| ENDWAVE CORP Item 1A Risk Factors You should consider carefully the following risk factors as well as other information in this report before investing in any of our securities |
| If any of the following risks actually occur, our business, operating results and financial condition could be adversely affected |
| This could cause the market price of our common stock to decline, and you may lose all or part of your investment |
| We also had net losses of dlra7dtta9 million and dlra4dtta4 million for the years ended December 31, 2003 and 2004 respectively |
| There is no guarantee that we will achieve or maintain profitability in the future |
| We depend on a small number of key customers in the telecommunications industry for a large portion of our revenues |
| If we lose any of our major customers, particularly Nera, Nokia or Siemens or there is any material reduction in orders for our products from any of these customers, our business, financial condition and results of operations would be adversely affected |
| We depend, and expect to continue to depend, on a relatively small number of telecommunication network original equipment manufacturers and systems integrators, collectively referred to in this report as telecom OEMs, for a large portion of our revenues |
| The loss of any of our major customers, particularly Nera, Nokia or Siemens, or any material reduction in orders from any of such customers would have a material adverse effect on our business, financial condition and results of operations |
| In 2003, 2004 and 2005 revenues from Nokia accounted for 59prca, 55prca and 47prca of our total revenues, respectively |
| Revenues from Nera ASA accounted for 10prca of our total revenues for 2004 and 2005 |
| Revenues from Stratex Networks, Inc |
| We had no other customers individually representing more than 10prca of our total revenues for 2003, 2004 or 2005 |
| Most of our customer agreements are in the form of purchase orders and are not pursuant to a formal agreement |
| As a result, none of our major customers is under any long-term commitment to purchase products from us, and there is no guarantee that any of them will continue to do business with us |
| We depend on the telecommunications industry for most of our revenues |
| If this industry suffers another downturn or fails to grow as anticipated, our revenues could decrease and our profitability could suffer |
| In addition, consolidation in this industry could result in delays or cancellations of orders for our products, adversely impacting our results of operations |
| We depend, and expect to remain dependent, on the telecommunications industry for most of our revenues |
| The telecommunications industry suffered a significant worldwide downturn beginning in 2000, and has only recently begun to grow again |
| In connection with this downturn, there were worldwide reductions in telecommunication network projects that resulted in the loss of some of our key customers and reduced revenues from our remaining customers |
| We also were forced to undertake significant cost reduction measures as a result |
| The telecommunications industry has only recently begun to grow again, but at a more measured rate than previously |
| 17 _________________________________________________________________ [70]Table of Contents Our revenues are dependent, in part, on growth of wireless telephony particularly in developing countries, increasing data-intensive cellular traffic, deployment of third-generation, or “3G”, networks and the introduction of other high capacity data-only telecommunication networks |
| If similar downturns reoccur, or if the telecommunications industry fails to grow as we anticipate, our revenues may remain flat or decrease |
| Significantly lower revenues would likely force us to make provisions for excess inventory and abandoned or obsolete equipment and reduce our operating expenses |
| To reduce our operating expenses, we could be required to reduce the size of our workforce and consolidate facilities |
| We cannot guarantee that we would be able to reduce operating expenses to a level commensurate with the lower revenues resulting from such an industry downturn |
| The telecommunications industry has undergone significant consolidation in the past few years and we expect that consolidation to continue |
| The acquisition of one of our major customers in this market, or one of the communications service providers supplied by one of our major customers, could result in delays or cancellations of orders of our products and, accordingly, delays or reductions in our anticipated revenues and reduced profitability or increased net losses |
| Our future success depends in part on our ability to further penetrate into new markets, such as defense electronics and homeland security, and we may be unable to do so |
| Historically, all or a large majority of our revenues have been attributable to sales of our RF modules to telecom OEMs such as Nokia |
| Part of our growth strategy is to design and sell high-frequency RF modules for and to OEMs and systems integrators in new markets, particularly defense electronics and homeland security |
| To date, only a modest percentage of our revenues has been attributable to sales of RF modules to defense systems integrators |
| We have only recently begun to design and sell products for the recently emerging homeland security market |
| The potential size of this market is unclear and we cannot predict how the market will evolve |
| If increased demand for high-frequency RF modules in the defense electronics and homeland security markets does not materialize, we fail to secure new design wins in these markets or we are unable to design readily manufacturable products for these new markets, our growth and revenues could be adversely impacted, thereby decreasing our profitability or increasing our net losses |
| Our operating results may fluctuate significantly based on seasonal factors in the telecommunication network market |
