ENWV Endwave Corp. (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2010

OR

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

For the transition period from                      to                     

000-31635
(Commission file number)

ENDWAVE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware (State of incorporation)		95-4333817 (I.R.S. Employer Identification No.)
130 Baytech Drive
San Jose, CA		95134
(Address of principal executive offices)		(Zip code)

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

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

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ
				(Do not check if a smaller reporting company)

     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 number of shares of the registrant’s Common Stock outstanding as of October 29, 2010 was 9,802,084 shares.

 

 

ENDWAVE CORPORATION

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			3
Condensed Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009			3
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009			4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009			5
Notes to Condensed Consolidated Financial Statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantitative and Qualitative Disclosure about Market Risk			25
Item 4. Controls and Procedures			26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			26
Item 1A. Risk Factors			27
Item 6. Exhibits			37
SIGNATURES			40
EXHIBITS			41
EX-31.1
EX-31.2
EX-32.1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

		September 30,				December 31,
		2010				2009
		(unaudited)				(1)
ASSETS
Current assets:
Cash and cash equivalents		$	9,834			$	55,158
Short-term investments			14,892				11,307
Accounts receivable, net			3,641				3,009
Inventories			4,499				4,879
Other current assets			532				788
Total current assets			33,398				75,141
Property and equipment, net			2,076				1,796
Other assets, net			78				179
Total assets		$	35,552			$	77,116
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,562			$	1,726
Accrued warranty			809				1,087
Accrued compensation			647				590
Restructuring liabilities, short-term			467				570
Other current liabilities			339				426
Total current liabilities			4,824				4,399
Restructuring liabilities, long-term			351				638
Other long-term liabilities			124				127
Total liabilities			5,299				5,164
Commitments and contingencies (Note 7)
Stockholders’ equity:
Convertible preferred stock, $0.001 par value; 5,000,000 shares authorized; zero and 300,000 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			—				43,092
Common stock, $0.001 par value; 50,000,000 shares authorized; 9,802,084 and 9,684,756 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			10				10
Additional paid-in capital, common stock			317,256				309,755
Accumulated other comprehensive income			3				15
Accumulated deficit			(287,016	)			(280,920	)
Total stockholders’ equity			30,253				71,952
Total liabilities and stockholders’ equity		$	35,552			$	77,116

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

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

(unaudited)

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenues:
Product revenues		$	4,058			$	3,126			$	12,645			$	15,948
Costs and expenses:
Cost of product revenues*			3,169				2,369				10,596				11,425
Research and development*			1,221				1,452				3,302				4,463
Sales and marketing*			594				594				1,745				1,656
General and administrative*			996				1,374				3,009				4,605
Restructuring			63				(21	)			49				1,212
Total costs and expenses			6,043				5,768				18,701				23,361
Loss from continuing operations			(1,985	)			(2,642	)			(6,056	)			(7,413	)
Interest and other income (expense), net			(14	)			(3	)			(40	)			197
Loss from continuing operations before benefit from income taxes			(1,999	)			(2,645	)			(6,096	)			(7,216	)
Benefit from income taxes			—				(11	)			—				(32	)
Loss from continuing operations			(1,999	)			(2,634	)			(6,096	)			(7,184	)
Income from discontinued operations, net of tax* (Note 9)			—				41				—				17,571
Net income (loss)		$	(1,999	)		$	(2,593	)		$	(6,096	)		$	10,387
Basic and diluted net loss per share from continuing operations		$	(0.20	)		$	(0.27	)		$	(0.62	)		$	(0.76	)
Basic and diluted net income per share from discontinued operations		$	—			$	—			$	—			$	1.86
Basic and diluted net income (loss) per share		$	(0.20	)		$	(0.27	)		$	(0.62	)		$	1.10
Shares used in computing basic and diluted net loss per share			9,798,972				9,625,583				9,757,899				9,477,516

Cost of product revenues		$	(15	)		$	80			$	6			$	190
Research and development			13				186				65				374
Sales and marketing			35				215				69				390
General and administrative			107				458				270				999
Income from discontinued operations, net of tax			—				—				—				355

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

ENDWAVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

		Nine months ended
		September 30,
		2010				2009
Operating activities:
Net income (loss)		$	(6,096	)		$	10,387
Income from discontinued operations			—				17,571
Loss from continuing operations, net of tax			(6,096	)			(7,184	)
Adjustments to reconcile net loss to net cash used in continuing operating activities:
Depreciation			654				576
Stock compensation expense			410				1,953
Amortization of investments, net			249				198
Changes in operating assets and liabilities:
Accounts receivable, net			(632	)			478
Inventories			376				3,448
Other assets			357				(1,015	)
Accounts payable			836				528
Accrued warranty			(278	)			(631	)
Accrued compensation and other liabilities			(420	)			(831	)
Net cash used in operating activities			(4,544	)			(2,480	)
Investing activities:
Proceeds from sale of discontinued operations			—				28,000
Change in restricted cash			—				600
Purchases of property and equipment			(934	)			(289	)
Proceeds on sales and maturities of investments			15,530				19,715
Purchases of investments			(19,376	)			(30,331	)
Net cash (used in) provided by investing activities			(4,780	)			17,695
Financing activities:
Repurchase of preferred stock			(36,238	)			—
Payments on capital leases			(3	)			(13	)
Proceeds from common stock issuance			74				242
Proceeds from exercises of stock options			167				331
Net cash (used in) provided by financing activities			(36,000	)			560
Cash flows from discontinued operations:
Operating activities			—				(2,472	)
Investing activities			—				(794	)
Financing activities			—				—
Net cash used in discontinued operations			—				(3,266	)
Net change in cash and cash equivalents			(45,324	)			12,509
Cash and cash equivalents at beginning of period			55,158				33,998
Cash and cash equivalents at end of period		$	9,834			$	46,507

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

ENDWAVE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

      1. Business and Basis of Presentation

     Endwave Corporation (“Endwave” or the “Company”) designs, manufactures and markets radio frequency, or RF, products that enable the transmission, reception and processing of high frequency RF signals. The Company currently has two key product lines:

	•		The Company’s transceiver modules, which serve as the core RF sub-system in digital microwave radios, are produced for telecommunication network original equipment manufacturers and system integrators located throughout the world, collectively referred to as telecom OEMs.
	•		The Company’s semiconductor product line consists of a broad range of monolithic microwave integrated circuits, or MMICs, including amplifiers, voltage controlled oscillators, up and down converters, variable gain amplifiers, voltage variable attenuators, fixed attenuators and filters. These types of devices find wide application in numerous telecommunications, avionic, defense, homeland security, instrumentation and consumer systems.

