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, 2008. 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
On April 30, 2009, we entered into an Asset Purchase Agreement with Microsemi Corporation ("Microsemi") pursuant to which Microsemi purchased our defense and security 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 business and paid $28 million in cash. Additionally, as part of the sale, approximately 130 employees associated with the defense and security business transferred to Microsemi. As a result of the divestiture, we will now focus our resources on our communication module and RF semiconductor businesses. The sale of the defense and security business will have a meaningful impact on our operations and financial results in future periods.
The funding of the installation and enhancement of mobile communication networks integrating our products, often rely on the availability of credit. Over the past several months, global economic conditions have continued to be weak and credit has continued to be severely restricted. This continued restriction in credit has materially impacted our customers and vendors and has had a negative effect on our business. We expect the restriction in credit will continue to impact our customers and vendors for the foreseeable future. Without appropriate capital, our customers may have difficulty funding their on-going operations and may reduce their orders for our products. This could significantly impact our operations and financial results.

Results of Operations
Three and six months ended June 30, 2009 and 2008
   The following table sets forth certain statement of operations data as a
percentage of total revenues for the periods indicated:

                                                  Three months ended                 Six months ended
                                                       June 30,                          June 30,
                                                 2009             2008             2009            2008
Total revenues                                     100.0 %         100.0 %           100.0 %        100.0 %

Cost of product revenues                            75.9            65.9              70.6           66.9
Research and development                            23.4            13.9              23.5           12.6
Selling, general and administrative                 34.7            22.8              33.5           24.6
Restructuring                                        3.0               -               9.6              -

Total costs and expenses                           137.0           102.6             137.2          104.1

Loss from continuing operations                    (37.0 )          (2.6 )           (37.2 )         (4.1 )
Interest and other income, net                       1.7             2.4               1.6            3.3

Loss from continuing operations before
provision (benefit) for income taxes               (35.3 )          (0.2 )           (35.6 )         (0.8 )
Provision (benefit) for income taxes                (0.2 )           0.2              (0.1 )          0.1

Loss from continuing operations                    (35.1 )          (0.4 )           (35.5 )         (0.9 )
Income (loss) from discontinued
operations, net of tax                             333.3            (5.9 )           136.7          (11.0 )

Net income (loss)                                  298.2 %          (6.3 )%          101.2 %        (11.9 )%

Total revenues

                                     Three months ended June 30,                           Six months ended June 30,
                               2009             2008            % Change           2009             2008            % Change
                                   (In thousands)                                      (In thousands)
Total revenues              $     5,580      $    12,093           (53.9)%      $    12,822      $    22,553            (43.1)%
Product revenues            $     5,580      $    12,093           (53.9)%      $    12,822      $    22,493            (43.0)%
Development fees            $         -      $         -                 -      $         -      $        60           (100.0)%

Total revenues consist of product revenues and development fees. Product revenues are attributable to sales of our mobile communication products. Development fees are attributable to the development of product prototypes and custom products pursuant to development agreements that provide for payment of a portion of our research and development or other expenses. We do not expect development fees to represent a significant percentage of our total revenues for the foreseeable future.
During the three months ended June 30, 2009, total revenues decreased by $6.5 million, or 54%, compared to the same period in 2008. During the six months ended June 30, 2009, total revenues decreased by $9.7 million, or 43%, compared to the same period in 2008. The demand for our products has declined relative to prior periods as the mobile communication industry has been impacted by the current global economic downturn and credit crisis.
During the remainder of 2009, we expect revenues to be lower relative to 2008 in absolute dollar terms because global economic conditions continue to remain weak and uncertain.

Cost of product revenues

                                     Three months ended June 30,                            Six months ended June 30,
                               2009              2008            % Change            2009           2008           % Change
                                    (In thousands)                                        (In thousands)
Cost of product
revenues                    $    4,237         $  7,976              (46.9 )%      $  9,056         $  15,095         (40.0 )%
Percentage of total
revenues                          75.9 %           65.9 %                              70.6 %            66.9 %

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 second quarter of 2009, the cost of product revenues as a percentage of revenues increased compared to the same period in 2008, primarily due to the decreased absorption of our overhead costs resulting from decreased production. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to approximately $46,000 during the second quarter of 2009 and $15,000 during the second quarter of 2008.
During the first half of 2009, the cost of product revenues as a percentage of revenues increased compared to the same period in 2008, primarily due to the decreased absorption of our overhead costs resulting from decreased production. The cost of product revenues in both periods was favorably impacted by the utilization of inventory that was previously written off, amounting to approximately $65,000 during the first half of 2009 and $34,000 during the first half of 2008.
We continue to focus on reducing the cost of product revenues as a percentage of total revenues through the introduction of new designs and technology and further improvements to our offshore manufacturing processes. In addition, our product costs are impacted by the mix and volume of products sold and will continue to fluctuate as a result.
Research and development expenses

                                    Three months ended June 30,                     Six months ended June 30,
                              2009              2008           % Change         2009            2008         % Change
                                   (In thousands)                                       (In thousands)
Research and
development expenses        $   1,306         $  1,680           (22.3) %    $    3,011      $    2,841           6.0 %
Percentage of total
revenues                         23.4 %           13.9 %                           23.5 %          12.6 %

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 second quarter of 2009, research and development costs decreased in absolute dollars compared to the second quarter of 2008. During the second quarter of 2009, a decrease of $297,000 in personnel related expenses and a decrease of $105,000 for stock-based compensation expenses were partially offset by a $62,000 increase in project related expenses.
During the first half of 2009, research and development costs increased in absolute dollars compared to the first half of 2008. During the first half of 2009, an increase of $578,000 for project related expenses was partially offset by a decrease of $242,000 in personnel related expenses and a decrease of $131,000 for stock-based compensation expenses.
During the remainder of 2009, we expect research and development expenses to be flat on a quarterly basis relative to research and development expenses incurred during the second quarter of 2009. Selling, general and administrative expenses

                                       Three months ended June 30,                   Six months ended June 30,
                                  2009             2008          % Change        2009           2008         % Change
                                       (In thousands)                                   (In thousands)
Selling, general and
administrative expenses         $   1,935         $ 2,757          (29.8) %    $   4,293      $   5,536        (22.5) %
Percentage of total
revenues                             34.7 %          22.8 %                         33.5 %         24.6 %

Selling, general and administrative expenses consist primarily of salaries and related expenses for executive, sales, marketing, finance, accounting, legal, information technology and human resources personnel, professional fees, facilities costs, expenses related to stock-based compensation and promotional activities.
During the second quarter of 2009, selling, general and administrative expenses decreased in absolute dollars compared to the second quarter of 2008 primarily due to a $437,000 decrease in personnel-related expenses, a $246,000 decrease in stock-based compensation expenses, and a $57,000 decrease in professional fees.
During the first half of 2009, selling, general and administrative expenses decreased in absolute dollars compared to the first half of 2008 primarily due to a $533,000 decrease in personnel-related expenses, a $381,000 decrease in stock-based compensation expenses, a $124,000 decrease in professional fees and a $75,000 decrease in travel and entertainment.
During the remainder of 2009, we expect selling, general and administrative expenses to moderately decrease on a quarterly basis relative to selling, general and administrative expenses incurred during the second quarter of 2009. Restructuring

                                      Three months ended June 30,                            Six months ended June 30,
                               2009               2008            % Change              2009             2008          % Change
                                     (In thousands)                                        (In thousands)

During the first quarter of 2009, we undertook certain restructuring activities to reduce expenses ("First Quarter 2009 Restructuring Plan"). We terminated the employment of 33 employees in order to reduce our cost structure. These terminations affected all areas of our operations. The components of the restructuring charge include severance, benefits, payroll taxes and other costs associated with the termination of the employees. The charge for these restructuring activities was $1.2 million and the restructuring activities are expected to be substantially completed by the end of the first quarter of 2010.
During the second quarter of 2009, we undertook certain restructuring activities to reduce expenses ("Second Quarter 2009 Restructuring Plan"). We terminated the employment of several employees in order to reduce our cost structure. The components of the restructuring charge included severance, benefits, payroll taxes and other costs associated with the termination of the employees. The charge for these restructuring activities was $258,000 and is expected to be substantially completed by the end of the first quarter of 2010.
During the second quarter of 2009, we recorded $166,000 of restructuring expenses. A restructuring charge of $258,000 for the Second Quarter 2009 Restructuring Plan was partially offset by a $55,000 adjustment to the First Quarter 2009 Restructuring Plan and $37,000 of restructuring expense recorded in discontinued operations.
Interest and other income, net

                                    Three months ended June 30,                          Six months ended June 30,
                             2009             2008            % Change            2009             2008            % Change
                                  (In thousands)                                       (In thousands)
Interest and other
income, net                 $    94         $    294              (68.0 %)      $    200         $    733              (72.7 %)

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 and gains and losses related to foreign currency transactions.

The decrease in interest and other income, net during both the three and six months ended June 30, 2009 was primarily the result of decreased interest earned on our investments. Interest rates have decreased significantly from the prior year, especially on the highest rated investment vehicles, leading to lower interest income.
During the second quarter of 2009, we earned $68,000 of interest income and recognized $38,000 of other income from the amortization of the deferred gain from the sale of our Diamond Springs, California location which were partially offset by banking charges and losses on foreign currency transactions. During the second quarter of 2008, we earned $254,000 of interest income, recognized a gain of $37,000 from the sale of securities and recognized $38,000 of other income from the amortization of the deferred gain from the sale of our Diamond Springs, California location, which were partially offset by banking charges and losses on foreign currency transactions.
During the first half of 2009, we earned $154,000 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. During the first half of 2008, we earned $707,000 of interest income, recognized a gain of $45,000 from the sales of securities and recognized $77,000 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 second quarter of 2009, we recorded a foreign currency transaction gain of $2,000 and during the second quarter of 2008 we recorded a foreign currency transaction loss of $19,000. During the first half of 2009 and 2008, we recorded foreign currency transaction losses of $3,000 and $41,000, respectively. Provision (benefit) for income taxes

                                    Three months ended June 30,                       Six months ended June 30,
                               2009            2008          % Change           2009            2008          % Change
                                  (In thousands)                                   (In thousands)
Provision
(benefit) for income
taxes                        $   (13 )        $  22            159.1 %        $   (21 )        $  22            195.5 %

During the second quarter of 2009, we recorded an income tax benefit of $13,000 due to a benefit from refundable research and development tax credits in the United States. During the six months ended June 30, 2009, we recorded an income tax benefit of $21,000 due to a benefit from refundable research and development tax credits in the United States. Discontinued operations, net of tax

                                      Three months ended June 30,                            Six months ended June 30,
                                2009              2008           % Change             2009              2008           % Change
                                   (In thousands)                                         (In thousands)
Income (loss) from
discontinued
operations, net of tax       $  18,597          $ (712 )          2,711.9 %        $ 17,530          $ (2,488 )          804.6 %

On April 30, 2009, we entered into an Asset Purchase Agreement with Microsemi pursuant to which Microsemi purchased our defense and security business ("the 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 business and paid $28 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 second quarter of 2009, we recognized income from discontinued operations of $18.6 million net of tax expense of $41,000 related to the sale of the Business.

Liquidity and Capital Resources
   At June 30, 2009, we had $49.1 million of cash and cash equivalents,
$19.5 million in short-term investments, working capital of $74.8 million and no
debt outstanding. The following table sets forth selected condensed consolidated
statement of cash flows data:

                                                                         Six months ended
                                                                             June 30,
                                                                      2009              2008
                                                                          (in thousands)
Net cash provided by (used in) operating activities                $ (2,190 )        $    636
Net cash provided by (used in) investing activities                  20,231            (2,990 )
Net cash provided by financing activities                               459               424
Cash, cash equivalents, restricted cash, short- term and
long-term investments at end of period                             $ 68,667          $ 44,668

During the first half of 2009, operating activities used $2.2 million of cash as compared to the first half 2008 which provided $636,000 of cash. During the first half of 2009, our net loss, adjusted for depreciation and other non-cash items, used $3.1 million of cash as compared to the first half of 2008 which provided $1.6 million of cash. During the first half of 2009, the remaining provision of $942,000 of cash was primarily due to a $4.6 million decrease in inventory and a $123,000 increase in accounts payable which were partially offset by a $1.8 million increase in accounts receivable, an $898,000 increase in other assets, a $531,000 decrease in accrued warranty and a $527,000 decrease in accrued compensation and other current and other long-term liabilities. During the first half of 2008, the remaining use of $980,000 of cash was primarily due to a $979,000 increase in inventory, a $277,000 decrease in accrued compensation, other current liabilities and other long-term liabilities and a $167,000 increase in accounts receivable, which were partially offset by a $346,000 increase in accounts payable and a $154,000 decrease in other assets.
During the first half of 2009, investing activities provided $20.2 million of cash as compared to the first half of 2008 which used $3.0 million of cash. The source of cash during the first half of 2009 was due to the $28.0 million proceeds from sale of our defense and security business and a $600,000 decrease to restricted cash, which were partially offset by a net increase in investments of $8.2 million and the purchase of $178,000 of property and equipment. The use of cash during the first half of 2008 was due to the $1.0 million final payment for the purchase of ALC, a net increase in investments of $688,000, the purchase of $675,000 of property and equipment and a $600,000 increase to restricted cash.
During the first half of 2009, financing activities provided $459,000 of cash as compared to the first half of 2008, which provided $424,000 of cash. During the first half of 2009, we received $242,000 of cash from the proceeds of stock issuance and $226,000 from the exercise of stock options, which were partially offset by capital lease payments. During the first half of 2008, we received $434,000 of cash from the proceeds of stock issuance, which was partially offset by capital lease payments.
At June 30, 2009, we had a net unrealized gain of $1,000 related to $19.5 million of investments in 10 debt securities. The investments all mature during 2009 or 2010 and we believe that we have the ability to hold these investments until the maturity date. Realized gains were $37,000 for the quarter ended June 30, 2008 and $45,000 for the first half of 2008. There were no such gains during the second quarter of 2009 or the first half of 2009. During the first half of 2009 and 2008, we recorded foreign currency transaction losses of $3,000 and $41,000, 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. We currently have inventory consigned to a customer location and may increase this inventory in the future. Generally, if the consigned inventory is not withdrawn by our customer within a certain period of time we have the ability to invoice the customer for the consigned inventory. These 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 June 30, 2009:

                                                                      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                   $    21        $        12        $              9                  -        $         -
Operating lease obligations            1,315                542                     643                130                  -

Total                                $ 1,336        $       554        $            652        $       130        $         -

Recent Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board ("FASB") issued Staff Position ("FSP") No. FAS 157-4, "Determining Fair Value When the Volume or Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" ("FSP 157-4"). FSP 157-4 provides . . .