UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

Commission file number: 000-31635

 

 

 

 

Endwave Corporation

(Exact name of registrant as specified in its charter)

 

 

 

 

 

(408) 522-3100

(Registrant’s telephone number, including area code)

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.  Yes o     No þ

 

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.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2009 was approximately $20 million. Shares of voting common stock held by directors and executive officers have been excluded as such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The aggregate market value has been computed based on a price of $2.56, which was the closing sale price on June 30, 2009 as reported by The NASDAQ Global Market.

 

The number of shares outstanding of the registrant’s common stock as of February 5, 2010 was 9,684,756.

 

 

ENDWAVE CORPORATION

 

FORM 10-K

 

Year Ended December 31, 2009

 

TABLE OF CONTENTS

 

FORWARD-LOOKING INFORMATION

 

This report contains forward-looking statements within the meaning of Section 17A of the Securities Act of 1933, or the Securities Act, and within the meaning of Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, that are subject to the “safe harbor” created by those sections. These forward-looking statements can generally be identified as such because the statement will include words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “opportunity,” “plan,” “potential,” “predict” or “will,” the negative of these words or words of similar import. Similarly, statements that describe our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. Discussions containing these forward-looking statements may be found, among other places, in the sections of this report entitled “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These forward-looking statements are based largely on our expectations and projections about future events and future trends affecting our business, and so are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. The risks and uncertainties are attributable to, among other things: global economic conditions and their impact on our customers; our new semiconductor product line, our suppliers’ abilities to deliver raw materials to our specifications and on time; our customer and market concentration; volatility resulting from consolidation of key customers; our ability to achieve revenue growth and maintain profitability; our successful implementation of next-generation programs, including inventory transitions; our ability to penetrate new markets; fluctuations in our operating results from quarter to quarter; our reliance on third-party manufacturers and semiconductor foundries; acquiring businesses and integrating them with our own; component, design or manufacturing defects in our products; our dependence on key personnel; our ability to develop new or improved semiconductor process technologies; and fluctuations in the price of our common stock. Because of the risks and uncertainties referred to above and other risks and uncertainties, including the risks described in the section of this report entitled “Risk Factors,” actual results or outcomes could differ materially from those expressed in any forward-looking statements and you should not place undue reliance on any forward-looking statements. New risks emerge from time to time, and it is not possible for us to predict which risks will arise. In addition, we cannot assess the impact of each risk on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Except as required by law, we undertake no obligation to publicly revise our forward-looking statements to reflect events or circumstances that arise after the date of this report or the date of documents incorporated by reference in this report that include forward-looking statements.

 

 

Introduction

 

We design, manufacture and market radio frequency, or RF, products that enable the transmission, reception and processing of high frequency RF signals. As a result of the divestiture of our Defense and Security RF module business in April 2009, our products now consist of two key product lines:

 

 

We were originally incorporated in California in 1991 and reincorporated in Delaware in 1995. In March 2000, we merged with TRW Milliwave Inc., a RF sub-system supplier that was a wholly-owned subsidiary of TRW Inc. In connection with the merger, we changed our name from Endgate Corporation to Endwave Corporation. On October 17, 2000, we successfully completed the initial public offering of our common stock. As used in this report, “we,” “us,” “our,” “Endwave” and words of similar import refer to Endwave Corporation.

 

Industry Background and Markets

 

High-Frequency RF Technology

 

The applications of RF technology are broad, extending from terrestrial AM radio at the low end of the frequency spectrum, which is less than 1 MHz (megahertz, or million cycles per second), to atmospheric monitoring applications at the high end of the frequency spectrum, which is around 100 GHz (gigahertz, or billion cycles per second). Microwave technology refers to technology for the transmission of signals at high frequencies, from approximately 1 GHz to approximately 20 GHz and millimeter wave technology refers to technology for the transmission of signals at very high frequencies, from approximately 20 GHz to beyond 100 GHz. Our products employ both microwave and millimeter wave technology. The term microwave, however, is commonly understood in the industries we serve, and we use that term in this report as meaning both microwave and millimeter wave.

 

Our products are typically designed to operate at frequencies between 1 GHz and 100 GHz, which we refer to in this report as high-frequency RF. Due to their physical attributes, these frequencies are well-suited for applications in telecommunication networks requiring high data throughput, defense systems demanding advanced radar, imaging and communication capabilities and homeland security systems requiring detection, measurement and imaging capabilities.

 

Telecommunication Networks

 

High-frequency transceiver modules and their key constituent components, MMICs, are an integral part of microwave radios, which in turn play a key role in many telecommunication networks. Microwave radio links have a number of applications:

 

Cellular Telephone Backhaul.  The communication link between the cellular base station site and the overall telephone network is referred to as cellular backhaul. This is the most common use of microwave

radios. In most parts of the world, cellular backhaul is typically accomplished through the use of microwave radios either because of their ease of deployment and low overall cost relative to available wireline options or because adequate wireline facilities are not available. While in the United States and Canada cellular backhaul has typically been accomplished through the use of wireline facilities, there is a growing trend to migrate to microwave backhaul because wireline systems are not a practical alternative to provide the extremely high backhaul data rates necessitated by contemporary “smart phones” and similar devices.

 

Carrier Class Trunking.  To deploy their networks, communications carriers require high capacity links, or trunk circuits, between major voice and data switching centers. While fiber optic cables are the most common type of trunk circuit facility, microwave radios are often used for portions of these circuits when the intervening terrain, such as mountains or bodies of water, is difficult to traverse or as redundant backup links for the fiber optic network.

 

Private Voice and Data Networks.  When private users, such as companies and universities, deploy stand-alone campus area or metropolitan area voice and data networks, they often encounter situations where it is not possible to access a direct physical path between their facilities due to distance or intervening structures and roads. If third-party wireline facilities are not available or cost-effective, a microwave radio link is often used to provide the network connection. In addition, companies often implement microwave facilities as redundant backup links for their wireline facilities.

 

Fixed Wireless Access Network Backhaul.  Similar to the situation in cellular telephone networks, fixed wireless access networks require a backhaul infrastructure to move the data from individual access points to an internet portal. Various approaches are being considered for the widespread implementation of fixed wireless access networks, including the IEEE 802.16 WiMAX standard and LTE (Long Term Evolution) technology. Regardless of the underlying access technology, all such fixed wireless access networks will face the technological and cost issues associated with connecting individual access points to the wireline network infrastructure. We believe this need for backhaul represents an opportunity for microwave radios, particularly because the anticipated high bandwidth requirements of fixed wireless access networks are served more cost-effectively by microwave radios than by wireline alternatives.

 

While macroeconomic conditions have slowed the deployment of telecommunication networks, we believe there will be a long-term demand for microwave radios and the components used to build them. In developing countries such as Brazil, Russia, India and China, there has been a rapid growth in the penetration of cellular telephone services. We expect that this growth will result in a continuing demand for microwave backhaul radios because these countries lack well-established wireline infrastructures to support the backhaul requirements of a wireless telephony network. In more mature economies, there has been an increasing demand for mobile data services. We believe this demand will also drive the need for more high-capacity backhaul.

 

Defense and Homeland Security Markets

 

High-frequency RF technology is an integral part of various defense and homeland security systems. Although we sold our Defense and Security RF module business in April 2009, we are planning to enter into the defense and homeland security markets with our semiconductor product line in order to address additional markets and broaden our customer base. Key applications in these markets include:

 

Radar Systems.  Traditional radar systems are configured to detect large objects at significant distances. To add to this capability, many new systems employ complementary high frequency RF radar systems designed to detect small vehicles and personnel. These new systems often use these higher frequencies in order to provide greater resolution. A further use of high frequency radar is airborne imaging equipment that allows pilots to see through low-lying haze and dust much in the same way night vision goggles permit one to see in the dark.

 

Signal Intelligence Systems.  Information about an opposing force can be gathered by monitoring their electronic communications. Systems that gather such information utilize a variety of RF and microwave components to monitor and interpret information over a broad spectrum of potential frequencies that a hostile force might use.

High Capacity Communications.  A modern, widely-dispersed military or security force requires communication systems to transmit voice, video and data wherever and whenever it is needed. Many military or security communication systems, whether terrestrial, airborne or satellite, employ microwave technology to meet these requirements. As the data rates in these systems increase, the systems must be able to operate at higher frequencies to take advantage of the transmission bandwidth that is available at those frequencies.

