UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from                     to                    

000-31635
(Commission file number)

ENDWAVE CORPORATION

(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 [x] No[  ].

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [x].

     The number of shares of the registrant’s Common Stock outstanding as of October 29, 2004 was 10,074,495 shares.

ENDWAVE CORPORATION

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENDWAVE CORPORATION

(1) Derived from the Company’s audited financial statements as of December 31, 2003

See accompanying notes.

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ENDWAVE CORPORATION

See accompanying notes.

4

ENDWAVE CORPORATION

See accompanying notes.

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ENDWAVE CORPORATION

1. Business and Basis of Presentation

     Endwave Corporation and its subsidiary, JCA Technology, Inc. (together referred to below as “Endwave” or “the Company”) design, manufacture and market RF (radio frequency) subsystems and components that enable the transmission, reception and processing of high-speed electromagnetic signals in broadband wireless telecommunications systems, cellular telephone infrastructure networks, defense electronics systems, security systems, radar equipment, homeland security and other similar systems requiring RF, microwave and millimeter wave technology.

     The Company designs products to best satisfy its customers’ technical, inventory, logistical, and cost requirements by using proprietary technologies, RF design, and manufacturing expertise. Endwave offers a broad range of products at multiple levels of integration that are optimized for a customer’s specific product and performance needs. Products include RF modules such as power amplifiers, low noise amplifiers, up and down converters, frequency multipliers, oscillators, frequency synthesizers, integrated transceivers, and power amplifier switch combiners used in cellular base stations. The Company’s proprietary circuit and manufacturing technologies enable it to design and manufacture RF subsystems that minimize the use of expensive gallium arsenide and reduce labor costs. The Company uses third-party fabrication facilities both for the manufacture of gallium arsenide and other semiconductor devices, which it designs, and for the assembly and test of its commercial production.

     The accompanying unaudited condensed consolidated financial statements of Endwave include the financial results of JCA from the purchase date, July 21, 2004 and have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the information contained herein reflects all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation of the results of the interim periods presented. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2003. Certain prior period amounts have been reclassified to conform to the current period presentation.

2. Summary of Significant Accounting Policies

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue Recognition

     The Company’s primary customers are equipment manufacturers who integrate the Company’s products into their systems. The Company recognizes product revenues at the time title passes, which is upon product shipment or when withdrawn from a consignment location. Revenues related to product sales are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s 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 revenue. Up-front fees, if any, associated with development agreements are recognized over the estimated development and production period. In no event are revenues recognized prior to becoming payable by the customer. The costs incurred under these development agreements are included in research and development expenses.

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Warranty

     The warranty periods for the Company’s products are generally between one and three years from date of shipment. The Company generally 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. During the second quarter of 2004, the Company determined that approximately $1.3 million of warranty accrual related to a possible pattern defect on a specific customer issue was no longer necessary. The amount is included in “warranties settled or reversed” in the table below. This decrease in the warranty accrual was partially offset by increases to the warranty accrual of $996,000 during the nine months ended September 30, 2004.

     Changes in the Company’s product warranty liability during the nine-month periods ended September 30, 2004 and 2003 are as follows:

Impairment of Long-Lived Assets

     For long-lived assets used in operations, the Company records impairment losses when events and circumstances indicate that these assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. If less, the impairment losses are based on the excess of the carrying amounts over their respective fair values. Their fair values would then become the new cost basis. Fair value is determined by discounted future cash flows, appraisals, or other methods. For assets held for sale, impairment losses are measured at the lower of the carrying amount of the assets or the fair value of the assets less costs to sell. For assets to be disposed of other than by sale, impairment losses are measured as their carrying amount less salvage value, if any, at the time the assets cease to be used.

     During the first quarter of 2003, the Company recorded a charge of $2.4 million to reduce the carrying value of manufacturing equipment based on the amounts by which the carrying value of the assets exceeded their salvage value. The impairment took into consideration the move of production to the Company’s offshore supplier, which increased during 2003.

     During the third quarter of 2003, the Company recorded an additional charge of $139,000 to reduce the carrying value of engineering equipment based on the amounts by which the carrying value of these assets exceeded their fair value. The impairment evaluation took in to consideration the reduction in engineering headcount that occurred during the third quarter of 2003. The Company’s estimate of the fair value of the assets was based on selling prices of similar equipment.

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

Restructuring Charges

     Restructuring charges include estimates pertaining to employee severance and fringe benefit costs and facility exit costs. In accordance with Statement of Financial Accounting Standards No. 146, “Accounting for Costs

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Associated with Exit or Disposal Activities” (“SFAS 146”), costs associated with restructuring activities initiated after December 31, 2002 have been recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company reviews remaining restructuring accruals on a quarterly basis and adjusts these accruals when changes in facts and circumstances suggest actual amounts will differ from management’s estimates. Changes in estimates occur when it is apparent that exit and other costs accrued will be more or less than originally estimated.

Stock-Based Compensation

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

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

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

3. Business Combinations

     On July 21, 2004, the Company acquired all of the outstanding capital stock of JCA Technology, Inc. (“JCA”), a wholly owned subsidiary of Bookham Technology plc. JCA is a provider of RF amplifiers and modules and its products are broadly used in applications including electronic warfare, radar and secure communications. This acquisition is complementary to the Company’s existing portfolio of RF module products and allows it to strengthen its presence in the defense, commercial radar and homeland security markets.

     The transaction was accounted for under the purchase method of accounting and, accordingly, the results of operations are included in the accompanying unaudited condensed consolidated statements of operations for all periods or partial periods subsequent to the acquisition date.