     The accompanying unaudited condensed consolidated financial statements of Endwave have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The year-end condensed consolidated balance sheet data was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, the information contained herein reflects all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation of the results of the interim periods presented. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2010 or any future periods. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2009.

     Certain prior year financial statement amounts have been reclassified to conform to the current year’s presentation. These reclassifications had no impact on previously reported total assets, stockholders’ equity or total net income (loss).

     On April 30, 2009, the Company sold its Defense and Security RF module business to Microsemi Corporation (“Microsemi”). The Company’s financial statements have been presented to reflect the Defense and Security RF module business as a discontinued operation for all periods presented. See additional discussion at Note 9, Discontinued Operations.

      2. Investments

     The following fair value amounts have been determined using available market information.

		September 30, 2010
						Gross				Gross
		Amortized				Unrealized				Unrealized
		Cost				Gains				Losses				Fair Value
		(In thousands)
Investments:
Commercial paper		$	2,649			$	—			$	—			$	2,649
United States government agencies			12,240				3				—				12,243
Total		$	14,889			$	3			$	—			$	14,892

		December 31, 2009
						Gross				Gross
		Amortized				Unrealized				Unrealized
		Cost				Gains				Losses				Fair Value
		(In thousands)
Investments:
Commercial paper		$	799			$	—			$	—			$	799
United States government agency			8,759				5				(2	)			8,762
Corporate securities			1,734				12				—				1,746
Total		$	11,292			$	17			$	(2	)		$	11,307

     At September 30, 2010, the Company had $14.9 million of short-term investments with maturities of less than one year and no long term investments.

     At September 30, 2010, the Company had unrealized gains of $3,000 related to $9.0 million of investments. The investments mature through 2011 and the Company believes that it has the ability to hold these investments until their maturity dates. Realized gains and losses were insignificant for the three and nine months ended September 30, 2010 and 2009.

     The Company reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, credit quality and the Company’s ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. If the Company believes the carrying value of an investment is in excess of its fair value, and this difference is other-than-temporary, it is the Company’s policy to write down the investment to reduce its carrying value to fair value.

Fair Value Measurements

     The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009 (in thousands):

		Quoted Prices in
		Active Markets of								Significant Other
		Identical Assets								Observable Inputs
		(Level 1)								(Level 2)
		Sept 30,				Dec 31,				Sept 30,				Dec 31,
		2010				2009				2010				2009
Assets:
Cash equivalents:
Money market funds		$	7,491			$	54,097			$	—			$	—
Commercial paper			—				—				650				—
Short-term investments:
Commercial paper			—				—				2,649				799
United States government agencies			—				—				12,243				8,762
Corporate securities			—				—				—				1,746
Total		$	7,491			$	54,097			$	15,542			$	11,307
Liabilities:		$	—			$	—			$	—			$	—

     The Company’s 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 September 30, 2010, the Company 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).

     As of September 30, 2010 and December 31, 2009, the Company did not have any significant transfers of investments between Level 1 and Level 2.

     The amounts reported as cash and cash equivalents, accounts receivable, accounts payable and accrued warranty, compensation and other liabilities approximate fair value due to their short-term maturities. The fair value for the Company’s investments in marketable debt securities is estimated based on quoted market prices. Based upon borrowing rates currently available to the Company for capital leases with similar terms, the carrying value of its capital lease obligations approximates fair value.

      3. Inventories

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

		September 30,				December 31,
		2010				2009
Raw materials		$	3,597			$	4,046
Work in process			398				292
Finished goods			504				541
		$	4,499			$	4,879

      4. Note Receivable

     During the third quarter of 2008, the Company was issued a note receivable by one of its customers, Allgon Microwave Corporation AB (“Allgon”) which failed to meet the terms of its accounts receivable owed to the Company. The note was in the amount of $545,000, with payments of $25,000 due on a weekly basis. The note was to be paid in full by the end of the first quarter of 2009.

     During the third and fourth quarters of 2008, Allgon made the first five payments under the note. However, during the fourth quarter of 2008, Allgon went in default on the note and filed for bankruptcy protection. At the time of default, the note receivable balance was $420,000. Based on Allgon’s bankruptcy liquidation and the related estimates of payments to Allgon’s creditors, the Company reserved 100%, or $420,000, of the remaining balance of the note receivable.

     Subsequent to Allgon’s default on the note receivable, the Company filed a complaint alleging that Allgon’s parent company, Advantech Advanced Microwave Technologies Inc. of Montreal, Canada (“Advantech”), had breached its contractual obligations with the Company and owes the Company $994,500 which includes amounts owed under the note receivable and for purchased inventory and authorized and accepted purchase orders resulting in shippable finished goods. See additional discussion at Note 7, Commitments and Contingencies.

      5. Warranty

     The warranty periods for the Company’s products are between 12 and 30 months from date of shipment. The Company provides for estimated warranty expense at the time of shipment. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of component suppliers, its warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the estimates, revisions to the estimated warranty accrual and related costs may be required.

     Changes in the Company’s product warranty liability during the nine months ended September 30, 2010 and 2009 are as follows (in thousands):

		Nine months ended Sept 30,
		2010				2009
Balance at January 1		$	1,087			$	2,439
Warranties accrued			345				641
Warranties settled or reversed			(623	)			(1,190	)
Warranties transferred due to sale of business			—				(728	)
Balance at September 30		$	809			$	1,162

      6. Restructuring

     During the first quarter of 2009, the Company undertook certain 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 was $1.2 million and all cash payments have been made. Of this amount, approximately $182,000 has been included in the discontinued operations line item on the consolidated statements of operations.

     During the second quarter of 2009, the Company 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 was $243,000 and all cash payments have been made. Of this amount, approximately $39,000 has been included in the discontinued operations line item on the consolidated statements of operations.