 

Long Distance Personnel Detection.  High-frequency RF signals can be used to detect the presence of humans at significant distances, much in the same way lower frequency radar systems can detect metal objects at a distance. This phenomenon can be employed as a radar fence to detect intrusion along lengthy security perimeters such as airport runways, military bases and international borders.

 

For these reasons, we believe demand for high-frequency RF components in the defense and homeland security market is growing. We believe that the growth of these markets may represent a significant opportunity for our semiconductor product line.

 

Our Business Approach

 

Historically, when OEMs and other systems integrators incorporated high-frequency RF technology into their products, they designed and manufactured the requisite hardware internally. However, when faced with the need to generate cost efficiencies and technological innovations with fewer resources, OEMs and systems integrators frequently look to merchant suppliers for these items. We believe there are several key characteristics that define an attractive supply partner for fulfilling these requirements, including:

 

Technical Depth.  OEMs and systems integrators seek merchant suppliers that have significant experience in and understanding of the overall system design. This depth and breadth of understanding is crucial to optimizing the system design and making appropriate overall system level tradeoffs, thereby enabling the OEM or system integrator to design and deploy its systems more cost-effectively.

 

Innovative Technology.  New technology is the key to providing enhanced performance and continued cost reduction. Thus, OEMs and systems integrators value this capability and prefer partners that create new technologies offering additional functionality, higher reliability, lower cost and better performance.

 

Semiconductor Devices.  Beyond seeking complete hardware solutions, OEMs and system integrators may seek technologically advanced and cost effective semiconductor devices including custom design capabilities that meet their unique technological needs on existing or next generation hardware platforms.

 

Low Cost.  OEMs and systems integrators are under increasing pricing pressure from their customers and expect effective and persistent cost-reduction programs from their merchant suppliers. These cost-reduction programs require merchant suppliers to mount a comprehensive effort at multiple levels, including integration of multiple functions, efficient manufacturing, effective supply chain management, streamlined life cycle support and use of low cost sub-contractors.

 

Flexible Supply Chain Capabilities.  Volatility of demand is common in the markets we serve. Therefore OEMs and system integrators need merchant suppliers that can accommodate fluctuations in the demand, whether in mix and/or quantity, and that can flexibly scale their manufacturing to match these fluctuating demands.

 

We believe that few merchant suppliers comprehensively address all of these requirements. Many of the merchant suppliers that populate the industry are small and lack the requisite operational strength and technical capability to address these needs. Further, many suppliers use labor-intensive assembly and test methods that limit their ability to produce high frequency RF products in high volumes and at a low cost. Others do not possess the breadth of component-to-system expertise that is desired by telecom OEMs. In contrast, we believe that we possess several key strengths that enable us to provide our customers with superior products and services. These strengths include:

 

Extensive Technical Expertise.  We have extensive experience in all aspects of high frequency design and manufacturing. Our body of intellectual property and a highly-skilled technical team are critical when dealing with the higher frequencies required by emerging applications. Our technical team has broad expertise

in device physics, semiconductor device and circuit design, system engineering, test engineering and other critical disciplines. In addition, our large library of proprietary designs enables us to introduce new products rapidly and cost-effectively. We believe the depth and breadth of our technical expertise differentiates us from many of our competitors, enabling us to optimize our products for critical performance factors and to assist our customers in developing an optimal overall design.

 

A Commitment to Develop Next-Generation Technology.  A key component of our value proposition is providing our customers with powerful and cost-effective technologies that offer them a major technical and economic advantage. We have invested in the development of next-generation circuit and packaging technologies that allow us to provide our customers with high-performance and low-cost solutions. Our ability to develop new semiconductor devices on a custom basis provides us greater flexibility to optimize product designs for our customers and their specific applications. We intend to continue to invest in research and development, maintain a team of talented engineers and scientists, and build on our manufacturing technologies.

 

Comprehensive Approach to Cost-Effective Manufacturing.  We have taken a comprehensive approach to developing a cost-effective, outsourced manufacturing capability that allows us to compete on a worldwide basis and to offer our customers product solutions at attractive prices:

 

 

Products and Technology

 

Integrated Transceiver Sub-system Modules

 

Integrated transceiver sub-system modules combine several functional RF blocks, such as amplifiers, mixers, switches or oscillators, with various types of control and support circuitry, such as a microprocessor or a power

supply, to form a stand-alone transceiver sub-system. These complex modules, generally comprising hundreds of individual components, combine RF functions with sophisticated analog and digital system interface and control capabilities.

 

Within these modules, the core RF functions are performed with either of two circuit technologies:

 

 

In high-frequency RF modules, the circuit packaging technology also significantly impacts cost and performance. Many of our newer products employ a unique packaging technology named Epsilon^tm. In this approach, MMIC or MLMS circuits are directly mounted to a composite printed wiring board and then enclosed with a metalized molded plastic or machined cover. The composite wiring board consists of a top RF circuit layer built on a low loss substrate with lower layers of the board consisting of conventional printed wiring board substrates for power and control circuitry. This approach reduces the size, weight and cost of the packaging components.

 

Semiconductor Devices

 

As noted above, in the course of developing several different transceiver module variants to meet a range of customer requirements, we have designed a broad range of semiconductor devices including a large number of MMIC devices. The breadth and depth of this repertoire is such that we can fulfill the requirements for most circuit functions in the frequency range of 10 GHz to 100 GHz. Our motivation to design these circuits has been to both achieve superior electrical performance and to reduce costs through vertical integration. Once designed, these devices are fabricated in several merchant foundries throughout the world. By using a mixture of foundries, we are able to select the best foundry and fabrication process to achieve the desired performance in the most cost-effective manner. Our devices have been particularly designed to meet the high frequency and high bandwidth requirements of contemporary systems. In addition to the core devices, we have developed a range of device packaging technologies that allow our circuits to be installed using industry standard surface mount technology, or SMT, assembly processes. We have extended this technology such that devices operating at frequencies up to 50 GHz can be assembled in the SMT format, thus facilitating ease of downstream assembly of the sub-system module. In addition to supporting our transceiver product line, we now offer these devices as stand-alone products to the various markets and applications noted earlier.

 

Sales and Marketing

 

We sell our products both through direct sales efforts and a network of independent domestic and international representatives. For each of our major customers, we assign a technical account manager, who has responsibility for developing and expanding our relationship with that customer. Our direct and representative sales efforts are augmented by traditional marketing activities, including advertising, participation in industry associations and presence at major trade shows.

 

Our products are highly technical and the sales cycle can often be long. Our sales efforts typically involve a collaborative and iterative process with our customers to determine their specific requirements, verify a product design and develop an effective manufacturing approach matched to the application. Depending on the product type and market, the sales cycle can typically take anywhere from 2 to 24 months.

Customers

 

In 2009, revenues from our telecom OEM customers comprised nearly all of our total revenues. More specifically, revenues from Nokia Siemens Networks and its manufacturing partner, SRI Radio Systems, and Nera accounted for 70% and 18% of our total revenues, respectively. We expect revenues from our telecom OEM customers to comprise the large majority of our revenues in the immediate term. In the telecom market, our revenues are attributable to a limited number of telecom OEMs, and we would expect this pattern to remain for the foreseeable future.

 

Divestitures

 

In April of 2009 we completed the divestiture of our Defense and Security RF module business to Microsemi, Inc. as described below:

 

 

Competition

 

The markets for our products are extremely competitive, and are characterized by rapid technological change and continuously evolving customer requirements and many of our competitors have significantly greater resources than we do.

 

Among merchant suppliers of transceiver modules in the telecommunication network market, we compete with Compel Electronics SpA, Filtronic plc, Microelectronics Technology Inc., and Remec Broadband Wireless, Inc., among others. 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 transceiver modules, rather than using merchant suppliers such as ourselves. While we have limited opportunities to supply transceiver modules to these telecom OEMs, we believe we have opportunities to supply them semiconductor devices for their captive products.

 

In the case of our semiconductor product line, we compete with Avago Technologies, Ltd., Hittite Microwave Corp., MIMIX Broadband, Inc., RF Micro Devices, Inc., TriQuint Semiconductor, Inc. and United Monolithic Semiconductors, S.A.S., among others.

 

We believe that the principal competitive factors in our industry are:

 

 

Research and Development

 

We direct our research efforts towards developing advanced device, circuit and packaging technologies, creating new proprietary circuit designs and integrating these technologies and designs into the semiconductor devices we provide to our customers. Our product development activities focus on designing products to meet specific customer and market needs and introducing these products to manufacturing.