| In the past, our operating results have reflected lower revenues in the first and third calendar quarters due to seasonality in the telecommunication network market |
| Revenues attributable to telecom OEMs typically have contracted in the first quarter due to delays in purchasing resulting from wireless carriers’ budgeting processes |
| The third quarter generally has been slow in our telecommunication network market as many of our European telecom OEM customers shut down their factories for a portion of the summer months |
| The fourth quarter historically has been our strongest quarter as the wireless carriers expend their remaining capital budgets for the year |
| However, we did not experience this seasonality in 2005, and we cannot be certain what seasonal factors, if any, will impact our revenues in the future or the extent of such potential fluctuations |
| Because of the shortages of some components and our dependence on single source suppliers and custom components, we may be unable to obtain an adequate supply of components of sufficient quality in a timely fashion, or we may be required to pay higher prices or to purchase components of lesser quality |
| This means that we cannot change components in our products easily without the risks and delays associated with requalification |
| Accordingly, while a number of the components we use in our products are made by multiple suppliers, we may effectively have single source suppliers for some of these components |
| In addition, we currently purchase a number of components, some from single source suppliers, including, but not limited to: • semiconductor devices; • application-specific monolithic microwave integrated circuits; 18 _________________________________________________________________ [71]Table of Contents • voltage-controlled oscillators; • voltage regulators; • lead-free surface mount components; • high-frequency circuit boards; • custom connectors; • electromagnetic housings; • yttrium iron garnet components; and • magnetic components |
| Any delay or interruption in the supply of these or other components could impair our ability to manufacture and deliver our products, harm our reputation and cause a reduction in our revenues |
| In addition, any increase in the cost of the components that we use in our products could make our products less competitive and lower our margins |
| During 2005, we suffered from shortages of and quality issues with various components, including voltage-controlled oscillators, voltage regulators, metal enclosures and certain high-frequency circuit boards |
| These shortages and quality issues adversely impacted our product revenues throughout the year and could continue to do so in the future |
| Our single source suppliers could enter into exclusive agreements with or be acquired by one of our competitors, increase their prices, refuse to sell their products to us, discontinue products or go out of business |
| Even to the extent alternative suppliers are available to us and their components are qualified with our customers on a timely basis, identifying them and entering into arrangements with them may be difficult and time consuming, and they may not meet our quality standards |
| We may not be able to obtain sufficient quantities of required components on the same or substantially the same terms |
| Our cash requirements will be impacted by our need to increase inventories |
| As part of our expansion in the telecommunications market and our increased emphasis on the defense electronics and homeland security markets, we have increased the number of our products by over three times during 2005 |
| The products we manufacture require hundreds to thousands of components obtained from a wide variety of suppliers and we have faced component shortages and quality issues from our suppliers |
| In addition, in order to maintain and enhance our competitive position, we must be able to satisfy our customers’ rapidly-changing needs |
| As a result of these challenges, we have significantly increased our raw materials inventory and added more finished products to our key customers’ consignment stocks so that they will be better-positioned to meet their own customers’ demand |
| These increases in raw materials and finished goods have significantly increased our working capital needs and may further increase our capital needs in the future |
| We rely heavily on a Thailand facility of HANA Microelectronics Co, Ltd, a contract manufacturer, to produce our RF modules |
| If HANA is unable to produce these modules in sufficient quantities or with adequate quality, or it chooses to terminate our manufacturing arrangement, we will be forced to find an alternative manufacturer and may not be able to fulfill our production commitments to our customers, which could cause sales to be delayed or lost and could harm our reputation |
| We outsource the assembly and testing of most of our telecommunication related products to a Thailand facility of HANA Microelectronics Co, Ltd, or HANA, a contract manufacturer |
| We plan to continue this arrangement as a key element of our operating strategy |
| If HANA does not provide us with high quality products and services in a timely manner, or terminates its relationship with us, we may be unable to obtain a satisfactory replacement to fulfill customer orders on a timely basis |
| In the event of an interruption of supply from HANA, sales of our products could be delayed or lost and our reputation could be harmed |
| Our manufacturing agreement with HANA currently expires in July 2006 but will renew automatically for successive one-year periods unless either party notifies the other of its desire to terminate the agreement at least 90 days prior to the expiration of the term |
| In addition, either party may terminate the agreement without cause upon 120 days prior written notice to the other party, and either party may terminate the agreement if the non-terminating party is in breach and does not cure the 19 _________________________________________________________________ [72]Table of Contents breach within 30 days after notice of the breach is given by the terminating party |