     During the fourth quarter of 2009, the Company undertook certain additional restructuring activities, including the departure of a senior executive, 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 was $1.2 million. The remaining restructuring liability of $755,000 at September 30, 2010 is expected to be substantially paid by the end of the third quarter of 2012.

     During the third quarter of 2010, the Company undertook certain additional restructuring activities to reduce expenses. The components of the restructuring charge included severance, benefits, payroll taxes and other costs associated with an employee termination. The net charge for these restructuring activities was $63,000 and is expected to be substantially paid by the end of the fourth quarter of 2010.

     Changes in all of the Company’s restructuring liabilities discussed are summarized as follows (in thousands):

		Nine months ended September 30,
		2010				2009
Accrual at January 1		$	1,208			$	—
Restructuring charge			63				1,507
Cash payments			(475	)			(1,351	)
Imputed interest			36				—
Restructuring charge adjustment			(14	)			(76	)
Accrual at September 30		$	818			$	80

     At September 30, 2010, $467,000 and $351,000 of accrued restructuring charges were included in current liabilities and long-term liabilities, respectively, on the condensed consolidated balance sheet. At December 31, 2009, $570,000 and $638,000 of accrued restructuring charges were included in current liabilities and long-term liabilities, respectively, on the audited consolidated balance sheet. The restructuring liability related to a senior executive was recorded at its fair value based on an assumed interest rate of 5.0%, which represents the current market rate of interest at which the Company could borrow, due to the long-term nature of the liability. The

Company will recognize interest expense associated with amortizing the $77,000 discount on this liability over the 30 month term of the restructuring payout. During the three and nine months ended September 30, 2010, the Company recognized interest expense of $12,000 and $36,000, respectively.

     The Company’s restructuring estimates will be reviewed and revised quarterly, if necessary, and may result in an increase or decrease to restructuring charges. During the first quarter of 2010, the Company recorded a $14,000 positive adjustment as a result of lower benefit charges in connection with the first quarter 2009 restructuring plan than were originally anticipated.

      7. Commitments and Contingencies

     On October 31, 2008, the Company filed a complaint with the Canadian Superior Court in Montreal, Quebec alleging that Advantech, the parent company of Allgon Microwave Corporation AB, had breached its contractual obligations with Endwave and owes the Company $994,500, which includes amounts owed under the note receivable discussed in Note 4 and for purchased inventory and authorized and accepted purchase orders resulting in shippable finished goods. The Company cannot predict the outcome of these proceedings. Other than the complaint against Advantech, the Company is not currently a party to any material litigation

      8. Stockholders’ Equity

      Preferred Stock and Warrant Purchase Agreement

     The Company had 5,000,000 shares of convertible preferred stock authorized as of September 30, 2010 and December 31, 2009.

     In April 2006, the Company entered into a purchase agreement with Oak Investment Partners XI, Limited Partnership (“Oak”). Pursuant to the purchase agreement, Oak purchased 300,000 shares of the Company’s Series B preferred stock, par value $0.001 per share, for $150 per preferred share, or a total of $45.0 million. The preferred shares were convertible initially into 3,000,000 shares of common stock, for an effective purchase price of $15 per common share equivalent. The Company also issued Oak a warrant granting Oak the right to purchase an additional 90,000 shares of Series B preferred stock at an exercise price of $150 per share. The warrant expired on April 24, 2009. The Company received net proceeds of $43.1 million from the sale of the Series B preferred stock and the warrant after the payment of legal fees and other expenses, including commissions.

     On January 21, 2010, the Company repurchased all 300,000 outstanding shares of its preferred stock held by Oak for $120 per share, or a total of $36.0 million in cash. The total cost of the repurchase was $36.2 million, which included fees and expenses. The 300,000 outstanding shares represented 3,000,000 shares of Endwave common stock on an as-converted basis. Such shares had entitled Oak to a liquidation preference equal to its original investment of $45.0 million before any proceeds from a liquidation or sale of the Company would have been paid to the holders of Endwave’s common stock. In connection with the share repurchase, Eric Stonestrom, Oak’s designee to Endwave’s board of directors, resigned from the board of directors.

     Since the Company repurchased the preferred stock for official retirement, the excess of the stated value, $43.1 million, over the effective repurchase price of $36.2 million was credited to additional paid-in capital.

      Stock Option Exchange

     On August 11, 2009, the Company filed a Tender Offer Statement on Schedule TO with the Securities and Exchange Commission. The tender offer related to an offer by the Company to certain optionholders to exchange some or all of their outstanding stock option grants to purchase shares of the Company’s common stock granted under the Company’s 2007 Equity Incentive Plan with an exercise price per share greater than or equal to $5.00 for new option grants at an exchange ratio of three old options for one new option. The exchange offer was made to employees and directors of the Company who, as of the date the exchange offer commenced, were actively employed by or acting as a member of the Board of Directors of the Company and held eligible options. The exchange offer expired on September 9, 2009. A total of 1,570,938 options were eligible to participate in the

exchange offer and a total 1,559,113 options were exchanged for 519,624 new options. The new options have a two-year vesting period, except for 67,143 director’s shares which primarily have a one-year vesting period. All new options have an exercise price of $2.53 per share which was the closing price of the Company’s common stock on September 10, 2009.

     The exchange of original options for new options was treated as a modification of the original options. As such, the Company will continue to incur compensation cost for the incremental difference between the fair value of the new options and the fair value of the original options immediately before modification, reflecting the current facts and circumstances on the modification date, over the expected term of the new options. Since the incremental difference between the fair value of the new options and the fair value of the original options immediately before modification was immaterial, the value of the options of $661,000 is primarily due to the carry-forward value of the old options into the new options.

      Stock-based Compensation

     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 the Company’s stock compensation is accounted for as an equity instrument.