 

Our technical approach emphasizes the following capabilities:

 

Semiconductor Design Capabilities.  Our ability to design semiconductor devices allows us to optimize and reduce the cost of designs beyond what is possible with standard off-the-shelf semiconductor devices.

 

Breadth of Expertise.  We are experienced in a broad range of technical disciplines and possess the know-how to design products at multiple levels of integration.

 

Computer Modeling Capabilities.  Our extensive computer modeling capabilities allow us to create designs quickly and to minimize the number of iterations required to develop specification compliant, cost-effective designs.

 

Extensive Library of Designs.  Our extensive library of device, circuit and sub-system designs enables us to generate new products and produce prototypes quickly to meet our customers’ time-to-market demands.

 

Automated Testing Processes.  High-frequency RF products require extensive testing after assembly to verify compliance with customer specifications. We use high speed, custom-designed, automated test sets that are capable of rapidly testing devices and modules. This increases throughput in the manufacturing process and reduces the skill level required to conduct the tests. Concurrently with the development of these test methods, we develop data analysis and reporting tools to facilitate rapid communication of test data to our customers.

 

Our investment in research and development and related engineering projects has resulted in research and development expenses from continuing operations of $6.5 million, $6.8 million, and $5.5 million in 2007, 2008 and 2009, respectively.

 

Patents and Intellectual Property Rights

 

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 December 31, 2009, we had 43 United States patents issued, many with associated foreign filings and patents. Our issued patents include those relating to basic circuit and device designs, semiconductors, MLMS technology and system designs. Our United States patents expire between 2013 and 2028. We do not anticipate the expiration of patents over the near term to have a significant impact on our research and development or operations. 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.

 

We maintain a vigorous technology development program that routinely generates potentially patentable intellectual property. Our decisions as to whether to seek formal patent protection, and the countries in which to seek it, are taken on a patent-by-patent basis and are 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 an implement to protect the underlying intellectual property. 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. Further, any existing or future patents may be challenged, invalidated or circumvented thus reducing or eliminating their commercial value.

 

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 our strategic partners, 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 attempt to 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.

 

Operations

 

All of our manufacturing operations are located in Lamphun, Thailand and utilize the facilities of our contract manufacturing partner, HANA. Under our manufacturing contract, HANA supplies the physical plant, direct labor, basic assembly equipment and warehousing functions. We supplement those activities with our own full-time, in-country staff consisting of 17 people who provide production planning, process engineering, test engineering, product support, design engineering and quality assurance support. We own certain assets held securely in HANA’s factory, including specialized test and assembly equipment and various raw material and product inventories. Our arrangement with HANA allows us to reduce our labor and facility expenses while maintaining tight control of process and quality. To reduce our costs further, we have identified lower cost Asian sources for various raw materials, especially basic metal and circuit board components. Our manufacturing agreement with HANA currently expires in October 2010, but will renew automatically for successive one-year periods unless either party notifies the other of its desire to terminate the agreement at least one year prior to the expiration of the term. In addition, either party may terminate the agreement without cause upon 365 days prior written notice to the other party, and either party may terminate the agreement if the non-terminating party is in material 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 use both industry-standard and Endwave-designed semiconductor devices. We obtain industry-standard devices from various suppliers of these parts and we contract with various third-party foundries to produce our own designs. Our use of third-party foundries for custom designed devices gives us the flexibility to use the process technology that is best suited for each application and eliminates the need for us to invest in and maintain our own semiconductor facilities. While the loss of our relationship with or our access to any of the semiconductor foundries we currently use, 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, we estimate that we could shift production to a new foundry within six months. We currently use the foundry services of Global Communication Semiconductors, Inc., M/A-COM Technology Solutions Inc., Northrop Grumman Space Technology, TriQuint Semiconductors and WIN Semiconductors Corp. Our largest suppliers of industry standard semiconductor devices include Hittite Microwave Corp, MIMIX Broadband, and Sumitomo Electric Device Innovations, Inc.

 

All of the manufacturing facilities we operate or use worldwide are registered under ISO 9001-2000, an international certification standard of quality for design, development and business practices. Additionally, we are certified under AS-9100 in support of our defense industry market initiatives. We maintain comprehensive quality systems at all of our facilities to ensure compliance with customer specifications, configuration control, documentation control and supplier quality conformance.

 

We maintain raw materials, work-in-process and finished goods inventory in Thailand at HANA’s plant. In order to maintain and enhance our competitive position, we must be able to satisfy our customers’ short lead-times and rapidly-changing needs. Meeting this requirement necessitates that we maintain significant raw material and finished goods inventories. Maintaining these inventories is costly and requires significant working capital and may increase our capital needs in the future.

 

Backlog

 

Our backlog at February 19, 2010 for shipments expected to occur through December 31, 2010 was approximately $23.4 million. By comparison, our backlog as of February 20, 2009 for shipments then expected to occur through December 31, 2009 excluding the Defense and Security RF module business was approximately $17.4 million.

Our order backlog consists of a combination of conventional purchase orders and formal forecasts given to us under annual and multi-year agreements. Typically, the forecast portion of the backlog is the significantly larger amount. The forecasts we receive normally have a firm commitment portion of one to three months in duration that obligate the customer to accept at least some portion of the amount forecasted for that period, with the remainder of the forecast including no such obligation. These forecasts are subject to change on a regular basis and we have experienced significant forecast variations in both unit volumes and product mix. As a result, we do not believe that backlog is a reliable indicator of future revenues.

 

Governmental Regulation

 

Government regulations indirectly affect our business. The frequencies at which wireless systems transmit and receive data are dictated by government licensing agencies in the location where they are deployed. Unexpected difficulties in obtaining licenses or changes in the operating frequencies allowed can halt or delay microwave radio deployments and therefore halt or delay the need for our products. Both national and international regulatory bodies have set stringent standards on the performance of microwave radios, especially spurious emissions and their potential to cause interference in other systems. Meeting these regulations is technologically challenging and changes in the regulations could require a re-design of our products to achieve compliance. Also, on occasion we are required to obtain various export permissions from the U.S. government to ship product to overseas customers.

 

Seasonality

 

Although we have experienced significant quarterly fluctuations in revenue at times over the past several years, we do not believe that volatility was primarily attributable to seasonality in our business.

 

Employees

 

As of December 31, 2009, we had 54 regular employees, including 34 in product and process engineering, 10 in sales and marketing and 10 in general and administrative. Of our regular employees, 17 are based in our Chiang Mai, Thailand office. Our employees are not subject to any collective bargaining agreement with us and we believe that our relations with our employees are good.

 

Available Information

 

Our principal executive offices are located at 130 Baytech Drive, San Jose, CA 95134 and our main telephone number is (408) 522-3100. Our Internet address is www.endwave.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC.

 

The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington D.C., 20549. The public may obtain information on the operations of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site, http://www.sec.gov, that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.

 

You should consider carefully the following risk factors as well as other information in this report before investing in 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 had a net loss from continuing operations of $10.6 million in 2009. We also had a net loss from continuing operations of $4.0 million for the year ended December 31, 2008 and net income from continuing operations of $670,000 for year ended December 31, 2007. There is no guarantee that we will achieve or maintain profitability in the future. The mobile communication industry has been impacted by the global economic downturn. In addition, we have launched our semiconductor product line which requires us to incur significant expenses. The future success of our semiconductor product line will depend on our ability to develop these products in a cost-effective and timely manner.

 

We depend on the mobile communication industry for substantially all of our revenues. As this industry is negatively impacted by the global economic downturn, our revenues and our profitability could continue to suffer. In addition, consolidation in this industry could result in delays or cancellations of orders for our products, adversely impacting our results of operations.

 

The global economic downturn has impacted the mobile communication industry. If the downturn in the mobile communication industry persists, our revenues will continue to suffer and we may be forced to write off excess inventories, uncollectible accounts receivable and abandoned or obsolete equipment and attempt to reduce our operating expenses through additional restructuring activities. We cannot guarantee that we will be able to reduce operating expenses to a level commensurate with the lower revenues resulting from such a prolonged industry downturn.

 

The mobile communication industry has undergone significant consolidation in the past few years. For example, during April 2007, Nokia and Siemens merged their mobile communication network businesses. 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 for our products and, accordingly, delays or reductions in our anticipated revenues and reduced profitability or increased net losses.

 

The current turmoil in the global economy could adversely impact our operations and financial results.