| There can be no guarantee that HANA will not seek to terminate its agreement with us |
| We rely on Velocium and other third-party semiconductor foundries to manufacture the semiconductors contained in our products |
| The loss of our relationship with any of these foundries, particularly Velocium, without adequate notice would adversely impact our ability to fill customer orders and could damage our customer relationships |
| We design semiconductor devices |
| However, we do not own or operate a semiconductor fabrication facility, or foundry, and rely on a limited number of third parties to produce these components |
| Our largest semiconductor foundry supplier is Velocium, a business unit of Northrop Grumman Space & Mission Systems Corp |
| Velocium produced over 65 percent of our semiconductors in 2005, with the balance provided by other suppliers |
| The loss of our relationship with or our access to any of the semiconductor foundries we currently use, particularly Velocium, and any resulting delay or reduction in the supply of semiconductor devices to us, would severely impact our ability to fulfill customer orders and could damage our relationships with our customers |
| Our current supply agreement with Velocium would have expired in December 2005 but was extended by mutual agreement through March 31, 2006 |
| We are currently in contract renewal negotiations but may not be able to negotiate a new supply agreement on favorable terms, if at all |
| We also may not be successful in forming alternative supply arrangements that provide us with a sufficient supply of gallium arsenide devices |
| Because there are a limited number of semiconductor foundries that use the particular process technologies we select for our products and that have sufficient capacity to meet our needs, using alternative or additional semiconductor foundries would require an extensive qualification process that could prevent or delay product shipments and revenues |
| We estimate that it may take up to six months to shift production of a given semiconductor circuit design to a new foundry |
| Implementing our acquisition strategy could result in dilution to our stockholders and operating difficulties leading to a decline in revenues and operating profit |
| One of our strategies is to grow through acquisitions |
| To that end, we have completed five acquisitions since our initial public offering and intend to pursue attractive acquisitions in our market as appropriate |
| The process of investigating, acquiring and integrating any business into our business and operations is risky and may create unforeseen operating difficulties and expenditures |
| The areas in which we may face difficulties include: • diversion of our management from the operation of our core business; • assimilating the acquired operations and personnel; • integrating information technology and reporting systems; • retention of key personnel; • retention of acquired customers; and • implementation of controls, procedures and policies in the acquired business |
| For example, it took us longer to integrate JCA Technology into our operations at our Diamond Springs facilities than we originally anticipated |
| Additionally, the JCA acquisition required us to devote efforts to standardize the product design and manufacturing process to reduce dependence on specific personnel |
| As a result of these difficulties, our ability to deliver our defense electronics products to our customers in a timely manner was temporarily adversely affected |
| In addition to the factors set forth above, we may encounter other unforeseen problems with acquisitions that we may not be able to overcome |
| Future acquisitions may require us to issue shares of our stock or other securities that dilute our other stockholders, expend cash, incur debt, assume liabilities, including contingent or unknown liabilities, or create additional expenses related to write-offs or amortization of intangible assets with estimated useful lives, any of which could materially adversely affect our revenues and our operating profits |
| 20 _________________________________________________________________ [73]Table of Contents Our products may contain component, manufacturing or design defects or may not meet our customers’ performance criteria, which could cause us to incur significant repair expenses, harm our customer relationships and industry reputation, and reduce our revenues and profitability |
| We have experienced manufacturing quality problems with our products in the past and may have similar problems in the future |
| As a result of these problems, we have replaced components in some products, or replaced the product, in accordance with our product warranties |
| Our product warranties typically last one to two years |
| As a result of component, manufacturing or design defects, we may be required to repair or replace a substantial number of products under our product warranties, incurring significant expenses as a result |
| Further, our customers may discover latent defects in our products that were not apparent when the warranty period expired |
| These defects may cause us to incur significant repair or replacement expenses beyond the normal warranty period |
| In addition, any component, manufacturing or design defect could cause us to lose customers or revenues or damage our customer relationships and industry reputation |
| For example, some radios incorporating our transceivers that are manufactured and shipped by one of our customers have experienced degraded performance after installation in the field |
| The cause of the degradation was identified to be a faulty semiconductor component originally developed and supplied by TRW Inc |
| that was incorporated in the transceiver |
| TRW was later acquired by Northrop Grumman Corporation and renamed Northrop Grumman Space & Mission Systems Corp |