     The net tangible assets acquired and liabilities assumed in the acquisition were recorded at fair value, which approximates the carrying amount as of the acquisition date. The Company determined the valuation of the identifiable intangible assets using future revenue assumptions and a valuation analysis from an independent appraiser. The amounts allocated to the identifiable intangible assets were determined through established valuation techniques accepted in the technology industry.

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     In calculating the value of the acquired in-process research and development (“IPR&D”), the independent appraiser gave consideration to the relevant market size and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by the Company and our competitors, individual product sales cycles, and the estimated lives of each of the products derived from the underlying technology. The value of the acquired IPR&D reflects the relative value and contribution of the acquired research and development. Consideration was given to the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the expected cost to complete the project in determining the value assigned to the acquired IPR&D. The amounts allocated to the acquired IPR&D were immediately expensed in the period the acquisition was completed because the projects associated with the IPR&D had not yet reached technological feasibility and no future alternative uses existed for the technology.

     The income approach, which includes an analysis of the cash flows and risks associated with achieving such cash flows, was used to value all of the identifiable intangible assets. Key assumptions used in analyzing the expected cash flows from the other identifiable intangible assets included our estimates of revenue growth, cost of sales, operating expenses and taxes. The purchase price in excess of the identified tangible and intangible assets was allocated to goodwill.

     The total purchase price of $6.1 million consisted of $5.9 million in cash and $158,000 in direct transaction costs. In connection with the acquisition of JCA, the Company implemented a restructuring plan to consolidate JCA’s manufacturing process to our Diamond Springs location. The restructuring plan terminated or will terminate a total of 39 employees, in order to eliminate duplicative activities and to reduce the cost structure of the combined company. These terminations primarily affected the manufacturing and operations group. The estimated cost for the related severance, benefits, payroll taxes and other associated costs totaled $431,000 and was accrued for at the time of the acquisition and has been recognized as a liability assumed in the business combination in accordance with EITF 95-3. The remaining obligations as of September 30, 2004 were $316,000. Severance payments will be substantially complete by the end of the fourth quarter of fiscal 2004.

     The aggregate purchase price for the JCA acquisition has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition as follows (in thousands):

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Pro forma financial information

     The following table presents the unaudited pro forma financial information for the combined entity of Endwave and JCA for the three and nine month periods ended September 30, 2004 and 2003, as if the acquisition had occurred at the beginning of the periods presented after giving effect to certain purchase accounting adjustments (in thousands, except per share amounts):

     These results are presented for illustrative purposes only and are not necessarily indicative of the actual operating results or financial position that would have occurred if the Company and JCA had been a consolidated entity during the periods presented.

4. Goodwill and Intangible Assets

Goodwill

     During the three months ended September 30, 2004, the Company recorded $1.8 million of goodwill associated with the purchase of JCA. See Note 3. Business Combinations for additional information. At the time of the acquisition the Company had no other goodwill on its balance sheet. Under SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is no longer subject to amortization. Rather, the Company evaluates goodwill for impairment at least annually or more frequently if events and changes in circumstances suggest that the carrying amount may not be recoverable.

Intangible Assets

     The components of acquired identifiable intangible assets as of September 30, 2004 are as follows (in thousands):

     The identifiable intangible assets are subject to amortization and have approximate original estimated weighted-average useful lives as follows: core/developed technology – 5 years, customer backlog – 6 months and customer relationships – 5 years.

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     The tradename has a gross carrying value of $1.1 million and is not subject to amortization and will be evaluated for impairment at least annually or more frequently if events and changes in circumstances suggest that the carrying amount may not be recoverable.

5. Inventories

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

6. Notes Payable

     On May 29, 2002, the Company obtained a loan, secured by fixed assets, in the amount of $1.5 million from U.S. Bancorp Finance, Inc. This loan had a term of three years and had a variable interest rate. The rate was 25 basis points above LIBOR and reviewed quarterly. During the second quarter of 2004, the Company paid off the remaining loan balance of $477,000 and, as such, there are no future payments to be made on the note.

7. Property, Plant and Equipment

     During the second quarter of 2004, the Company finalized the sale of its land and two buildings located in Diamond Springs, California. The Company received $4.3 million for the land and buildings net of related closing costs and legal fees. The net book value of the property on the date of sale was $3.5 million. At the time of the closing, the Company entered into a five-year operating lease with the new owner for one of the two buildings. As a result of the sale-leaseback transaction, the Company will recognize an overall gain of $777,000, which will be recognized on a straight-line basis over the term of the lease. The Company recognized $38,000 of gain during the third quarter of 2004.

     At September 30, 2004 and December 31, 2003, the Company had $0 and $306,000 of equipment classified as held for sale. See Note 2. Summary of Significant Accounting Policies for additional information on the write-off of equipment held-for-sale.

8. Restructuring Charges, Net

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

     During the third quarter of 2004, in connection with the acquisition of JCA, the Company recorded a charge for restructuring of $431,000. The charge was included as part of the purchase price allocation in accordance with EITF 95-3. As discussed in Note 3. Business Combinations, the Company has or is planning to terminate a total of 39 employees, in order to eliminate duplicative activities and to reduce the cost structure of the combined company. These terminations primarily affected the manufacturing and operations group. The charge was for the related severance, benefits, payroll taxes and other associated costs. The remaining obligations as of September 30, 2004 were $316,000. Severance payments will be substantially complete by the end of the fourth quarter of fiscal 2004.

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     During the third quarter of 2003, the Company recorded a restructuring charge of $490,000 (the “Third Quarter 2003 Plan”), all of which was for severance payments. Through the end of the third quarter of 2004, the Company eliminated 18 positions and made cash payments of $486,000 under the Third Quarter 2003 Plan.