 

Over the past several months, global economic conditions have continued to remain weak and uncertain. For example, credit continues to be severely restricted. This restriction in credit has materially impacted our operations and financial results and we expect it to continue to do so. Our customers often rely on credit markets to finance the build-out of their networks and systems. With the current restriction in credit markets, capital may not be available to our customers or may only be available at unfavorable terms. Without appropriate capital, our customers may have difficulty funding their on-going operations and may reduce their orders for our products. This could significantly impact our operations and financial results. Additionally, our vendors may rely on credit markets to finance their operations. With the current restriction in credit markets, capital may not be available to our vendors or may only be available at unfavorable terms. Without appropriate capital, our vendors may have difficulty funding their on-going operations and may not be able to fulfill requirements for their products. This could significantly impact our operations and financial results through a reduction in our revenues.

 

Our semiconductor product line will require us to incur significant expenses and may not be successful.

 

Our new semiconductor product line will require us to incur expenses to design, test, manufacture and market these new products including the purchase of inventory, supplies and capital equipment. The future success of our semiconductor product line will depend on our ability to develop these new products in a cost-effective and timely

manner. The development of our products is complex, and from time to time we may experience delays in completing the development and introduction of our new products or fail to efficiently manufacture such products in the early production phase. The semiconductor product line may have little immediate impact on our revenue because a new standard product may not generate meaningful revenue. In the meantime, we will have incurred expenses to design, produce and market the products, and we may not recover these expenses if demand for the product fails to reach forecasted levels which may adversely affect our operating results.

 

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 the risks and 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:

 

 

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. In the past, we suffered from shortages of and quality issues with various components. These shortages and quality issues adversely impacted our product revenues and could reappear 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.

 

We depend on a small number of key customers in the mobile communication industry for a significant portion of our revenues. If we lose any of our major customers 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 mobile communication customers for a significant part of our revenues. The loss of any of our major customers or any material reduction in orders from any such customers, would have a material adverse effect on our business, financial condition and results of operations. In 2009, revenues from Nokia Siemens Networks and its manufacturing partner, SRI Radio Systems, and Nera accounted for 70% and 18% of our total revenues, respectively. In 2008, revenues from Nokia

Siemens Networks, accounted for 83% of our total revenues. We had no other customers individually representing more than 10% of our total revenues for these periods.

 

Our operating results may be adversely affected by substantial quarterly and annual fluctuations and market downturns.

 

Our revenues, earnings and other operating results have fluctuated in the past and our revenues, earnings and other operating results may fluctuate in the future. These fluctuations are due to a number of factors, many of which are beyond our control. These factors include, among others, global economic conditions, overall growth in our target markets, the ability of our customers to obtain adequate capital, U.S. export law changes, changes in customer order patterns, customer consolidation, availability of components from our suppliers, the gain or loss of a significant customer, changes in our product mix and market acceptance of our products and our customers’ products. These factors are difficult to forecast, and these, as well as other factors, could materially and adversely affect our quarterly or annual operating results.

 

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

 

We intend to pursue acquisitions in our markets that we believe will be beneficial to our business. 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:

 

 

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 operating results.

 

We rely on the semiconductor foundry operations of third-party semiconductor foundries to manufacture the integrated circuits sold directly to our customers or contained in our products. The loss of our relationship with any of these foundries without adequate notice would adversely impact our ability to fill customer orders and could damage our customer relationships.

 

We utilize both industry standard semiconductor components and our own custom-designed 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 our custom-designed components. If any of our semiconductor suppliers is unable to deliver semiconductors to us in a timely fashion, the resulting delay could severely impact our ability to fulfill customer orders and could damage our relationships with our customers. In addition, the loss of our relationship with or our access to any of the semiconductor foundries we currently use for the fabrication of custom designed components 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.

 

We may not be successful in forming alternative supply arrangements that provide us with a sufficient supply of gallium arsenide devices. Gallium arsenide devices are used in a substantial portion of the products we manufacture. Because there are a limited number of semiconductor foundries that use the particular process technologies we select for our products and that 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.

 

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

 

Over the past year, we have reduced many of our prices of telecommunication products 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 and improve our manufacturing efficiencies. The combined effects of these actions may be insufficient to achieve the cost reductions needed to maintain or increase our gross margins or achieve profitability.

 

We rely heavily on a Thailand facility of HANA, a contract manufacturer, to produce our RF modules and to package our microwave and millimeter wave integrated circuits. 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 our products to a Thailand facility of 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, terminates its relationship with us, or is unable to produce our products due to financial difficulties or political instability 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 latest manufacturing agreement with HANA expires in October 2010, but will renew automatically for successive one-year periods unless either party notifies the other of its desire to terminate the agreement at least one year prior to the expiration of the term. No such notification has been sent to or received from HANA. In addition, either party may terminate the agreement without cause upon 365 days prior written notice to the other party, and either party may terminate the agreement if the non-terminating party is in material 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.

 

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 twelve to thirty months. 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 integrated circuits and module products that were not apparent when the warranty period expired. These latent 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.

 

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. We have, in the past, expended significant resources on research and design efforts on potential customer products that did not result in additional revenue.

 

Each of our communication products is designed for a specific range of frequencies. Because different national governments license different portions of the frequency spectrum for the mobile communication 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.

 

Our customers often have specific requirements that can be at the forefront of technological development and therefore difficult and expensive to meet. 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 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.

 

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 integrated circuits and module products 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 and market, the sales cycle can take anywhere from 2 to 24 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 system. 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 manufacture and deliver our products as quickly as our customers require, which could cause us to lose sales and would harm our reputation.

 

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:

 

 

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.

 

Although we do have long-term commitments from many of our customers, they are not for fixed quantities of product. As a result, we must estimate customer demand, and errors in our estimates could have negative effects on our cash, inventory levels, revenues and results of operations.

 

We have been required historically 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. If we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell when we expect, if at all. As a result, we would have additional usage of cash, excess inventory and overhead expense, which would harm our financial results. On occasion, we have experienced adverse financial results due to excess inventory and excess manufacturing capacity. The fourth quarter of 2009 included an $878,000 write-down of inventory because there was a rapid and unanticipated drop in sales of a legacy product for a major customer’s radio platform.

 

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.

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 December 31, 2009, we had 43 United States patents issued, many with associated foreign filings and patents. Our issued patents include those relating to basic circuit and device designs, semiconductors, our multilithic microsystems technology and system designs. Our issued United States patents expire between 2013 and 2028. 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 case by case 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 regularly enter into written 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 attempt to 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. Moreover 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 chip technology licensed to us by Northrop Grumman Corporation. Steps taken by us to prevent misappropriation or infringement of our intellectual property or the intellectual property of our customers may not be successful. 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.

We are exposed to fluctuations in the market values of our investment portfolio.

 

Although we have not experienced any material losses on our cash, cash equivalents and short-term investments, future declines in their market values could have a material adverse effect on our financial condition and operating results. Although our portfolio has no direct investments in auction rate or sub-prime mortgage securities, our overall investment portfolio is currently and may in the future be concentrated in cash equivalents including money market funds. If any of the issuers of the securities we hold default on their obligations, or their credit ratings are negatively affected by liquidity, credit deterioration or losses, financial results, or other factors, the value of our cash equivalents and short-term and long-term investments could decline and result in a material impairment.

 

Risks Relating to Our Industry

 

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

 

Among merchant suppliers in the mobile communication market who provide integrated transceivers to radio OEMs, we primarily compete with Compel Electronics SpA, Filtronic plc, and Microelectronics Technology Inc. Additionally, there are mobile communication OEMs, such as Ericsson and NEC Corporation, that use their own captive resources for the design and manufacture of their transceiver modules, rather than using merchant suppliers like us. To the extent that mobile communication OEMs presently, or may in the future, produce their own transceiver modules, we lose the opportunity to provide our modules to them. However, as we launched our semiconductor product line, we gain the opportunity to provide integrated circuits to all radio OEMs.

 

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 RoHS Directive. The RoHS Directive is European Union legislation that restricts the use of a number of substances, including lead, after July 2006. We believe that our products impacted by these regulations are compliant with the RoHS Directive and that materials will continue to be available to meet these new 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. Further, the Federal Communications Commission and foreign regulatory agencies have adopted regulations that impose stringent RF emissions standards on the communications industry.

 

Our failure to continue to develop new or improved semiconductor process technologies could impair our competitive position.