| Pursuant to a settlement agreement between TRW and us, we are responsible for the direct costs associated with the repair and replacement of the degraded transceivers produced under our supply agreement with the customer |
| Northrop Grumman Space & Mission Systems Corp, as successor to TRW, compensated our customer for the indirect costs associated with the repair and replacement of the degraded radios and transceivers |
| These indirect costs include the costs associated with removing and replacing the radios in the field as well as removing and replacing the transceiver module in each returned radio |
| During 2001, we reserved dlra4dtta6 million for warranty charges to cover the actual repair of the transceivers containing these faulty components, of which dlra2dtta4 million had been used or reversed through December 31, 2005 |
| Under an agreement we entered into with Northrop Grumman Space & Mission Systems Corp |
| as final reimbursement for these indirect costs and to assume sole responsibility for any future product failures attributable to the semiconductor component |
| We are in the process of qualifying a replacement component, which will be fabricated by an alternate supplier that we believe will eliminate the degradation of performance in future production units |
| We depend on our key personnel |
| If we are unable to retain our current personnel or hire additional qualified personnel, our ability to develop and successfully market our products would be harmed |
| We believe that our future success depends upon our ability to attract, integrate and retain highly skilled managerial, research and development, manufacturing and sales and marketing personnel |
| To attract and retain qualified personnel, we may be required to grant large stock option or other stock-based incentive awards, which may harm our operating results or be dilutive to our other stockholders |
| We may also be required to pay significant base salaries and cash bonuses, which could harm our operating results |
| Due to our relatively small number of employees and the limited number of individuals with the skill set needed to work in our industry, we are particularly dependent on the continued employment of our senior management team and other key personnel |
| If one or more members of our senior management team or other key personnel were unable or unwilling to continue in their present positions, these persons would be very difficult to replace, and our ability to conduct our business successfully could be seriously harmed |
| We do not maintain key person life insurance policies |
| 21 _________________________________________________________________ [74]Table of Contents Competitive conditions may require us to reduce prices in the future and, as a result, we may need to reduce our costs in order to be profitable |
| Over the past year, we have reduced our prices by 10prca to 15prca in order to remain competitive and we expect market conditions will cause us to reduce our prices in the future |
| In order to reduce our per-unit cost of product revenues, we must continue to design and re-design products to require lower cost materials, improve our manufacturing efficiencies and successfully move production to low-cost, offshore locations |
| The combined effects of these actions may be insufficient to achieve the cost reductions needed to be profitable |
| The length of our sales cycle requires us to invest substantial financial and technical resources in a potential sale before we know whether the sale will occur |
| There is no guarantee that the sale will ever occur and if we are unsuccessful in designing a high-frequency RF module for a particular generation of a customer’s products, we may need to wait until the next generation of that product to sell our products to that particular customer |
| Our products are highly technical and the sales cycle can be long |
| Our sales efforts involve a collaborative and iterative process with our customers to determine their specific requirements either in order to design an appropriate solution or to transfer the product efficiently to our offshore contract manufacturer |
| Depending on the product and market, the sales cycle can take anywhere from 2 to 24 months, and we incur significant expenses as part of this process without any assurance of resulting revenues |
| We generate revenues only if our product is selected for incorporation into a customer’s system and that system is accepted in the marketplace |
| If our product is not selected, or the customer’s development program is discontinued, we generally will not have an opportunity to sell our product to that customer until that customer develops a new generation of its system |
| There is no guarantee that our product will be selected for that new generation of its system |
| In the past, we have had difficulty meeting some of our major customers’ stated volume and cost requirements |
| The length of our product development and sales cycle makes us particularly vulnerable to the loss of a significant customer or a significant reduction in orders by a customer because we may be unable to quickly replace the lost or reduced sales |
| We may not be able to design our products as quickly as our customers require, which could cause us to lose sales and may harm our reputation |
| Existing and potential customers typically demand that we design products for them under difficult time constraints |
| In the current market environment, the need to respond quickly is particularly important |
| If we are unable to commit the necessary resources to complete a project for a potential customer within the requested timeframe, we may lose a potential sale |
| Our ability to design products within the time constraints demanded by a customer will depend on the number of product design professionals who are available to focus on that customer’s project and the availability of professionals with the requisite level of expertise is limited |
| Each of our telecommunication network products is designed for a specific range of frequencies |
