding common stock. As a result, they also may have a significant impact on matters requiring approval of our stockholders. This concentration of ownership may also delay, deter or prevent a change in control and may make some transactions more difficult or impossible to complete without the support of these stockholders, even if the transaction is favorable to our stockholders.

Our certificate of incorporation, bylaws and arrangements with executive officers contain provisions that could delay or prevent a change in control.

We are subject to certain Delaware anti-takeover laws by virtue of our status as a Delaware corporation. These laws prevent us from engaging in a merger or sale of more than 10% of our assets with any stockholder, including all affiliates and associates of any stockholder, who owns 15% or more of our outstanding voting stock, for three years following the date that the stockholder acquired 15% or more of our voting stock, unless the board of directors approved the business combination or the transaction which resulted in the stockholder becoming an interested stockholder, or upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of our voting stock of the corporation, or the business combination is approved by our board of directors and authorized by at least 66 2/3% of our outstanding voting stock not owned by the interested stockholder. A corporation may opt out of the Delaware anti-takeover laws in its charter documents, however we have not chosen to do so. Additionally, our certificate of incorporation and bylaws include a number of provisions that may deter or impede hostile takeovers or changes of control of management, including a staggered board of directors, the elimination of the ability of our stockholders to act by written consent, discretionary authority given to our board of directors as to the issuance of preferred stock, and indemnification rights for our directors and executive officers. We have an Executive Officer Severance and Retention Plan and a Key Employee Severance and Retention Plan that provide for severance payments and the acceleration of vesting of a percentage of certain stock options granted to our executive officers and certain senior, non-executive employees under specified conditions. We also have a Transaction Incentive Plan for the benefit of our executive officers and certain senior, non-executive employees that provides for bonus payments to be made to them upon a change in control transaction. These plans may make us a less attractive acquisition target or may reduce the amount a potential acquirer may otherwise be willing to pay for our company.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

There have been no material changes in our reported market risks since our report on market risks in our Annual Report on Form 10-K for the year ended December 31, 2004 under the heading corresponding to that set forth above. Our exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, as our investments in cash equivalents include investment grade commercial paper and government securities. We place our investments with high-quality issuers and attempt to limit when possible the amount of credit exposure to any one issuer. Due to the nature of our short-term investments, we do not believe we are subject to any material market risk exposure. We do not have any material equity investments or foreign currency or other derivative financial instruments.

Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective as of the end of the period covered by this report.

Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and our chief executive officer and our chief financial officer have concluded that these controls and procedures are effective at the “reasonable assurance” level. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b) Changes in internal controls over financial reporting.

There were no changes in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 6. Exhibits


Number		Description
3.1(1)		Amended and Restated Certificate of Incorporation effective October 20, 2000.

3.2(2)		Certificate of Amendment of Amended and Restated Certificate of Incorporation effective June 28, 2002.

3.3(1)		Amended and Restated Bylaws effective October 20, 2000.

4.1(1)		Form of specimen Common Stock Certificate.

4.2(1)		Investors’ Rights Agreement by and among Endwave Corporation and certain investors named therein dated March 31, 2000.

4.3(3)		Amended and Restated Registration Rights Agreement by and between Northrop Grumman Space & Mission Systems Corp. and Endwave Corporation dated September 14, 2005.

10.1(1)		Form of Indemnity Agreement entered into by Endwave Corporation with each of its directors and officers.

10.2(1)*		1992 Stock Option Plan.

10.3(1)*		Form of Incentive Stock Option under 1992 Stock Option Plan.

10.4(1)*		Form of Nonstatutory Stock Option under 1992 Stock Option Plan.

10.5(1)*		2000 Equity Incentive Plan, as amended.

10.6(1)*		Form of Stock Option Agreement under 2000 Equity Incentive Plan.

10.7(1)*		2000 Employee Stock Purchase Plan.

10.8(1)*		Form of 2000 Employee Stock Purchase Plan Offering.

10.9(4)*		2000 Non-Employee Directors’ Stock Option Plan, as amended.

10.10(1)*		Form of Nonstatutory Stock Option Agreement under the 2000 Non-Employee Director Plan.

10.11(5)*		Description of Compensation Payable to Non-Employee Directors.

10.12(5)*		2005 Base Salaries for Named Executive Officers.

10.13(5)*		2005 Executive Incentive Compensation Plan.

10.14*		Executive Officer Severance and Retention Plan.

10.15(6)*		Transaction Incentive Plan.

10.16(1)		License Agreement by and between TRW Inc. and TRW Milliwave Inc. dated February 28, 2000.

10.17(1)†		Production Agreement by and between TRW Inc. and Endwave Corporation dated March 31, 2000 for the performance of the Development Agreement by and between TRW Inc. and Nokia Telecommunications OY dated January 28, 1999.

10.18(1)†		Services Agreement by and between TRW Inc. and Endwave Corporation dated March 31, 2000.


Number		Description
10.19(7)†		Development Agreement by and between Nokia and Endwave Corporation dated August 14, 2003.

10.20(8)†		Purchase Agreement by and between Nokia Corporation and Endwave Corporation dated December��31, 2003.

10.21(2)		Industrial Lease by and between The Irvine Company and Endwave Corporation dated January 28, 2004.

10.22(2)†		Amended and Restated Supply Agreement by and between Northrop Grumman Space and Mission Systems Corp. and Endwave Corporation dated March 26, 2004.

10.23(9)		Settlement and Release Agreement by and between Northrop Grumman Space & Mission Systems Corp. and Endwave Corporation dated March 23, 2005.

10.24†		Manufacturing and Supply Agreement by and between HANA Microelectronics and Endwave Corporation dated September 18, 2002.

31.1		Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


(1)		Previously filed with Endwave Corporation’s Registration Statement on Form S-1 (Registration No. 333-41302).

(2)		Previously filed with Endwave Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.

(3)		Previously filed as an exhibit to Endwave Corporation’s Current Report on Form 8-K filed on September 15, 2005.

(4)		Previously filed with Endwave Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

(5)		Previously filed as an exhibit to Endwave Corporation’s Current Report on Form 8-K filed on February 3, 2005.

(6)		Previously filed with Endwave Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.

(7)		Previously filed with an amendment to Endwave Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 filed on August 4, 2004.

(8)		Previously filed with an amendment to Endwave Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed on August 4, 2004.

(9)		Previously filed as an exhibit to Endwave Corporation’s Current Report on Form 8-K filed on March 25, 2005.

*		Indicates a management contract or compensatory plan or arrangement.

†		Confidential treatment has been requested for a portion of this exhibit.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, Endwave Corporation has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

ENDWAVE CORPORATION


		Date: November 14, 2005
		By:		/s/ Edward A. Keible, Jr.

		Edward A. Keible, Jr.
		President and Chief Executive Officer

		By:		/s/ Julianne M. Biagini

		Julianne M. Biagini
		Executive Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)

Index to Exhibits


Number		Description
10.14*		Executive Officer Severance and Retention Plan.

10.24†		Manufacturing and Supply Agreement by and between HANA Microelectronics and Endwave Corporation dated September 18, 2002.

31.1		Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Indicates a management contract or compensatory plan or arrangement.

†		Confidential treatment has been requested for a portion of this exhibit.

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Endwave Inactive 10-Q2005 Q3 Quarterly report

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