 

Our future success depends in part upon our ability to continue to gain access to the current semiconductor process technologies in order to adapt to emerging customer requirements and competitive market conditions. If we fail to keep abreast of the new and improved semiconductor process technologies as they emerge, we may lose market share which could adversely affect our operating results.

The segment of the semiconductor industry in which we participate is intensely competitive, and our inability to compete effectively would harm our business.

 

The markets for our products are extremely competitive, and are characterized by rapid technological change and continuously evolving customer requirements. Many of our competitors have significantly greater financial, technical, manufacturing, sales and marketing resources than we do. As a result, our competitors may develop new technologies, enhancements of existing products or new products that offer price or performance features superior to ours. In addition, our competitors may be perceived by prospective customers to offer financial and operational stability superior to ours.

 

We expect competition in our markets to intensify, as new competitors enter the RF, microwave and millimeterwave component market, existing competitors merge or form alliances, and new technologies emerge. If we are not able to compete effectively, our market share and revenue could be adversely affected, and our business and results of operations could be harmed.

 

Risks Relating to Ownership of Our Stock

 

The market price of our common stock has fluctuated historically 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. In 2009, the lowest daily sales price for our common stock was $1.36 and the highest daily sales price for our common stock was $3.43. In 2008, the lowest daily sales price for our common stock was $1.93 and the highest daily sales price for our common stock was $7.69. The market price of our common stock can fluctuate significantly for many reasons, including, but not limited to:

 

 

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.

We have a few shareholders that each own a large percentage of our outstanding capital stock and, as a result of their significant ownership, are able to significantly affect the outcome of matters requiring stockholder approval.

 

On January 21, 2010, the Company repurchased all 300,000 shares of its preferred stock held by Oak Investment Partners XI, Limited Partnership for $36.0 million in cash. However, our outstanding capital stock continues to be owned by just a few shareholders. As of February 5, 2010, four shareholders together owned 40% of our capital stock. Because most matters requiring approval of our stockholders require the approval of the holders of a majority of the shares of our outstanding capital stock present in person or by proxy at the annual meeting, the significant ownership interest of these shareholders allows them to significantly affect the election of our directors and the outcome of corporate actions requiring stockholder approval. 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 their support, even if the transaction is favorable to our stockholders as a whole.

 

Our certificate of incorporation, bylaws and arrangements with executive officers 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 our 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 662/3% 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. 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. Additionally, we have adopted a Stockholder Rights Plan, providing for the distribution of one preferred share purchase right for each outstanding share of common stock that may lead to the delay or prevention of a change in control that is not approved by our board of directors. We have a Senior Executive Officer Severance Retention Plan, an Executive Officer Severance 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.

 

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.

 

 

Not applicable.

 

 

Our principal executive offices are located in San Jose, California, where we lease approximately 33,000 square feet, which encompasses our corporate headquarters and research and development facilities. This lease expires in August 2011.

 

During 2008, we moved our Northeast operations to Salem, New Hampshire where we lease approximately 5,000 square feet. This lease expires in November 2013.

 

In Chiang Mai, Thailand, near the facilities of our contract manufacturer, HANA, we lease approximately 3,000 square feet under an office lease that expires in March 2010. We believe that these facilities are adequate to meet our current and near term future needs.

 

On October 31, 2008, we filed a complaint with the Canadian Superior Court in Montreal, Quebec alleging that Advantech Advanced Microwave Technologies Inc., or Advantech, the parent company of Allgon Microwave Corporation AB, or Allgon, had breached its contractual obligations with Endwave and owes us $994,500 in a note receivable, purchased inventory and authorized and accepted purchase orders resulting in shippable finished goods. We cannot predict the outcome of these proceedings. An adverse decision in these proceedings could harm our consolidated financial position and results of operations.

 

In a related action, we have filed a creditor’s claim for $994,500 against Allgon in the composition of creditors’ proceedings now pending in a Stockholm, Sweden bankruptcy court. Although a recovery under Swedish bankruptcy law is not assured, if it occurs any recovery will be a set-off in the Montreal action against Allgon’s parent, Advantech.

 

The Company is not a party to any other material legal proceeding which is expected to have a material adverse effect on our consolidated financial statements or results of operations. From time to time, we 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 resources and diversion of management efforts.

 

 

Information Relating to our Common Stock

 

Our common stock is traded on the NASDAQ Global Market under the symbol “ENWV.” The following table sets forth the high and low daily sales prices per share of our common stock, as reported by the NASDAQ Global Market.

 

 

The last reported sale price of our common stock on the NASDAQ Global Market on February 5, 2010 was $2.58 per share. As of February 5, 2010, there were approximately 92 holders of record of our common stock.

 

Dividend Policy

 

We have never paid any cash dividends on our capital stock. Because we currently intend to retain any future earnings to fund the development and growth of our business, we do not anticipate paying any cash dividends in the near future.

Equity Compensation Plan Information

 

The following table provides certain information with respect to all of our equity compensation plans in effect as of the end of December 31, 2009.

 

 

 

Performance Measurement Comparison

 

The graph below shows the cumulative total stockholder return of an investment of $100 (and the reinvestment of any dividends thereafter) on December 31, 2004 in (i) our common stock, (ii) the NASDAQ Stock Market Index (U.S. Companies) and (ii) the NASDAQ Telecommunications Index. Our stock price performance shown in the graph below is not indicative of future stock price performance.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Endwave Corporation, The NASDAQ Composite Index
And The NASDAQ Telecommunications Index

 

 

 

 

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included elsewhere in this report. The selected consolidated statements of operations data for the fiscal years ended December 31, 2009, 2008 and 2007 and the selected consolidated balance sheet data as of December 31, 2009 and 2008 are derived from our audited consolidated financial statements that are included elsewhere in this report. The selected consolidated statements of operations data for the fiscal years ended December 31, 2006 and 2005 and the selected consolidated balance sheet data as of December 31, 2007, 2006 and 2005 are derived from our audited consolidated financial statements not included in this report. The historical results are not necessarily indicative of the results of operations to be expected in any future periods.

 

 

 

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report, as well as the information set forth in the “Risk Factors” section of this report. 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.

 

Overview

 

We design, manufacture and market radio frequency, or RF, products that enable the transmission, reception and processing of high frequency RF signals.

On April 30, 2009, we entered into an Asset Purchase Agreement with Microsemi Corporation (“Microsemi”) pursuant to which Microsemi purchased our Defense and Security RF module business, including all of the outstanding capital stock of our subsidiary, Endwave Defense Systems Incorporated. As consideration, Microsemi assumed certain liabilities associated exclusively with the Defense and Security RF module business and paid $28.0 million in cash. Additionally, as part of the sale, approximately 130 employees associated with the Defense and Security RF module business transferred to Microsemi. Accordingly, we reclassified the results of our Defense and Security RF module business as a discontinued operation in our consolidated statements of operations for all periods presented in this Annual Report on Form 10-K, and all amounts set forth in this Management’s Discussion and Analysis of Financial Condition and Results of Operation reflect such reclassification.

 

As a result of the divestiture of our Defense and Security RF module business in April 2009, our products now consist of two key product lines:

 

 

Markets and Diversification Strategy

 

Telecommunications market.  Most of our RF modules are deployed in telecommunication networks, carrier class trunking networks and point-to-point transmission networks. Our target customers for these applications are telecom OEMs. Telecom OEMs provide the equipment used by service providers to deliver voice, data and video services to businesses and consumers.

 

Non-telecommunication markets.  Our RF semiconductors are also designed into various applications outside of the telecommunication network market, including defense and homeland security markets. Our target customers in the defense market include defense systems integrators and their subcontractors that design aerospace systems, defense systems and weapons and electronics platforms for both domestic and foreign defense customers. Our target customers in the homeland security market include those utilizing the properties of high-frequency RF energy to create new systems designed to detect and identify security threats.

 

2009 Revenues.  Due to the divestiture of our Defense and Security RF module business and associated reclassification of such business as a discontinued operation, telecom OEMs accounted for nearly all of our total revenues in 2009. During 2009, total revenues from continuing operations decreased by $19.2 million, or 50%, from 2008. The demand for our products has declined relative to prior periods as the mobile communication industry has been impacted by the global economic downturn and credit crisis. Additionally, during the second half of 2009 a key legacy product for a major customer’s radio platform experienced a rapid and unanticipated drop in sales while sales of our new module designs supporting next-generation radios were just beginning their production ramp. The revenues from the new module designs did not offset the decline in revenues from the legacy product.