| Because different national governments license different portions of the frequency spectrum for the telecommunication network market, and because communications service providers license specific frequencies as they become available, in order to remain competitive we must adapt our products rapidly to use a wide range of different frequencies |
| This may require the design of products at a number of different frequencies simultaneously |
| This design process can be difficult and time consuming, could increase our costs and could cause delays in the delivery of products to our customers, which may harm our reputation and delay or cause us to lose revenues |
| In our other markets, our customers have specific requirements that can be at the forefront of technological development and therefore difficult and expensive to develop |
| If we are not able to devote sufficient resources to these products, or we experience development difficulties or delays, we could lose sales and damage our reputation with those customers |
| 22 _________________________________________________________________ [75]Table of Contents We may not be able to manufacture and deliver our products as quickly as our customers require, which could cause us to lose sales and would harm our reputation |
| We may not be able to manufacture products and deliver them to our customers at the times and in the volumes they require |
| Manufacturing delays and interruptions can occur for many reasons, including, but not limited to: • the failure of a supplier to deliver needed components on a timely basis or with acceptable quality; • lack of sufficient capacity; • poor manufacturing yields; • equipment failures; • manufacturing personnel shortages; • labor disputes; • transportation disruptions; • changes in import/export regulations; • infrastructure failures at the facilities of our offshore contract manufacturer; • natural disasters; • acts of terrorism; and • political instability |
| Manufacturing our products is complex |
| The yield, or percentage of products manufactured that conform to required specifications, can decrease for many reasons, including materials containing impurities, equipment not functioning in accordance with requirements or human error |
| If our yield is lower than we expect, we may not be able to deliver products on time |
| For example, in the past, we have on occasion experienced poor yields on certain products that have prevented us from delivering products on time and have resulted in lost sales |
| If we fail to manufacture and deliver products in a timely fashion, our reputation may be harmed, we may jeopardize existing orders and lose potential future sales, and we may be forced to pay penalties to our customers |
| As part of our strategy, we may expand our domestic manufacturing capacity beyond the level required for our current sales in order to accommodate anticipated increases in our defense electronics business |
| As a result, our domestic manufacturing facilities may be underutilized from time to time |
| Conversely, if we do not maintain adequate manufacturing capacity to meet demand for our defense electronic products, we may lose opportunities for additional sales |
| Any failure to have sufficient manufacturing capacity to meet demand could cause us to lose revenues, thereby reducing our profitability, or increasing our net losses, and could harm our reputation with customers |
| Because we do not have long-term commitments from many of our customers, we must estimate customer demand, and errors in our estimates could have negative effects on our inventory levels, revenues and results of operations |
| Our sales are generally made on the basis of formal agreements and purchase orders, which may be later modified or canceled by the customer, rather than firm long-term purchase commitments |
| We have historically been required to place firm orders for products and manufacturing equipment with our suppliers up to six months prior to the anticipated delivery date and, on occasion, prior to receiving an order for the product, based on our forecasts of customer demands |
| Our sales process requires us to make multiple demand forecast assumptions, each of which may introduce error into our estimates, causing excess inventory to accumulate or a lack of manufacturing capacity when needed |
| If we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell when we expect or at all |
| Conversely, if we underestimate customer demand or if insufficient manufacturing capacity were available, we would lose revenue opportunities, market share and damage our customer relationships |
| On occasion, we have been unable to adequately respond to unexpected increases in customer purchase orders and were unable to 23 _________________________________________________________________ [76]Table of Contents benefit from this increased demand |
| There is no guarantee that we will be able to adequately respond to unexpected increases in customer purchase orders in the future, in which case we may lose the revenues associated with those additional purchase orders and our customer relationships and reputation may suffer |
| Some of our customer contracts require us to manufacture products designed by our customers |
| While we intend to convert many of these products to products of our own design, such transitions may be difficult and/or expensive to implement and delays or difficulties in doing so could harm our operating results |
| Some of our customer contracts are based on the transfer of product manufacturing from our customers’ factories to those of our contract manufacturer, HANA Under these contracts, we may be required to manufacture the products in a manner similar to the way our customers previously manufactured them until we are able to convert these products to products of our own design |
| The objective of converting a product to one of our own design is to improve manufacturability and lower costs, thereby improving our gross margins |
| If we encounter difficulties or delays in transitioning a customer’s product to our manufacturing process, revenues attributable to that product could be delayed or lost |
| The cost of manufacturing a customer-designed product is typically higher than the cost of manufacturing a product of our own design |
| In the short term, while we are manufacturing a customer-designed product, our gross margins will be adversely impacted |
| Similarly, difficulties and delays in transitioning a product to a product of our own design will result in reduced profitability over the long-term |
| Any failure to protect our intellectual property appropriately could reduce or eliminate any competitive advantage we have |
| Our success depends, in part, on our ability to protect our intellectual property |
| We rely primarily on a combination of patent, copyright, trademark and trade secret laws to protect our proprietary technologies and processes |
| As of December 31, 2005, we had 38 United States patents issued, many with associated foreign filings and patents |
| Our issued patents include those relating to basic circuit and device designs, semiconductors, MLMS technology and system designs |
| Our issued United States patents expire between 2007 and 2020 |
| We maintain a vigorous technology development program that routinely generates potentially patentable intellectual property |
| Our decision as to whether to seek formal patent protection is done on a patent by patent basis and is based on the economic value of the intellectual property, the anticipated strength of the resulting patent, the cost of pursuing the patent and an assessment of using a patent as a strategy to protect the intellectual property |
| To protect our intellectual property, we enter into confidentiality and assignment of rights to inventions agreements with our employees, and confidentiality and non-disclosure agreements with third parties, and generally control access to and distribution of our documentation and other proprietary information |
| These measures may not be adequate in all cases to safeguard the proprietary technology underlying our products |
| It may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents |
| In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited outside of the United States, Europe and Japan |
| We may not be able to obtain any meaningful intellectual property protection in other countries and territories |
| Additionally, we may, for a variety of reasons, decide not to file for patent, copyright, or trademark protection outside of the United States |
| We occasionally agree to incorporate a customer’s or supplier’s intellectual property into our designs, in which case we have obligations with respect to the non-use and non-disclosure of that intellectual property |
| We also license technology from other companies, including Northrop Grumman Corporation |
| There are no limitations on our rights to make, use or sell products we may develop in the future using the technology licensed to us by Northrop Grumman Corporation, provided that the products are for commercial customers and non-satellite applications |
| Steps taken by us to prevent misappropriation or infringement of our intellectual property or the intellectual property of our customers may not be successful |
| Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary rights of others, including our customers |
| Litigation of this type could result in substantial costs and diversion of our resources |
| We may receive in the future, notices of claims of infringement of other parties’ proprietary rights |
| In addition, the invalidity of our patents may be asserted or prosecuted against us |
| Furthermore, in a patent or trade secret action, we could be required to withdraw the product or products as to which infringement was claimed from the market or 24 _________________________________________________________________ [77]Table of Contents redesign products offered for sale or under development |
| We have also at times agreed to indemnification obligations in favor of our customers and other third parties that could be triggered upon an allegation or finding of our infringement of other parties’ proprietary rights |
| These indemnification obligations would be triggered for reasons including our sale or supply to a customer or other third parties of a product which was later discovered to infringe upon another party’s proprietary rights |
| Irrespective of the validity or successful assertion of such claims we would likely incur significant costs and diversion of our resources with respect to the defense of such claims |
| To address any potential claims or actions asserted against us, we may seek to obtain a license under a third party’s intellectual property rights |
| However, in such an instance, a license may not be available on commercially reasonable terms, if at all |
| With regard to our pending patent applications, it is possible that no patents may be issued as a result of these or any future applications or the allowed patent claims may be of reduced value and importance |
| If they are issued, any patent claims allowed may not be sufficiently broad to protect our technology |
| Further, any existing or future patents may be challenged, invalidated or circumvented thus reducing or eliminating their commercial value |
| The failure of any patents to provide protection to our technology might make it easier for our competitors to offer similar products and use similar manufacturing techniques |
| Risks Relating to Our Industry Our acquisition of JCA Technology and our own marketing and sales efforts have increased the volume of our products used by the United States government |
| Our revenues in this market largely depend upon the funding and implementation decisions of Congress and United States government agencies |
| These decisions could change abruptly and without notice, unexpectedly reducing our current or future revenues in this market |
| Our growth is partially dependent on growth in sales to defense electronics and homeland security prime contractors as a first-tier subcontractor |
| Government appropriations and prime contractor reactions to changing levels of contract funding availability can cause re-programming of first-tier subcontractor requirements by prime contractors in a way that reduces our current revenues or future revenue forecasts |
| These funding and implementation decisions are difficult to predict and may change abruptly |
| If they change in a manner unfavorable to us, we could find that previously expected and forecasted revenues do not materialize |
| Our failure to compete effectively could reduce our revenues and margins |
| Among merchant suppliers in the telecommunication network market, we primarily compete with Eyal Microwave Industry, Filtronics plc, the Forem division of Andrew Corporation, Linkra Srl, Microelectronics Technology Inc, Remec Broadband Wireless, Inc, Teledyne Technologies Incorporated, Thales Group SA and Xytrans Inc |
| In addition to these companies, there are telecom OEMs, such as Ericsson and NEC Corporation, that use their own captive resources for the design and manufacture of their high-frequency RF transceiver modules, rather than use merchant suppliers like us |
| We believe that approximately one half of the high-frequency RF transceiver modules manufactured today are being produced by these captive resources |
| To the extent that telecom OEMs presently, or may in the future, produce their own RF transceiver modules, we lose the opportunity to gain a customer and the potential related sales |
| Further, if a telecom OEM were to sell its captive operation to a competitor, we would lose the opportunity to acquire those potential sales |
| In the defense electronics and homeland security markets, we primarily compete with Aeroflex Incorporated, AML Communications Inc, Chelton, Ltd, CTT Inc, Herley Industries, Inc, KMIC Technology, Inc, Miteq, Inc |
| and Teledyne Technologies Incorporated |
| Many of our current and potential competitors are substantially larger than us and have greater financial, technical, manufacturing and marketing resources |
| If we were unable to compete successfully, our future operations and financial results would be harmed |
| 25 _________________________________________________________________ [78]Table of Contents Our failure to comply with any applicable environmental regulations could result in a range of consequences, including fines, suspension of production, excess inventory, sales limitations and criminal and civil liabilities |
| Due to environmental concerns, the need for lead-free solutions in electronic components and systems is receiving increasing attention within the electronics industry as companies are moving towards becoming compliant with the Restriction of Hazardous Substances Directive, or RoHS Directive |
| The RoHS Directive is European legislation that restricts the use of a number of substances, including lead, effective July 2006 |
| We believe that our products will be compliant with the RoHS Directive and that materials will be available to meet these emerging regulations |
| However, it is possible that unanticipated supply shortages or delays or excess non-compliant inventory may occur as a result of these new regulations |
| Failure to comply with any applicable environmental regulations could result in a range of consequences, including loss of sales, fines, suspension of production, excess inventory, and criminal and civil liabilities |
| Government regulation of the communications industry could limit the growth of the markets that we serve or could require costly alterations of our current or future products |
| The markets that we serve are highly regulated |
| Communications service providers must obtain regulatory approvals to operate broadband wireless access networks within specified licensed bands of the frequency spectrum |
| Further, the Federal Communications Commission and foreign regulatory agencies have adopted regulations that impose stringent RF emissions standards on the communications industry |
| In response to the new environmental regulations on health and safety in Europe and China, we are required to design and build a lead-free product |
| Changes to these regulations may require that we alter the performance of our products |
| Risks Relating to Ownership of Our Stock The assets of Wood River Capital Management, LLC and certain of its affiliates, the holders of 36dtta7prca of our outstanding common stock as of December 31, 2005, have been placed into receivership by the Securities and Exchange Commission, and the receiver may dispose of such shares of our common stock |
| Such disposition may adversely affect the trading price of our common stock |
| Based on filings made with the Securities and Exchange Commission, as of December 31, 2005, Wood River Capital Management, LLC and certain of its affiliated hedge funds, which we refer to collectively as Wood River, owned approximately 36dtta7prca of our outstanding common stock |
| On October 13, 2005, the Securities and Exchange Commission filed an emergency action against Wood River and, concurrently with the filing of the action, an order was entered placing all assets of Wood River, including the Endwave shares owned by Wood River, into receivership |
| As a result, the receiver is also deemed to have beneficial ownership of such shares |
| The receiver will be required to liquidate the assets of Wood River or distribute such assets to the investors in the Wood River Funds |
| We currently do not know what the timing and manner of any liquidation or distribution of Endwave shares is likely to be, nor do we control any such liquidation or distribution |
| Such disposition of Endwave shares may have the effect of reducing the trading price of our common stock |
| The market price of our common stock has historically fluctuated and is likely to fluctuate in the future |
| The price of our common stock has fluctuated widely since our initial public offering in October 2000 |
| For example, in 2005, the lowest bid price for our common stock was dlra9dtta46 and the highest bid price for our common stock was dlra55dtta41 |
| The market price of our common stock can fluctuate significantly for many reasons, including, but not limited to: • our financial performance or the performance of our competitors; • the purchase or sale of common stock, or short-selling or other transactions involving our securities, particularly by Wood River or other large stockholders; • technological innovations or other trends or changes in the telecommunication network, defense electronics or homeland security markets; 26 _________________________________________________________________ [79]Table of Contents • successes or failures at significant product evaluations or site demonstrations; • the introduction of new products by us or our competitors; • acquisitions, strategic alliances or joint ventures involving us or our competitors; • decisions by major participants in the communications industry not to purchase products from us or to pursue alternative technologies; • decisions by investors to de-emphasize investment categories, groups or strategies that include our company or industry; • market conditions in the industry, the financial markets and the economy as a whole; and • the low trading volume of our common stock |
| It is likely that our operating results in one or more future quarters may be below the expectations of security analysts and investors |
| In that event, the trading price of our common stock would likely decline |
| In addition, the stock market has experienced extreme price and volume fluctuations |
| These market fluctuations can be unrelated to the operating performance of particular companies and the market prices for securities of technology companies have been especially volatile |
| Future sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock |
| Additionally, future stock price volatility for our common stock could provoke the initiation of securities litigation, which may divert substantial management resources and have an adverse effect on our business, operating results and financial condition |
| Our existing insurance coverage may not sufficiently cover all costs and claims that could arise out of any such securities litigation |
| We anticipate that prices for our common stock will continue to be volatile |
| Wood River and the receiver of the Wood River assets control a large percentage of our common stock and are able to affect significantly the outcome of matters requiring stockholder approval |
| As of December 31, 2005, Wood River and the receiver of the Wood River assets beneficially owned 36dtta7prca of our outstanding common stock |
| Because most matters requiring approval of our stockholders require the approval of the holders of a majority of the shares of our outstanding common stock present in person or by proxy at the meeting, the significant ownership interest of Wood River allows Wood River and the receiver of the Wood River assets to affect significantly the election of our directors and the outcome of corporate actions requiring stockholder approval |
| This concentration of ownership may also delay, deter or prevent a change in control and may make some transactions more difficult or impossible to complete without their support, even if the transaction is favorable to our stockholders as a whole |
| Our certificate of incorporation, bylaws and arrangements with executive officers contain provisions that could delay or prevent a change in control |
| We are subject to certain Delaware anti-takeover laws by virtue of our status as a Delaware corporation |
| These laws prevent us from engaging in a merger or sale of more than 10prca of our assets with any stockholder, including all affiliates and associates of any stockholder, who owns 15prca or more of our outstanding voting stock, for three years following the date that the stockholder acquired 15prca or more of our voting stock, unless the board of directors approved the business combination or the transaction which resulted in the stockholder becoming an interested stockholder, or upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85prca of our voting stock of the corporation, or the business combination is approved by our board of directors and authorized by at least 662/3prca of our outstanding voting stock not owned by the interested stockholder |
| A corporation may opt out of the Delaware anti-takeover laws in its charter documents, however we have not chosen to do so |
| Our certificate of incorporation and bylaws include a number of provisions that may deter or impede hostile takeovers or changes of control of management, including a staggered board of directors, the elimination of the ability of our stockholders to act by written consent, discretionary authority given to our board of directors as to the issuance of preferred stock, and indemnification rights for our directors and executive officers |
| Additionally, during 2005, our board of directors adopted a Stockholder Rights Plan, providing for the distribution of one preferred share purchase right for each outstanding share of common stock held as of 27 _________________________________________________________________ [80]Table of Contents December 12, 2005, that may lead to the delay or prevention of a change in control that is not approved by our board of directors |
| We have an Executive Officer Severance and Retention Plan and a Key Employee Severance and Retention Plan that provide for severance payments and the acceleration of vesting of a percentage of certain stock options granted to our executive officers and certain senior, non-executive employees under specified conditions |
| We also have a Transaction Incentive Plan for the benefit of our executive officers and certain senior, non-executive employees that provides for bonus payments to be made to them upon a change in control transaction |
| These plans may make us a less attractive acquisition target or may reduce the amount a potential acquirer may otherwise be willing to pay for our company |