     The effect of recording stock-based compensation for the three months ended September 30, 2010 and 2009 was as follows (in thousands, except per share data):

		Three months ended September 30,
		2010				2009
Stock-based compensation expense by type of award:
Employee stock options and restricted stock units		$	81			$	847
Employee stock purchase plan			58				109
Amounts capitalized into inventory during the three month period			—				(17	)
Amounts previously capitalized into inventory and expensed			1				—
Total stock-based compensation			140				939
Tax effect on stock-based compensation			—				—
Total stock-based compensation expense		$	140			$	939
Impact on net loss per share — basic and diluted		$	(0.01	)		$	(0.10	)

     The effect of recording stock-based compensation for the nine months ended September 30, 2010 and 2009 was as follows (in thousands, except per share data):

		Nine months ended September 30,
		2010				2009
Stock-based compensation expense by type of award:
Employee stock options and restricted stock units		$	443			$	1,998
Employee stock purchase plan			(38	)			314
Amounts capitalized into inventory during the nine month period			(6	)			(29	)
Amounts previously capitalized into inventory and expensed			11				25
Total stock-based compensation			410				2,308
Tax effect on stock-based compensation			—				—
Total stock-based compensation expense		$	410			$	2,308
Impact on net income (loss) per share — basic and diluted		$	(0.04	)		$	(0.24	)

     During the three months ended September 30, 2010, the Company granted options to purchase 6,400 shares of common stock, with an estimated total grant-date fair value of $10,000 or $1.57 per share. Of these amounts, the Company estimated that the stock-based compensation expense of the awards not expected to vest was $2,000.

     During the three months ended September 30, 2009, the Company granted options to purchase 562,624 shares of common stock, including 519,624 options granted as part of an option exchange program. The 519,624 options granted as part of the exchange program had an estimated total grant-date fair value of $661,000 or $1.27 per share. The remaining 43,000 options had an estimated total grant-date fair value of $58,000 or $1.35 per share. The total estimated grant-date fair value of all 562,624 options granted was $719,000. Of this amount, the Company estimated that the stock-based compensation expense of the awards not expected to vest was $128,000.

     During the three months ended September 30, 2010, the Company granted 50,000 restricted stock units with an estimated grant-date fair value of $133,000 or $2.65 per share. Of this amount, the Company estimated that the stock-based compensation expense of the awards not expected to vest was $15,000. The Company did not grant any restricted stock units during the three months ended September 30, 2009.

     During the nine months ended September 30, 2010, the Company granted options to purchase 301,500 shares of common stock, with an estimated total grant-date fair value of $457,000 or $1.52 per share. Of these amounts, the Company estimated that the stock-based compensation expense of the awards not expected to vest was $77,000.

     During the nine months ended September 30, 2009, the Company granted options to purchase 1,082,624 shares of common stock, including 519,624 options granted as part of an option exchange program. The remaining 563,000 options had an estimated total grant-date fair value of $596,000 or $1.06 per share. The total estimated grant-date fair value of all 1,082,624 options granted was $1.3 million. Of this amount, the Company estimated that the stock-based compensation expense of the awards not expected to vest was a total of $274,000.

     During the nine months ended September 30, 2010, the Company granted 218,000 restricted stock units with an estimated grant-date fair value of $583,000 or $2.67 per share. Of this amount, the Company estimated that the stock-based compensation expense of the awards not expected to vest was $65,000. The Company did not grant any restricted stock units during the nine months ended September 30, 2009.

     During the three months ended June 30, 2009, the Company fully accelerated the vesting of 165,600 options in connection with the closing of the Microsemi transaction described in Note 9 and certain restructuring activities. The Company recorded additional stock-based compensation expense of $66,000 relating to the incremental value of the fully vested modified awards.

     As of September 30, 2010, the unrecorded stock-based compensation balance related to all stock options was $426,000, net of estimated forfeitures, and will be recognized over an estimated weighted-average service period of 1.3 years. As of September 30, 2010, the unrecorded stock-based compensation balance related to all restricted stock units was $367,000, net of estimated forfeitures, and will be recognized over an estimated weighted-average service period of 1.4 years. As of September 30, 2010 the unrecorded stock-based compensation balance related to the employee stock purchase plan was $108,000, net of estimated forfeitures, and will be recognized over an estimate weighted-average service period of 0.3 years.

Valuation Assumptions

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model and the graded-vesting method with the following weighted-average assumptions:

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Risk-free interest rate			0.84% - 1.60	%			1.62% - 2.53	%			0.84% - 2.43	%			1.44% - 2.53	%
Expected life of options		4.6 years				3.7 years				4.6 years				4.1 years
Expected dividends			0.0	%			0.0	%			0.0	%			0.0	%
Volatility			70	%			70	%			70	%			70	%

     The fair value of purchase rights under the employee stock purchase plan is determined using the Black-Scholes option valuation model with the following weighted-average assumptions:

		Nine months ended
		September 30,
		2010				2009
Risk-free interest rate			0.24% - 1.06	%			0.35% - 0.93	%
Expected life of options		1.2 years				1.2 years
Expected dividends			0.0	%			0.0	%
Volatility			51	%			51	%

     There were no enrollments or shares issued under the employee stock purchase plan for the three months ended September 30, 2010 or 2009.

     The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the combination of historical volatility of the Company’s common stock and the expected future volatility over the period commensurate with the expected life of the options and other factors. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options. The expected term calculation is based on the Company’s observed historical option exercise behavior and post-vesting cancellations of options by employees.

     The total intrinsic value of options exercised during the three months ended September 30, 2010 and 2009 was $2,000 and $36,000, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2010 and 2009 was $53,000 and $145,000, respectively.

Equity Incentive Program

     The Company’s equity incentive program is a broad-based, long-term retention program designed to align stockholder and employee interests. Under the Company’s equity incentive program, stock options generally have a vesting period of four years, are exercisable for a period not to exceed ten years from the date of issuance and are generally granted at prices not less than the fair market value of the Company’s common stock at the grant date. Under the Company’s equity incentive program, restricted stock units have a vesting period of two years.

The following table summarizes the stock option activity for the indicated periods:

										Weighted-
						Weighted-				Average				Aggregate
						Average				Remaining				Intrinsic
		Number of				Exercise				Contractual				Value
		Shares				Price				Term (Years)				(In thousands)
Outstanding at December 31, 2009			1,010,561			$	2.31
Options granted			301,500				2.69
Options exercised			(80,725	)			2.07
Options cancelled			(57,957	)			2.97
Outstanding at September 30, 2010			1,173,379			$	2.39				6.69			$	122
Options vested and exercisable and expected to be exercisable at September 30, 2010			1,118,107			$	2.39				6.59			$	119
Options vested and exercisable at September 30, 2010			615,930			$	2.33				4.82			$	82

     The options outstanding and options vested and exercisable at September 30, 2010 were in the following exercise price ranges:

														Options Vested and Exercisable
Options Outstanding at September 30, 2010														At September 30, 2010
										Weighted-Average
						Weighted-Average				Remaining								Weighted-Average
Range of Exercise Price		Shares				Exercise Price				Contractual Life				Shares				Exercise Price
$0.76 - $  1.21			11,183			$	1.13				2.25				11,183			$	1.13
$1.81 - $  1.81			278,926			$	1.81				5.36				166,539			$	1.81
$1.93 - $  2.40			86,372			$	2.17				5.76				56,396			$	2.04
$2.53 - $  2.53			460,617			$	2.53				6.15				306,035			$	2.53
$2.55 - $  2.55			30,300			$	2.55				8.59				30,093			$	2.55
$2.65 - $  2.65			261,825			$	2.65				9.05				32,740			$	2.65
$2.82 - $  6.59			41,781			$	3.45				8.58				10,682			$	4.27
$9.90 - $13.23			2,375			$	10.43				5.54				2,262			$	10.40
			1,173,379			$	2.39				6.69				615,930			$	2.33

     The following table summarizes the restricted stock unit activity for the indicated periods:

										Weighted-
						Weighted-				Average				Aggregate
						Average				Remaining				Intrinsic
		Number of				Grant Date				Contractual				Value
		Shares				Fair Value				Term (Years)				(In thousands)
Outstanding at December 31, 2009			—			$	0.00
Awarded			218,000				2.67
Released			—				0.00
Forfeited			(6,200	)			2.58
Outstanding at September 30, 2010			211,800			$	2.68				0.94			$	460

     At September 30, 2010, the Company had 196,090 restricted stock units vested and expected to vest with a weighted average remaining contractual term of 0.93 years and an aggregate intrinsic value of $426,000.

     At September 30, 2010, the Company had 4,718,185 shares available for grant under its equity incentive plans.

Employee Stock Purchase Plan

     In October 2000, the Company established the Endwave Corporation Employee Stock Purchase Plan. All employees who work a minimum of 20 hours per week and are customarily employed by the Company (or an affiliate thereof) for at least five months per calendar year are eligible to participate. Under this plan, employees may purchase shares of common stock through payroll deductions of up to 15% of their earnings with a limit of 3,000 shares per offering period under the plan. The price paid for the Company’s common stock purchased under the plan is equal to 85% of the lower of the fair market value of the Company’s common stock on the date of commencement of participation by an employee in an offering under the plan or the date of purchase.

     For the compensation cost in connection with the purchase plan for the three months ended September 30, 2010, the Company recognized an expense of $58,000. For the compensation cost in connection with the purchase plan for the three months ended September 30, 2009, the Company recognized an expense of $109,000.

     For the compensation cost in connection with the purchase plan for the nine months ended September 30, 2010, the Company recognized a benefit of $38,000 due to actual contributions being less than expected contributions for the offering period, resulting in the recognition of compensation cost only for those awards that actually vested. For the compensation cost in connection with the purchase plan for the nine months ended September 30, 2009, the Company recognized an expense of $314,000.

     There were no shares issued under the purchase plan during the three months ended September 30, 2010 or the three months ended September 30, 2009. During the nine months ended September 30, 2010 and 2009, there were 36,603 and 103,075 shares issued under the purchase plan at weighted average prices of $2.03 and $2.35 per share, respectively. At September 30, 2010, there were 327,229 shares available for purchase under the purchase plan.

      9. Discontinued Operations

     On April 30, 2009, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Microsemi, pursuant to which Microsemi purchased the Company’s Defense and Security RF module business (the “Business”), including all of the outstanding capital stock of Endwave Defense Systems, Incorporated (“EDSI”). As consideration, Microsemi assumed certain liabilities associated exclusively with the Business, including the Company’s building lease in Folsom, California, and paid $28.0 million in cash. The Purchase Agreement contains standard representations and warranties as to the Business that survives for two years following the closing. In connection with the transaction, the Company entered into an indemnification agreement pursuant to which the Company agreed to indemnify Microsemi for environmental, product liability and intellectual property infringement claims related to the Company’s operation of the Business prior to the closing date, as well as for any other excluded liability, and Microsemi agreed to indemnify the Company for any claims related to the operation of the Business following the closing date and for any other assumed liability, subject in some cases to a customary deductible and limitation on maximum damages.

     Concurrently with the closing of the acquisition, the Company entered into a transition services agreement and an employee transition services agreement with Microsemi pursuant to which the Company agreed to provide to Microsemi for a limited period of time certain transitional services, including human resources, information technology and product supply services.

     During the fiscal year ended December 31, 2009, the Company recognized a $19.6 million gain on sale of discontinued operations, net of tax, which included the following: $28.0 million of cash received from Microsemi and $1.3 million of liabilities assumed by Microsemi reduced by $647,000 of deal fees and $9.1 million of assets transferred to Microsemi.

     The results of operations for the Business classified as discontinued operations are as follows (in thousands):

		Three months ended				Nine months ended
		September 30,				September 30,
		2009				2009
Revenue of discontinued operations		$	—			$	5,313
Loss from discontinued operations		$	—			$	(2,028	)
Gain on sale of discontinued operation, net of tax			41				19,599
Income from discontinued operations, net of tax		$	41			$	17,571

      10. Net Income (Loss) Per Share

     Basic net income (loss) per share is computed by dividing net loss by the weighted-average number of common shares outstanding for the period. Diluted net income (loss) per share is computed by dividing the net loss for the period by the weighted-average number of shares of common stock and potential common stock equivalents outstanding during the period, if dilutive. Potential common stock equivalents include the convertible preferred stock which was repurchased in January 2010, options to purchase common stock, restricted stock units and shares to be purchased in connection with the Company’s employee stock purchase plan.

     As of September 30, 2009, 300,000 shares of preferred stock were outstanding, which were convertible into 3,000,000 shares of common stock. On January 21, 2010, the Company repurchased all 300,000 shares of its preferred stock.

     As the Company incurred net losses from continuing operations for all periods presented, shares associated with common stock issuable upon the conversion of the preferred shares were not included in the calculation of diluted net loss per share, as the effect would be anti-dilutive. Potential dilutive common shares of 1,385,179 as of September 30, 2010 and 1,034,167 as of September 30, 2009 from the assumed exercise of stock options and unvested restricted stock units were not included in the net income (loss) per share calculations as their inclusion would have been anti-dilutive. As a result, diluted net loss per share is the same as basic net loss per share for all periods presented.

      11. Comprehensive Income (Loss)

     Comprehensive income (loss) generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized gains and losses on its available-for-sale securities and gains and losses resulting from foreign exchange translations represent the only components of comprehensive loss excluded from the reported net loss and are displayed in the statements of stockholders’ equity.

     The components of comprehensive income (loss) were as follows (in thousands):

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Net income (loss)		$	(1,999	)		$	(2,593	)		$	(6,096	)		$	10,387
Change in unrealized gain (loss) on investments			2				4				(12	)			(37	)
Total comprehensive income (loss)		$	(1,997	)		$	(2,589	)		$	(6,108	)		$	10,350

      12. Segment Disclosures

     The Company operates in a single business segment. Although the Company sells to customers in various geographic regions throughout the world, the end customers may be located elsewhere. The Company’s total revenues by billing location for the periods ended September 30 were as follows (in thousands):

		Three months ended September 30,
		2010								2009
United States		$	470				11.6	%		$	168				5.4	%
Finland			—				—				106				3.4	%
Germany			2,343				57.7	%			1,205				38.5	%
Slovakia			947				23.3	%			1,081				34.6	%
Hungary			230				5.7	%			448				14.3	%
Rest of the world			68				1.7	%			118				3.8	%
Total		$	4,058				100.0	%		$	3,126				100.0	%

		Nine months ended September 30,
		2010								2009
United States		$	3,793				30.0	%		$	213				1.3	%
Finland			—				—				9,997				62.7	%
Germany			5,520				43.7	%			2,181				13.7	%
Slovakia			2,280				18.0	%			2,178				13.7	%
Hungary			600				4.7	%			1,157				7.3	%
Rest of the world			452				3.6	%			222				1.3	%
Total		$	12,645				100.0	%		$	15,948				100	%

     For the three months ended September 30, 2010, three customers each accounted for greater than 10% of total revenues and combined they accounted for 92% of the Company’s total revenues. For the three months ended September 30, 2009, three customers each accounted for greater than 10% of total revenues and combined they accounted for 91% of the Company’s total revenues.

     In the first nine months of 2010, three customers each accounted for greater than 10% of total revenues and combined they accounted for 93% of the Company’s total revenues. In the first nine months of 2009, two customers accounted for 90% of our total revenues and no other customer accounted for more than 10% of our total revenues.

      13. Recent Accounting Pronouncements

     In October 2009, the Financial Accounting Standards Board (“FASB”) issued new standards for revenue agreements 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. The Company does not expect these new standards to significantly impact its 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. The Company does not expect these new standards to significantly impact its consolidated financial statements.

     In January 2010, the FASB issued new standards for fair value measurement and disclosures. These new standards require disclosures for significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers and activity. For Level 3 fair value measurements, purchases, sales, issuances and settlements must be reported on a gross basis. Further, additional disclosures are required by class of assets or liabilities, as well as inputs used to measure fair value and valuation techniques. These standards were required to be adopted in the first quarter of 2010. The Company adopted these standards which did not have a material impact on the Company’s consolidated financial statements.

     In February 2010, the FASB issued new standards which amend the subsequent event disclosure requirements for public company filers. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. These standards were effective upon issuance and did not a material impact on the Company’s consolidated financial statements.

     In July 2010, the FASB issued new standards which amend the receivable disclosure requirements, including the credit quality of financing receivables and the allowance for credit losses. These standards require additional disclosures that will facilitate financial statement user’s evaluation of the nature of credit risk inherent in financing receivables, how that risk is analyzed in arriving at the allowance for credit losses, and the reason for any changes in the allowance for credit losses. These new standards are required to be adopted for interim and annual reporting periods beginning on or after December 15, 2010. The Company does not expect these new standards to significantly impact its consolidated financials.

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

     The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements, related notes and “Risk Factors” section included elsewhere in this report on Form 10-Q, as well as the information contained under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2009. In addition to historical consolidated financial information, this discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those discussed in the forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements. In the past, our operating results have fluctuated and are likely to continue to fluctuate in the future.

     The terms “we,” “us,” “our” and words of similar import below refer to Endwave Corporation.

Overview

     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:

•

Our transceiver modules, which serve as the core RF sub-system in digital microwave radios, are produced for telecommunication network original equipment manufacturers and system integrators located throughout the world, collectively referred to as telecom OEMs.

•

Our semiconductor product line consists of a broad range of monolithic microwave integrated circuits, or MMICs, including amplifiers, voltage controlled oscillators, up and down converters, variable gain amplifiers, voltage variable attenuators, fixed attenuators and filters. These types of devices find wide application in numerous telecommunications, avionic, defense, homeland security, instrumentation and consumer systems. Our semiconductor product line was formally introduced to the market in the latter part of 2009 and has not yet become a significant source of revenue for us.

     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 Quarterly Report on Form 10-Q, and all amounts set forth in this Management’s Discussion and Analysis of Financial Condition and Results of Operation reflect such reclassification.

Critical Accounting Policies

     Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the

extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

     We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could potentially have a significant impact on our consolidated financial statements: Revenue recognition; Allowance for doubtful accounts; Warranty reserves; Inventory valuation; Stock-based compensation; Deferred taxes; Long-lived assets; Goodwill and intangible assets with an indefinite life; Fair value measurement; and Business combinations.

     There have been no material changes in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements during the nine months ended September 30, 2010 as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission (“SEC”) on March 24, 2010.

Results of Operations

Three and nine months ended September 30, 2010 and 2009

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

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Total revenues			100.0	%			100.0	%			100.0	%			100.0	%
Cost of product revenues			78.1				75.8				83.8				71.6
Research and development			30.1				46.5				26.1				28.0
Sales and marketing			14.6				19.0				13.8				10.4
General and administrative			24.5				44.0				23.8				28.9
Restructuring			1.6				(0.7	)			0.4				7.6
Total costs and expenses			148.9				184.5				147.9				146.5
Loss from continuing operations			(48.9	)			(84.5	)			(47.9	)			(46.5	)
Interest and other income (expense), net			(0.4	)			(0.1	)			(0.3	)			1.2
Loss from continuing operations before benefit from income taxes			(49.3	)			(84.6	)			(48.2	)			(45.3	)
Benefit from income taxes			—				(0.3	)			—				(0.2	)
Loss from continuing operations			(49.3	)			(84.3	)			(48.2	)			(45.1	)
Income from discontinued operations, net of tax			—				1.3				—				110.2
Net income (loss)			(49.3	)%			(83.0	)%			(48.2	)%			65.1	%

Total revenues

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Total revenues		$	4,058			$	3,126				29.8	%		$	12,645			$	15,948				(20.7	)%

     Total revenues primarily consist of product revenues for sales of our transceiver module and semiconductor products.

     During the third quarter of 2010, total revenues increased by $932,000 or 29.8%, compared to the third quarter of 2009 primarily due to an increased demand for our new module designs supporting next generation, high capacity, internet protocol-based radios.

     During first nine months of 2010, total revenues decreased by $3.3 million, or 20.7%, compared to the same period in 2009 primarily due to a rapid drop in sales for a key legacy product for a major customer’s radio platform while sales of our new module designs supporting next-generation radios were just beginning their production ramp. During the first nine months of 2010, the increased revenues from the new module designs did not offset the decline in revenues from the legacy product.

     During the fourth quarter of 2010, we expect revenues to be comparable to revenues in the third quarter of 2010. We expect revenues from our new module designs and to a lesser extent our semiconductor product line to offset the continued decline in revenues from our legacy products.

Cost of product revenues

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Cost of product revenues		$	3,169			$	2,369				33.8	%		$	10,596			$	11,425				(7.3	)%
Percentage of total revenues			78.1	%			75.8	%							83.8	%			71.6	%

     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 the third quarter of 2010, the cost of product revenues as a percentage of revenues increased compared to the third quarter of 2009 primarily due to a shift in product mix toward lower margin products. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to approximately $219,000 during the third quarter of 2010 and $32,000 during the third quarter of 2009.

     During the first nine months of 2010, the cost of product revenues as a percentage of revenues increased compared to the first nine months of 2009, primarily due to the write-off of inventory associated with excess material related to a rapid drop in sales of a legacy product for a major customer’s radio platform. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to approximately $321,000 during the first nine months of 2010 and $97,000 during the first nine months of 2009.

     We continue to focus on reducing the cost of product revenues as a percentage of total revenues through the introduction of new designs and technologies 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

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Research and development expenses		$	1,221			$	1,452				(15.9	)%		$	3,302			$	4,463				(26.0	)%
Percentage of total revenues			30.1	%			46.5	%							26.1	%			28.0	%

     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 the third quarter of 2010, research and development costs decreased in absolute dollars compared to the third quarter of 2009 which was primarily due to a $173,000 decrease in stock-based compensation expense, a $30,000 decrease in personnel-related expenses and a $24,000 decrease in project related expenses.

     During the first nine months of 2010, research and development costs decreased in absolute dollars compared to the first nine months of 2009 primarily due to a $555,000 decrease in personnel-related expenses, a $309,000 decrease in stock-based compensation expenses and a $300,000 decrease in project related expenses.

     During the remainder of 2010, we will continue to invest in our semiconductor product line and expect research and development expenses to moderately increase relative to research and development expenses incurred during the third quarter of 2010.

Sales and marketing

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Sales and marketing		$	594			$	594				0.0	%		$	1,745				$1,656				5.4	%
Percentage of total revenues			14.6	%			19.0	%							13.8	%			10.4	%

     Sales and marketing consist primarily of salaries and related expenses for sales and marketing personnel, professional fees, facilities costs, expenses related to stock-based compensation and promotional activities.

     During the third quarter of 2010, sales and marketing costs were comparable to the third quarter of 2009 primarily due to a $94,000 increase in sales commissions, a $59,000 increase in personnel-related expenses and a $20,000 increase in travel expenses which were offset by an $180,000 decrease in stock-based compensation expenses.

     During the first nine months of 2010, sales and marketing costs increased in absolute dollars compared to the first nine months of 2009 primarily due to an $177,000 increase in sales commissions, a $73,000 increase in personnel-related expenses, a $67,000 increase in marketing expenses and a $59,000 increase in travel expenses which were partially offset by a $321,000 decrease in stock-based compensation expenses.

     During the remainder of 2010, we expect sales and marketing expenses to remain flat on a quarterly basis relative to sales and marketing expenses incurred during the third quarter of 2010.

General and administrative

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
General and administrative		$	996			$	1,374				(27.5	)%		$	3,009			$	4,605				(34.7	)%
Percentage of total revenues			24.5	%			44.0	%							23.8	%			28.9	%

     General and administrative consist primarily of salaries and related expenses for executive, finance, accounting, legal, information technology and human resources personnel, professional fees, facilities costs, and expenses related to stock-based compensation.

     During the third quarter of 2010, general and administrative costs were $996,000 compared to $1.4 million in the third quarter of 2009. The decrease in general and administrative costs was primarily due to a $351,000 decrease in stock-based compensation and a $147,000 decrease in personnel-related expenses which were partially offset by a $114,000 increase for professional fees.

     During the first nine months of 2010, general and administrative costs were $3.0 million compared to $4.6 million in the first nine months of 2009. The decrease in general and administrative costs was primarily due to a $758,000 decrease in personnel-related expenses, a $729,000 decrease in stock-based compensation and a $106,000 decrease for professional fees. The decrease in personnel-related expenses is primarily due to the restructuring activities undertaken during fiscal 2009.

     During the remainder of 2010, we expect general and administrative expenses to remain flat on a quarterly basis relative to general and administrative expenses incurred during the third quarter of 2010.

Restructuring

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Restructuring expenses		$	63			$	(21	)			400.0	%		$	49			$	1,212				(96.0	)%

     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. Of this amount, approximately $182,000 has been included in income from discontinued operations. During the first quarter of 2010, we recorded a $14,000 positive adjustment as a result of lower benefit charges in connection with our first quarter 2009 restructuring plan than were originally anticipated.