 

Current market outlook.  The funding of the installation and enhancement of mobile communication networks integrating our products often relies on the availability of credit. Assuming global economic conditions continue to stabilize, we currently estimate revenues in 2010 will be higher than revenues in 2009. We believe revenue growth, if any, will be due to the ramp of our new module designs supporting next-generation radios that

began production ramp late in 2009 as well as from our semiconductor product line which we announced in September 2009.

 

Seasonality

 

Although we have experienced significant quarterly fluctuations in revenue at times over the past several years, we do not believe that volatility was primarily attributable to seasonality in our business.

 

Critical Accounting Policies and Estimates

 

General

 

Management’s discussion and analysis of its financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, warranty obligations, inventories, stock-based compensation, income taxes, asset impairments and other commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions. We discuss these policies further, as well as the estimates and judgments involved, below.

 

Revenue Recognition

 

Our primary customers are telecom OEMs and other systems integrators that incorporate our products into their systems. We recognize product revenues at the time title passes, which is generally upon product shipment or when withdrawn from a consignment location, coupled with persuasive evidence that an arrangement exists, delivery has occurred or services have been rendered, our price to the buyer is fixed or determinable and collectibility is reasonably assured. Revenues under development contracts are generally recorded on a percentage of completion basis, using project hours as the basis to measure progress toward completing the contract and recognizing revenues. Alternatively, where a development contract specifies defined progress gates or milestones tied to payments, revenue is recognized on a pro rata basis matching the milestones. Revenues attributable to development fees were insignificant during 2007, 2008 and 2009. The costs incurred under these development agreements are included in research and development expenses.

 

Allowance for Doubtful Accounts

 

We make ongoing assumptions relating to the collectibility of our accounts receivable in our calculation of the allowance for doubtful accounts. In determining the amount of the allowance, we make judgments about the creditworthiness of customers based on ongoing credit evaluations and assess current economic trends affecting our customers that might impact the level of credit losses in the future and result in different rates of bad debts than previously seen. We also consider our historical level of credit losses. Our allowance was $64,000 at December 31, 2008 and $19,000 at December 31, 2009. The decrease in our allowance from December 31, 2008 is primarily due to the sale of our Defense and Security RF module business in April 2009 which included the accounts receivable and related allowance for that division. If actual credit losses were to be significantly greater than the reserves we have established, our selling, general and administrative expenses would increase.

 

Warranty Reserves

 

We generally offer a 12 to 30 month warranty on all of our products. We record a liability based on estimates of the costs that may be incurred under our warranty obligations and charge to cost of product revenues the amount of such costs at the time revenues are recognized. Our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Our estimates of anticipated rates of warranty claims and costs per claim are primarily based on historical information and future forecasts. At

December 31, 2008 and 2009 our warranty reserves were $2.4 million and $1.1 million, respectively. The decrease in our reserves from December 31, 2008 is primarily due to the sale of our Defense and Security RF module business in April 2009 which included the related warranty reserve for that division. We periodically assess the adequacy of our recorded warranty reserve and adjust the amounts as necessary. If actual warranty claims are significantly higher than forecast, or if the actual costs incurred to provide the warranty is greater than the forecast, our gross margins could be adversely affected.

 

Inventory Valuation

 

We evaluate our ending inventories for excess quantities and obsolescence at each balance sheet date. This evaluation includes review of materials usage, market conditions and product life cycles and an analysis of sales levels by product and projections of future demand and market conditions. We adjust inventory balances to approximate the lower of our manufacturing cost or market value. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required, and would be reflected in cost of product revenues in the period the revision is made. This would have a negative impact on our gross margins in that period. At the time of write down, a new, lower cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. If in any period we are able to sell inventories that were not valued or that had been written off in a previous period, related revenues would be recorded without any offsetting charge to cost of product revenues, resulting in a net benefit to our gross margin in that period. To the extent these factors materially affect our gross margins, we would disclose them.

 

Stock-Based Compensation

 

Our stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. All of our stock compensation is accounted for as an equity instrument.

 

We estimate the fair value of stock options and shares under our stock purchase plan using the Black-Scholes valuation model. The fair value of each option grant and the right to purchase shares under our stock purchase plan are estimated on the date of grant using the Black-Scholes option valuation model and the graded-vesting method with assumptions concerning expected dividend yield, stock price volatility, risk free interest rate and expected life of the award.

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. As our stock option awards have characteristics that differ significantly from traded options, and as changes in the subjective assumptions can materially affect the estimated value, our estimate of fair value may not accurately represent the value assigned by a third party in an arms-length transaction. There currently is no market-based mechanism to verify the reliability and accuracy of the estimates derived from the Black-Scholes option valuation model or other allowable valuation models, nor is there a means to compare and adjust the estimates to actual values. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.

 

Deferred Taxes

 

We currently have significant deferred tax assets, which are subject to periodic recoverability assessments. We record a valuation allowance to reduce our deferred tax assets to the amount that we believe to be more likely than not realizable. We have recorded a valuation allowance in an amount equal to the net deferred tax assets to reflect uncertainty regarding future realization of these assets based on past performance and the likelihood of realization of our deferred tax assets.

 

Long-Lived Assets

 

We periodically review our property and equipment for possible impairment whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges. Significant

assumptions and estimates include the projected cash flows based upon estimated revenues and expense growth rates and the discount rate applied to expected cash flows. In addition, our depreciation policy reflects judgments on the estimated useful lives of assets.

 

During the fourth quarter of 2008, we reviewed our long-lived assets for indicators of impairment. Based on reduced estimates of future revenues and future negative cash flow, we identified potential indicators of impairment. As a result, we compared the fair value of our long-lived assets to their carrying value. Based on our discounted future cash flow and revenue projections, we recorded non-cash impairment charges of $2.1 million for all of our remaining intangible assets with a defined useful life. These assets relate to the Defense and Security RF module business and have been included in the income (loss) for discontinued operations line on the consolidated statements of operations. As a result, we have no remaining intangible assets with a defined useful life.

 

Goodwill and Intangible Assets with an Indefinite Life

 

We are required to assess the carrying value of goodwill and other intangible assets with an indefinite life annually or whenever circumstances indicate that a decline in value may have occurred. During the fourth quarter of 2008, based on the fair value of our common stock relative to our book value, revised estimates for our future revenues and the continued worsening of the global economy, we determined that indicators of potential impairment were present. Based on the fair market value of the business and our discounted future cash flow and revenue projections, we recorded non-cash impairment charges of $3.0 million for goodwill and $1.1 million for intangible assets with an indefinite life. These assets relate to the Defense and Security RF module business and have been included in the income (loss) for discontinued operations line on the consolidated statements of operations. As a result, we have no remaining intangible assets with a defined useful life.

 

Fair Value Measurement

 

Our financial assets and liabilities are valued using market prices on both active markets (Level 1) and less active markets (Level 2). Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily-available pricing sources for comparable instruments. As of December 31, 2009, we did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (Level 3).

 

Business Combinations

 

For our business combinations, the purchase price of an acquired company is allocated between the intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. The valuation of intangible assets is based on an income approach methodology that values the intangible assets based on the future cash flows that could potentially be generated by the asset over its estimated remaining life discounted to its present value utilizing an appropriate weighted average cost of capital. As a result of business acquisitions, the allocation of the purchase price to goodwill and intangible assets could have a significant impact on our future operating results.

Results of Operations

 

The following tables set forth selected consolidated statements of operations data for each of the periods indicated in dollars and as a percentage of total revenues.

 

 

 

Results of Operations

 

Year ended December 31, 2009 compared to year ended December 31, 2008

 

Total revenues

 

 

Total revenues consist of product revenues and development fees. Product revenues are attributable to sales of our communication products. Development fees are attributable to the development of 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 do not expect development fees to represent a significant percentage of our total revenues for the foreseeable future.

 

Total revenues decreased by $19.2 million, or 50%, from 2008 to 2009. The demand for our products has declined relative to prior periods as the mobile communication industry has been impacted to a significant degree by the current global economic downturn and credit crisis. Additionally, during the second half of 2009 a key legacy product for a major customer’s radio platform experienced a rapid and unanticipated drop in sales while sales of our new module designs supporting next-generation radios were just beginning their production ramp. The revenues from the new module designs did not offset the decline in revenues from the legacy product.

 

During 2010, we expect revenues to be higher relative to 2009 due to the stabilization of the global economic conditions. Additionally, we believe we will see revenue growth from our new module designs supporting next

generation based radios that began production ramp late in 2009 as well as from our semiconductor product line we announced in September 2009.

 

Cost of product revenues

 

 

Cost of product revenues consists primarily of: costs of direct materials; equipment depreciation; costs associated with procurement, production control, quality assurance and manufacturing engineering; fees paid to our offshore manufacturing vendor; reserves for potential excess or obsolete material; costs related to stock-based compensation; and accrued costs associated with potential warranty returns offset by the benefit of usage of materials that were previously written off.

 

During 2009, the cost of product revenues as a percentage of revenues increased compared to 2008, primarily due to the decreased absorption of our overhead costs resulting from decreased production, continued pricing pressure resulting in lower product margins, an $878,000 increase in inventory reserves due to excess material related to a rapid and unanticipated drop in sales of a legacy product for a major customer’s radio platform and an $86,000 increase in reserve for material related to a product built for a customer currently in bankruptcy liquidation. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to approximately $100,000 during 2009 and $85,000 during 2008.

 

We continue to focus on reducing the cost of product revenues as a percentage of total revenues through the introduction of new designs and technology and further improvements to our offshore manufacturing processes. In addition, our product costs are impacted by the mix and volume of products sold and will continue to fluctuate as a result.

 

Research and development expenses

 

 

Research and development expenses consist primarily of salaries and related expenses for research and development personnel, outside professional services, prototype materials, supplies and labor, depreciation for related equipment, allocated facilities costs and expenses related to stock-based compensation.

 

During 2009, we undertook certain restructuring activities to reduce expenses which resulted in a decrease of 21 product and process engineering employees and $808,000 in associated personnel-related expenses. In addition, during 2009, research and development costs decreased compared to 2008 due to a decrease of $317,000 for stock-based compensation expenses and a decrease of $209,000 for project-related expenses.

 

During 2010, we expect research and development expenses to be lower relative to 2009 in absolute dollar terms, as the restructuring activities we undertook in 2009 will fully impact our 2010 results.

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, expenses related to stock-based compensation and promotional activities.

 

During 2009 sales and marketing expenses were $2.2 million compared to $3.3 million in 2008. During 2009, we undertook certain restructuring activities to reduce expenses which resulted in a decrease of three sales and marketing employees and $498,000 in associated personnel-related expenses. In addition, during 2009 sales and marketing expenses decreased compared to 2008 due to a decrease of $250,000 for stock-based compensation expenses and a decrease of $184,000 for bad debt expenses.

 

During 2009 general and administrative expenses were $5.6 million compared to $7.7 million in 2008. During 2009, we undertook certain restructuring activities to reduce expenses which resulted in a decrease of ten general and administrative employees and $798,000 in associated personnel-related expenses. In addition, during 2009, general and administrative expenses decreased compared to 2008 primarily due to a decrease of $468,000 for professional fees and a decrease of $320,000 for stock-based compensation expenses.

 

During 2010, we expect selling, general and administrative expenses to be lower relative to 2009 in absolute dollar terms, as the restructuring activities we undertook in 2009 will fully impact our 2010 results.

 

Restructuring

 

 

During the first quarter of 2009, we undertook certain restructuring activities to reduce expenses. These terminations affected all areas of our operations. The components of the restructuring charge included severance, benefits, payroll taxes and other costs associated with employee terminations. The net charge for these restructuring activities in the first quarter of 2009 was $1.2 million and the restructuring activities are expected to be substantially completed by the end of the first quarter of 2010. Of this amount, approximately $182,000 has been included in income (loss) from discontinued operations.

 

During the second quarter of 2009, we undertook certain additional restructuring activities to reduce expenses. The components of the restructuring charge included severance, benefits, payroll taxes and other costs associated with employee terminations. The net charge for these restructuring activities in the second quarter of 2009 was $243,000 and is expected to be substantially completed by the end of the first quarter of 2010. Of this amount, approximately $39,000 has been included in income (loss) from discontinued operations.

 

During the fourth quarter of 2009, we undertook certain additional restructuring activities to reduce expenses. The components of the restructuring charge included severance, benefits, payroll taxes and other costs associated with employee terminations. The net charge for these restructuring activities in the fourth quarter of 2009 was $1.2 million and is expected to be substantially completed by the end of the third quarter of 2012.

 

At December 31, 2008, we had 228 employees. At December 31, 2009, we had 54 employees. The decrease in employees was due to the restructuring mentioned above and the sale of our Defense and Security RF module business to Microsemi.

Interest and other income, net

 

 

Interest and other income, net consists primarily of interest income earned on our cash, cash equivalents and investments, the amortization of the deferred gain from the sale of our Diamond Springs, California location, which ended in June 2009, and gains and losses related to foreign currency transactions.

 

The decrease in interest and other income from 2008 to 2009 was primarily the result of decreased interest earned on our investments. Interest rates decreased significantly from the prior year, especially on the highest rated investment vehicles, leading to lower interest income.

 

During 2009, we earned $205,000 of interest income and recognized $76,000 of other income from the amortization of the deferred gain from the sale of our Diamond Springs, California location, which was partially offset by banking charges and losses on foreign currency transactions. During 2008, we earned $1.1 million of interest income and recognized $154,000 of other income from the amortization of the deferred gain from the sale of our Diamond Springs, California location, which was partially offset by banking charges and losses on foreign currency transactions.

 

Our functional currency is the U.S. Dollar. Transactions in foreign currencies other than the functional currency are remeasured into the functional currency at the time of the transaction. Foreign currency transaction losses consist of the remeasurement gains and losses that arise from exchange rate fluctuations related to our operations in Thailand. During 2009 and 2008, we recorded foreign currency transaction losses of $15,000 and $59,000, respectively.

 

Income tax expense (benefit)

 

 

During 2009 and 2008, we recorded an income tax benefit of $105,000 and $66,000, respectively, due to a benefit from refundable research and development tax credits in the United States. No other income tax expense (benefit) has been recorded because we have incurred operating losses that cannot be benefitted due to a full valuation allowance.

 

Discontinued Operations

 

 

On April 30, 2009, we entered into an Asset Purchase Agreement with Microsemi pursuant to which Microsemi purchased our Defense and Security RF module business including all of the outstanding capital stock of Endwave Defense Systems Incorporated. As consideration, Microsemi assumed certain liabilities associated exclusively with the Defense and Security RF module business and paid $28.0 million in cash.

 

We classified the results of the Defense and Security RF module business as a discontinued operation in our consolidated statements of operations for all periods presented. During 2009, we recognized income from discontinued operations of $17.6 million net of tax expenses. The income was a result of the gain on sale of the discontinued operations of $19.6 million partially offset by a $2.0 million loss from the discontinued operations in 2009. During 2008, we recognized loss from discontinued operations of $10.8 million, which included

$6.1 million of impairment charges for the Defense and Security RF module business’ goodwill and intangible assets.

 

Year ended December 31, 2008 compared to year ended December 31, 2007

 

Total revenues

 

 

Product revenues decreased by $5.5 million, or 13%, from 2007 to 2008. The decrease in product revenues was primarily attributable to decreased revenues from the former Siemens product lines of Nokia Siemens Networks as they reduced purchases of legacy products that historically have been outsourced to us.

 

The decrease in development fees from 2008 to 2007 was attributable to decreased development of custom-designed products for our new and existing customers.

 

Cost of product revenues

 

 

During 2008, the cost of product revenues as a percentage of revenues decreased due primarily to a change in product mix favoring certain higher margin products, partially offset by increased inventory reserves associated with a customer of ours that filed for bankruptcy protection during the fourth quarter of 2008. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to $85,000 during 2008 and $258,000 during 2007.

 

Research and development expenses

 

 

During 2008, research and development expenses increased both as a percentage of total revenues and in absolute dollars compared to 2007. The increase in research and development expenses was primarily attributable to an increase of $183,000 in personnel-related expenses and an increase of $63,000 for stock based compensation.

 

Selling, general and administrative expenses

 

During 2008, selling, general and administrative expenses increased both as a percentage of total revenues and in absolute dollars compared to 2007. During 2008, sales and marketing expenses were $3.3 million compared to $2.7 million in 2007. The increase in sales and marketing expenses were primarily attributable to an increase of $155,000 in personnel-related expenses and an increase of $315,000 for a reserve on a note receivable from one of our customers. We originally set up a note receivable in the third quarter of 2008 as one of our customers was unable to meet the terms of their accounts receivable to us. During the fourth quarter of 2008 this customer filed for bankruptcy protection and we therefore reserved a significant portion of the remaining note receivable.