     During the second quarter of 2009, we undertook certain additional 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 the employee terminations. The net charge for these restructuring activities was $243,000 and all cash payments have been made. Of this amount, approximately $39,000 has been included in the discontinued operations line item on the consolidated statements of operations.

     During the third quarter of 2009, we recorded an adjustment of $6,000 to the first quarter 2009 restructuring plan and an adjustment of $15,000 to the second quarter 2009 restructuring plan.

     During the third quarter of 2010, 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 an employee termination. The net charge for these restructuring activities was $63,000 and is expected to be substantially paid by the end of the fourth quarter of 2010.

Interest and other income (expense), net

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Interest and other income (expense), net		$	(14	)		$	(3	)			(366.7	)%		$	(40	)		$	197				(120.3	)%

     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, gains and losses related to foreign currency transactions and interest expense imputed for a long-term restructuring liability.

     The decrease in interest and other income, net during both the three and nine months ended September 30, 2010 was primarily the result of decreased interest earned on our investments and increased interest expense for a long-term restructuring liability.

     During the third quarter of 2010, we earned $20,000 of interest income which was offset by interest expense for a long-term restructuring liability and banking charges. During the third quarter of 2009, we earned $21,000 of interest income which was offset by banking charges and losses on foreign currency transactions.

     During the first nine months of 2010, we earned $66,000 of interest income which was offset by interest expense for a long-term restructuring liability, banking charges and losses on foreign currency transactions. During the first nine months of 2009, we earned $175,000 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 were 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 the third quarter of 2010, we recorded a foreign currency transaction gain of $1,000 and during the third quarter of 2009, we recorded a foreign currency transaction loss of $12,000. During the first nine months of 2010 and 2009, we recorded foreign currency transaction losses of $4,000 and $15,000, respectively.

Benefit from income taxes

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Benefit from income taxes		$	—			$	(11	)			(100.0	)%		$	—			$	(32	)			(100.0	)%

     During the third quarter of 2009, we recorded an income tax benefit of $11,000 due to a benefit from refundable research and development tax credits in the United States. During the nine months ended September 30, 2009, we recorded an income tax benefit of $32,000 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.

Income from discontinued operations, net of tax

		Three months ended September 30,												Nine months ended September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Income from discontinued operations, net of tax		$	—			$	41				(100.0	)%		$	—			$	17,571				(100.0	)%

     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 Business as a discontinued operation in our condensed consolidated statements of operations for all periods presented. During the nine months ended September 30, 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.

     In the third quarter of 2009, based upon updated forecasts, we calculated a tax liability of $0 for the full year of 2009. As such, during the third quarter of 2009, we reversed the prior income tax accrual of $41,000 related to the sale.

Liquidity and Capital Resources

     At September 30, 2010, we had $9.8 million of cash and cash equivalents, $14.9 million in short-term investments, working capital of $28.6 million and no debt outstanding. The following table sets forth selected condensed consolidated statement of cash flows data:

		Nine months ended
		September 30,
		2010				2009
		(in thousands)
Net cash used in operating activities		$	(4,544	)		$	(2,480	)
Net cash (used in) provided by investing activities			(4,780	)			17,695
Net cash (used in) provided by financing activities			(36,000	)			560
Cash, cash equivalents, short-term investments at end of period		$	24,726			$	68,238

     During the first nine months of 2010, operating activities used $4.5 million of cash as compared to $2.5 million in the first nine months of 2009. During the first nine months of 2010, our net loss, adjusted for depreciation and other non-cash items, used $4.8 million of cash as compared to the first nine months of 2009, which used $4.5 million of cash. During the first nine months of 2010, the remaining provision of $239,000 of cash was primarily due to a $836,000 increase in accounts payable, a $376,000 decrease in inventories and a $357,000 decrease in other assets, which were partially offset by a $632,000 increase in accounts receivable, a $420,000 decrease in accrued compensation and other liabilities and a $278,000 decrease in accrued warranty. During the first nine months of 2009, the remaining provision of $2.0 million of cash was primarily due to a $3.4 million decrease in inventories, a $528,000 increase in accounts payable and a $478,000 decrease in accounts receivable, which were partially offset by a $1.0 million increase in other assets, a $831,000 decrease in accrued compensation and other liabilities and a $631,000 decrease in accrued warranty.

     During the first nine months of 2010, investing activities used $4.8 million of cash as compared to the first nine months of 2009 which provided $17.7 million of cash. The use of cash during the first nine months of 2010 was due to a net increase in investments of $3.8 million, and the purchase of $934,000 of property and equipment. The source of cash during the first nine months of 2009 was due to the $28.0 million proceeds from sale of our Defense and Security RF module business and a $600,000 decrease to restricted cash, which were partially offset by a net increase in investments of $10.6 million and the purchase of $289,000 of property and equipment.

     Financing activities used $36.0 million of cash during the first nine months of 2010 primarily due to the $36.2 million repurchase of our preferred stock, which was partially offset by $167,000 of proceeds from the exercise of stock options and $74,000 of cash from the proceeds of stock issuance. Financing activities provided $560,000 of cash during the first nine months of 2009 primarily due to $331,000 of proceeds from the exercise of stock options and $242,000 of cash from the proceeds of stock issuance, which were partially offset by capital lease payments.

     At September 30, 2010, we had a net unrealized gain of $3,000 related to $14.9 million of investments in 20 debt securities. The investments all mature through 2011 and we believe that we have the ability to hold these investments until their maturity dates. During the first nine months of 2010 and 2009, we recorded foreign currency transaction losses of $4,000 and $15,000, respectively.

     In order to maintain and enhance our competitive position, we must be able to satisfy our customers’ short lead-times and rapidly-changing needs. As a result of these challenges, we may increase our raw materials and finished goods inventory so that they will be better-positioned to meet their customers’ demand. These potential increases in raw materials and finished goods may increase our working capital needs in the future.

     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 and capital lease, excluding interest, as of September 30, 2010:

		Payments Due by Period
						Less Than												More Than
		Total				1 Year				1 – 3 Years				3-5 Years				5 Years
		(In thousands)
Contractual Obligations:
Capital lease obligations, including interest		$	6			$	6			$	—				—			$	—
Operating lease obligations			872				539				318				15				—
Total		$	878			$	545			$	318			$	15			$	—