 

During 2008 general and administrative expenses were $7.7 million compared to $7.6 million in 2007. The increase in general and administrative expenses was primarily attributable to an increase of $531,000 in personnel-related expenses was partially offset by a decrease of $168,000 for public company related expenses, a decrease of $117,000 for professional services and a decrease of $92,000 for stock-based compensation.

 

Interest and other income, net

 

 

The decrease in interest and other income, net during 2008 was primarily the result of decreased interest earned on our investments. We had a lower cash and investment balance due to our stock repurchase in the fourth quarter of 2007 and our acquisition of ALC during the second quarter of 2007. Additionally, interest rates have decreased significantly from the prior year, especially on the highest rated investment vehicles, leading to lower interest income. During 2008, we earned $1.1 million of interest income and recognized $154,000 of other income from the amortization of the deferred gain from the sale of our Diamond Springs, California location which were partially offset by banking charges and losses on foreign currency transactions. During 2007, we earned $3.5 million of interest income and recognized $154,000 of other income from the amortization of the deferred gain from our sale of the Diamond Springs, California location which were partially offset by banking charges and losses on foreign currency transactions.

 

During 2008 and 2007, we recorded a foreign currency loss of $59,000 and $17,000, respectively.

 

Income tax expense (benefit)

 

 

A net income tax benefit of $66,000 was recorded in the year ended December 31, 2008 compared to a net income tax expense of $2,000 recorded in the year ended December 31, 2007. The main change in 2008 was due to recording a benefit from refundable research and development tax credits in the United States. No other income tax expense (benefit) has been recorded because we have incurred operating losses that cannot be benefitted due to a full valuation allowance.

 

Discontinued Operations

 

 

We classified the results of the Defense and Security RF module business as a discontinued operation in our consolidated statements of operations for all periods presented. During 2008, we recognized loss from discontinued operations of $10.8 million which included $6.1 million of impairment charges for the Defense and Security RF

module business’ goodwill and intangible assets. During 2007, we recognized loss from discontinued operations of $6.1 million, net of tax.

 

Liquidity and Capital Resources

 

At December 31, 2009, we had $55.2 million of cash and cash equivalents, $11.3 million in short-term investments, working capital of $70.7 million and no long-term or short-term debt outstanding. The following table sets forth selected consolidated statements of cash flows data for our three most recent fiscal years.

 

 

During 2009, operating activities used $4.1 million of cash as compared to generating $2.4 million of cash in 2008. Our net loss from continuing operations adjusted for depreciation and other non-cash items, was a loss of $7.5 million in 2009 as compared to $375,000 in 2008. The remaining provision of $3.4 million of cash in 2009 was primarily due to a $4.7 million decrease in inventory and a $665,000 increase in accounts payable which were partially offset by a $767,000 increase in other assets, a $706,000 decrease in accrued warranty and a $462,000 increase in accounts receivable.

 

During 2008, $2.4 million of cash was generated by operating activities as compared to $8.8 million in 2008. Our net loss from continuing operations adjusted for depreciation and other non-cash items, was a loss of $375,000 in 2008 as compared to income of $4.3 million in 2007. The remaining provision of $2.7 million in cash in 2008 was primarily due to a $5.0 million decrease in accounts receivable partially offset by a $1.7 million decrease in accounts payable, a $600,000 decrease in accrued warranty and a $308,000 increase in inventory.

 

During 2009, investing activities provided $27.9 million of cash compared to using $4.1 million of cash in 2008. The source of cash in 2009 was due to the $28.0 million proceeds from sale of our Defense and Security RF module business and a $600,000 decrease in restricted cash which were partially offset by a purchase of $396,000 of property and equipment and a net $312,000 purchase of investments.

 

During 2008, investing activities used $4.1 million of cash compared to providing $25.4 million of cash in 2007. The use of cash by investing activities in 2008 was primarily due to the purchase of $1.3 million in property and equipment, a net $1.2 million purchase of investments, the $1.0 million final payment for the purchase of ALC and a $575,000 increase in restricted cash.

 

During 2009, financing activities provided cash of $632,000 as compared to $417,000 in 2008. During 2009, we received $331,000 from the exercise of stock options and $317,000 from the proceeds of stock issuance which was partially offset by capital lease payments.

 

During 2008, financing activities provided cash of $417,000 as compared to using cash of $16.0 million in 2007. During 2008, we received $791,000 in cash from the proceeds of stock issuance which was partially offset by $356,000 of payments we made related to the common stock we repurchased in 2007 and capital lease payments.

 

At December 31, 2009, we had a net unrealized gain of $15,000 related to $11.3 million of investments in nine debt securities. The increase in the value of these investments is primarily related to changes in interest rates. The investments all mature during 2010 and we believe that we have the ability and intent to hold these investments until the maturity date. Realized gains were $57,000 in 2008. Realized gains and losses were insignificant for the years ended December 31, 2009 and 2007. We recorded a foreign currency a translation gain of $12,000 in 2008 and a translation loss of $12,000 in 2007. There were no such losses in 2009.

In January 2010, we entered into a Stock Purchase Agreement with Oak Investment Partners XI, Limited Partnership, or Oak, pursuant to which we repurchased the 300,000 shares of Endwave Series B Preferred Stock held by Oak for $36.0 million in cash. Such shares had entitled to Oak to a liquidation preference equal to its original investment of $45.0 million before any proceeds from a liquidation or sale of Endwave would have been paid to the holders of our common stock.

 

We believe that our existing cash and investment balances will be sufficient to meet our operating and capital requirements for at least the next 12 months. With the exception of operating leases discussed in the notes to the consolidated financial statements included in this report, we have not entered into any off-balance sheet financing arrangements and we have not established or invested in any variable interest entities. 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 cash obligations for operating leases, capital leases and purchase obligations, excluding interest, at December 31, 2009:

 

 

We have purchase obligations to certain suppliers. In some cases the products we purchase are unique and have provisions against cancellation of the order. At December 31, 2009, we had approximately $2.2 million of purchase obligations, which are due within the following 12 months.

 

Other Long-Term Liabilities

 

At December 31, 2009, we had $765,000 of other long-term liabilities consisting of a $638,000 long-term liabilities for restructuring, $124,000 for income taxes and $3,000 related to our capital lease.

 

Recent Accounting Pronouncements

 

In October 2009, the Financial Accounting Standards Board (“FASB”) FASB issued new standards for revenue recognition with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are required to be adopted in the first quarter of 2011; however, early adoption is permitted. We do not expect these new standards to significantly impact our consolidated financial statements.

 

In October 2009, the FASB issued new standards for the accounting for certain revenue arrangements that include software elements. These new standards amend the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. These new standards are required to be adopted in the first quarter of 2011; however, early adoption is permitted. We do not expect these new standards to significantly impact our consolidated financial statements.

 

In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. We do not expect these new standards to significantly impact our consolidated financial statements.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Our exposure to market risk based on changes in interest rates relates primarily to our investment portfolio. In order to reduce this interest rate risk, we invest our cash primarily in investments with short maturities. As of December 31, 2009, our investments in our portfolio were classified as cash equivalents and short-term investments. The cash equivalents and short-term investments consisted primarily of United States treasury notes, United States government agency notes, United States government money market funds, Prime money market fund, corporate notes and commercial paper. Since our investments consist of cash equivalents and short-term investments, a change in interest rates would not have a material effect on our consolidated financial condition or results of operations. Declines in interest rates over time will, however, reduce interest income.

 

Currently, all sales to international customers are denominated in United States dollars and, accordingly, we are not exposed to foreign currency rate risks in connection with these sales. However, if the dollar were to strengthen relative to other currencies that could make our products less competitive in foreign markets and thereby lead to a decrease in revenues attributable to international customers. We currently pay a number of expenses related to our Thai personnel and office in Thai Bhat. During 2009, the total payments made in Thai Bhat were $804,000 and we recorded a related foreign currency transaction loss of $15,000.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

To the Board of Directors and Stockholders of

Endwave Corporation:

 

We have audited the accompanying balance sheets of Endwave Corporation and its subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule listed in Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Endwave Corporation and its subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

 

San Jose, California

March 24, 2010

ENDWAVE CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

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

ENDWAVE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

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

ENDWAVE CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY