10-Q 1 a05-18142_110q.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended October 2, 2005

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

For the transition period from to

Commission file number 000-31337

WJ COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		94-1402710
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

401 River Oaks Parkway, San Jose, California		95134
(Address of principal executive offices)		(Zip Code)

(408) 577-6200

(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, and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o

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

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

As of November 9, 2005 there were 65,088,067 shares outstanding of the registrant’s common stock, $0.01 par value.

SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q, our Annual Report on Form 10-K, our shareholders’ annual report, press releases and certain information provided periodically in writing or orally by the our officers, directors or agents contain certain forward-looking statements within the meaning of the federal securities laws that also involve substantial uncertainties and risks. These forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our industry, our beliefs and our assumptions. Words such as “may,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks” and “estimates” and variations of these words and similar expressions, are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed, implied or forecasted in the forward-looking statements. In addition, the forward-looking events discussed in this report might not occur. These risks and uncertainties include, among others, those described in the section of this report and our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 30, 2005 entitled “Risk Factors.” Readers should also carefully review the risk factors described in the other documents that we file from time to time with the Securities and Exchange Commission. We assume no obligation to update or revise the forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

WJ COMMUNICATIONS, INC.

QUARTERLY REPORT ON FORM 10-Q

THREE MONTHS AND NINE MONTHS ENDED OCTOBER 2, 2005

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Statements of Operations for the Three and Nine Months ended October 2, 2005 and September 26, 2004

	Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months ended October 2, 2005 and September 26, 2004

	Condensed Consolidated Balance Sheets at October 2, 2005 and December 31, 2004

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 2, 2005 and September 26, 2004

	Notes to Condensed Consolidated Financial Statements

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

Item 3.	Quantitative and Qualitative Disclosure About Market Risks

Item 4.	Controls and Procedures

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits

	Signatures

PART I — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended						Nine Months Ended
	October 2,			September 26,			October 2,			September 26,
	2005			2004			2005			2004

Sales:
Semiconductor and RFID	$	8,044		$	8,379		$	19,548		$	22,122
Other (1)	50			550			343			2,293
Total sales	8,094			8,929			19,891			24,415

Cost of goods sold	3,774			4,536			10,992			11,039
Gross profit	4,320			4,393			8,899			13,376
Operating expenses:
Research and development	4,451			4,354			13,591			12,588
Selling and administrative	3,632			3,523			11,644			9,326
Acquired in-process research and development	—			—			3,400			8,500
Restructuring reversals	—			(3,416		)	—			(3,845		)
Total operating expenses	8,083			4,461			28,635			26,569
Loss from operations	(3,763		)	(68		)	(19,736		)	(13,193		)
Interest income	272			167			773			486
Interest expense	(29		)	(20		)	(77		)	(72		)
Other income (expense)—net	3			—			11			—
Income (loss) before income taxes	(3,517		)	79			(19,029		)	(12,779		)
Income tax benefit	(123		)	(1,133		)	(123		)	(7,674		)
Net income (loss)	$	(3,394	)	$	1,212		$	(18,906	)	$	(5,105	)

Basic net income (loss) per share	$	(0.05	)	$	0.02		$	(0.30	)	$	(0.08	)
Basic average shares	64,516			60,908			63,860			60,195

Diluted net income (loss) per share	$	(0.05	)	$	0.02		$	(0.30	)	$	(0.08	)
Diluted average shares	64,516			65,913			63,860			60,195

(1) Other sales includes sales of the Company’s wireless and fiber optics products.

See notes to condensed consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

	Three Months Ended					Nine Months Ended
	October 2,			September 26,		October 2,			September 26,
	2005			2004		2005			2004

Net income (loss)	$	(3,394	)	$	1,212	$	(18,906	)	$	(5,105	)
Other comprehensive gain (loss):
Unrealized holding gains (losses) on securities arising during the period, net of reclassification adjustments	(5		)	17		1			7

Comprehensive income (loss)	$	(3,399	)	$	1,229	$	(18,905	)	$	(5,098	)

See notes to condensed consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	October 2,			December 31,
	2005			2004

ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	19,623		$	24,392
Short-term investments	13,176			18,732
Receivables (net of allowances of $111 and $496, respectively)	5,494			6,841
Inventories	5,260			5,148
Interest receivable	133			929
Other	1,995			2,254
Total current assets	45,681			58,296

PROPERTY, PLANT AND EQUIPMENT, net	7,668			9,679

Goodwill	6,881			1,368
Intangible assets, net	1,974			180
Other assets	210			210
	$	62,414		$	69,733

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES:
Accounts payable	$	3,015		$	2,633
Accrued liabilities	1,529			1,607
Accrued payroll and profit sharing	1,513			1,498
Accrued workers’ compensation	362			538
Income tax contingency liability	1,817			1,946
Deferred margin on distributor inventory	3,650			—
Restructuring accrual	3,341			3,350
Total current liabilities	15,227			11,572

Restructuring accrual	14,119			16,069
Other long-term obligations	741			795

Total liabilities	30,087			28,436

STOCKHOLDERS’ EQUITY:
Common stock	664			629
Treasury stock	(19		)	(18		)
Additional paid-in capital	204,546			194,262
Accumulated deficit	(172,105		)	(153,199		)
Deferred stock compensation	(748		)	(365		)
Other comprehensive loss	(11		)	(12		)
Total stockholders’ equity	32,327			41,297
	$	62,414		$	69,733

See notes to condensed consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended
	October 2,			September 26,
	2005			2004
OPERATING ACTIVITIES:
Net loss	$	(18,906	)	$	(5,105	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	2,329			2,064
Acquired in-process research and development	3,400			8,500
Amortization of deferred financing costs	31			31
Net gain on disposal of property, plant and equipment	(8		)	—
Non-cash restructuring charges (reversals)	52			(3,830		)
Stock based compensation	836			816
Provision for (reduction in) allowance for doubtful accounts	19			63
Amortization of net premiums on short-term investments	173			311
Net changes in:
Receivables	1,593			(1,194		)
Inventories	81			(339		)
Other assets	867			—
Restructuring liabilities	(2,011		)	(1,731		)
Income tax contingency liability	(129		)	(8,111		)
Deferred margin on distributor inventory	3,650			—
Accruals and accounts payable	29			(409		)
Net cash used in operating activities	(7,994		)	(8,934		)

INVESTING ACTIVITIES:
Purchase of short-term investments	(27,887		)	(45,711		)
Proceeds from sale and maturities of short-term investments	33,580			72,246
Purchases of property, plant and equipment	(473		)	(320		)
Acquisition of Telenexus and related costs	(3,218		)	—
Acquisition of EiC and related costs	(37		)	(11,190		)
Proceeds on disposal of property, plant and equipment	398			—
Net cash provided by investing activities	2,363			15,025

FINANCING ACTIVITIES:
Payments on long-term borrowings	(47		)	(82		)
Repurchase of common stock	(214		)	(267		)
Net proceeds from issuances of common stock	1,123			10,874
Net cash provided by financing activities	862			10,525

Net increase (decrease) in cash and cash equivalents	(4,769		)	16,616
Cash and cash equivalents at beginning of period	24,392			10,900
Cash and cash equivalents at end of period	$	19,623		$	27,516

Other cash flow information:
Income taxes paid	$	6		$	436
Interest paid	46			41
Noncash investing and financing activities:
Issuance of common stock for Telenexus acquisition	8,190			—
Issuance of common stock for EiC acquisition	—			2,484

See notes to condensed consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three month and nine month periods ended October 2, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of WJ Communications, Inc. (the “Company”) for the fiscal year ended December 31, 2004, which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2005.

The balance sheet at December 31, 2004 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

RECLASSIFICATIONS — Certain amounts for 2004 have been reclassified to conform with the 2005 presentation. Such reclassifications did not have any impact on net loss or stockholders’ equity.

STOCK-BASED COMPENSATION — The Company accounts for stock-based compensation granted to employees and directors under the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”

During the quarter ended September 26, 2004, the Company modified two option agreements (to extend the option exercise period) resulting in $594,000 of severance expense which was recorded as selling and administrative expense in the accompanying unaudited condensed consolidated statements of operations for the three and nine months ended September 26, 2004.

As required under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” the pro forma effects of stock-based compensation on net income (loss) and net income (loss) per common share have been estimated at the date of grant as if the Company had accounted for such awards under the fair value method of SFAS No. 123 using the Black-Scholes option-pricing model.

The following table illustrates the effect on net income (loss) and net income (loss) per share had compensation cost for all of the Company’s stock option plans been determined based upon the fair value at the grant date for awards under these plans, and amortized

to expense over the vesting period of the awards consistent with the methodology prescribed under SFAS No. 123 (in thousands, except per share amounts):

	Three Months Ended						Nine Months Ended
	Oct. 2,			Sept. 26,			Oct. 2,			Sept. 26,
	2005			2004			2005			2004

Reported net income (loss)	$	(3,394	)	$	1,212		$	(18,906	)	$	(5,105	)
Add: Total stock-based employee compensation expense included in reported net income (loss)	113			670			836			816
Deduct: Total stock-based employee compensation expense under fair value based method for all awards	988			(1,436		)	(1,019		)	(3,612		)
Pro forma net income (loss)	$	(2,293	)	$	446		$	(19,089	)	$	(7,901	)

Net income (loss) per basic share
As reported	$	(0.05	)	$	0.02		$	(0.30	)	$	(0.08	)
Pro forma	$	(0.04	)	$	0.01		$	(0.30	)	$	(0.13	)

Net income (loss) per diluted share
As reported	$	(0.05	)	$	0.02		$	(0.30	)	$	(0.08	)
Pro forma	$	(0.04	)	$	0.01		$	(0.30	)	$	(0.13	)

2. ORGANIZATION AND OPERATIONS OF THE COMPANY

WJ Communications, Inc. (formerly Watkins-Johnson Company, the “Company”) was founded in 1957 in Palo Alto, California. The Company was originally incorporated in California and reincorporated in Delaware in August 2000. For more than 45 years, the Company developed and manufactured radio frequency (“RF”) microwave devices for government electronics and space communications systems used for intelligence gathering and communication. In 1996, the Company began to develop commercial applications for its military technologies. The Company’s current operations design, develop and market innovative, high-performance products for both current and next generation wireless and broadband cable networks and radio frequency identification (“RFID”) systems worldwide. The Company’s products are comprised of advanced, highly functional RF semiconductors, components and integrated assemblies which seek to address the RF requirements of these various systems. The Company currently generates the majority of its revenue from products utilized in wireless and wireline networks. The Company’s revenue from products used in RF identification systems represents a less significant portion of its current revenue.

3. REVENUE RECOGNITION

Historically, revenues from the Company’s distributors were recognized upon shipment based on the following factors: the Company’s sales prices are fixed or determinable by contract at the time of shipment, payment terms are fixed at shipment and are consistent with terms granted to other customers, the distributors have full risk of physical loss, the distributors have separate economic substance, the Company has no obligation with respect to the resale of the distributors’ inventory, and the Company believed it could reasonably estimate the potential returns from its distributors based on their history and its visibility to the distributors’ success with its products and into the market place in general. The Company accrued for distributor right of return based on known events and historical trends in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 48 “Revenue Recognition When Right of Return Exists,” and for price protection in accordance with Emerging Issues Task Force Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”. Through the Company’s first quarter ended April 3, 2005 the amount of those reserves had not been material. The Company accrued a reserve based on its reasonable estimate of future returns based on historical trends and contractual limitations. Per contractual agreement, Richardson Electronics LTD may return product three times per year under the following conditions: the total value of inventory returned shall not exceed an amount equal to 5% of the total value of the distributor’s stock on hand of the Company’s products as reported in the prior month’s inventory report, the inventory is returned no earlier than 6 months and no later than 24 months from the date of the original invoice date and the product’s packaging has not been opened or any alteration or modification has been performed on the product. The contractual agreement with WAV Wireless Outfitters included identical terms though the total value of inventory returned could not exceed an amount equal to 15% of the total value of its stock on hand of the Company’s products as reported in the prior month’s inventory report.

The Company has historically received stock rotation requests from its distributors that were within the amounts estimated and contractually allowed with the only exception being the stock rotation in February, 2004 which was approximately $37,000 in excess of the amount contractually allowed. However, the request from its distributor for stock rotation within the Company’s second quarter ended July 3, 2005 was again higher than the amount contractually allowed by approximately $51,000. Management, with the concurrence of the Company’s Audit Committee, believes the increasing percentage of new products introduced by the Company makes it likely that stock rotation reserves will continue to be difficult to estimate based on historical patterns and contractual provisions. Based on this change in facts and circumstances and management’s future expectations, the Company believes that it can no longer reasonably estimate the amount of future returns from its distributors as of July 3, 2005. Accordingly, recognition of revenue and associated cost of sales on shipments to distributors is deferred until the resale to the end customer. This change in application resulted in a $4.1 million revenue deferral in the Company’s second quarter of 2005 which is reflected in the accompanying unaudited condensed consolidated statements of operations for the nine month period ending October 2, 2005. Although revenue is deferred until resale, title of products sold to distributors transfers upon shipment. Accordingly, shipments to distributors are reflected in the consolidated balance sheets as accounts receivable and a reduction of inventories at the time of shipment. Deferred revenue and the corresponding cost of sales on shipments to distributors are reflected in the consolidated balance sheet on a net basis as “Deferred margin on distributor inventory.”

As this change in the application of the Company’s revenue recognition policy is the result of a change in current facts and circumstances, in accordance with Accounting Principles Board Opinion No. 20 “Accounting Changes” paragraph 8, the Company accounted for the change within its second quarter ended July 3, 2005.

4. ACQUISITIONS

EiC Acquisition

On June 18, 2004, the Company completed its acquisition of the wireless infrastructure business and associated assets from EiC. The aggregate purchase price was $13.3 million which included payments of cash of $10.0 million, the issuance of 737,000 shares of the Company’s common stock valued at $2.5 million, acquisition costs of $1.2 million (including $700,000 paid to a related party for investment banking services in connection with the acquisition) and $152,000 registration statement related expenses reduced by a $576,000 benefit from the termination settlement of the associated supply agreement with EiC recognized during our quarter ended December 31, 2004. In connection with the acquisition, $1.5 million in cash and 294,118 shares of common stock have been held in escrow as security against certain financial contingencies. On March 30, 2005, the Company made a claim against the escrow account for unpaid invoices issued under the supply agreement. The Company received those funds on May 4, 2005. The uncontested amount was released to EiC on April 5, 2005 per the escrow agreement and the residual balance of the $1.5 million was released to EiC on May 4, 2005. The 294,118 shares in the escrow account less any shares for any properly noticed unpaid or contested amounts will be distributed within five days after March 31, 2006. On November 23, 2004 the Company filed a registration statement registering for resale by the seller of up to 442,882 shares of the Company’s common stock issued in the acquisition.

In addition to the closing consideration, EiC was originally entitled to further consideration of up to $7.0 million and $7.0 million in cash and shares of the Company’s common stock if certain revenue and gross margin targets were achieved by March 31, 2005 and March 31, 2006, respectively. The Company has determined that the revenue and gross margin targets were not met for the nine month period ending March 31, 2005. EiC subsequently notified the Company that it disagrees with the Company’s conclusion that the revenue and gross margin targets were not met for the nine month period ending March 31, 2005. While the Company believes EiC’s assertions are without merit and has notified EiC of such, there can be no assurances as to the eventual outcome of this matter.

If the Company achieves certain revenue targets by March 31, 2006, it will be obligated to pay EiC the remaining contingent consideration of up to $7.0 million, ninety percent (90%) in its common stock and ten percent (10%) in cash. The number of shares of its common stock to be delivered is to be determined by dividing the value in dollars of the portion payable in its common stock by the average closing price of its common stock, as quoted on the NASDAQ National Market, during the ten consecutive trading days ending one trading day before the end of the period covered by the payment, provided, however, that in the event that the calculation of the average closing price results in a price per share for the first payment that would be less than $5.00 or for the second payment that would be less than $6.00, then the Company, at its option, in its sole discretion, may elect to make the payment part or all in cash and the balance, if any, in shares of its common stock. If EiC receives such consideration, the amounts will be recorded as an increase to goodwill. The fair value of the Company’s common stock was determined based on the average closing price per share of the Company’s common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (June 21, 2004).

The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and accordingly the Company’s consolidated financial statements from June 18, 2004 include the impact of the acquisition. The following table summarizes the allocation of the total purchase price of the EiC acquisition, as of the date of the acquisition (in thousands):

Property and equipment	$	1,124
Inventory	2,038
In-process research and development	8,500
Developed technology	200
Goodwill	1,405
Total purchase price	$	13,267

The acquisition was accounted for as a purchase transaction, and accordingly, the assets of EiC were recorded at their estimated fair values at the date of the acquisition. With the exception of the goodwill and acquired in-process research and development (“IPRD”), the identified intangible assets will be amortized on a straight-line basis over their estimated useful lives, with a weighted average life of approximately five years.

A portion of the purchase price, $8.7 million, was allocated to developed and core technology and in-process research and development (“IPRD”). Developed and core technology and IPRD were identified and valued through extensive interviews, analysis of data provided by EiC Corporation concerning developmental products, their stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The income method was the primary technique utilized in valuing the developed and core technology and IPRD. Under the income method, fair value reflects the present value of the projected cash flows that are expected to be generated by the products incorporating the current technologies.

Developmental projects that reached technological feasibility were classified as developed and core technology, and the $200,000 value assigned to developed technology was capitalized to be amortized using the straight-line method over a weighted-average period of five years. Developmental projects that had not reached technological feasibility, and had no future alternative uses were classified as IPRD. The $8.5 million value allocated to projects that were identified as IPRD was charged to acquired in-process research and development in 2004. The value assigned to IPRD comprises the following projects: 12V heterojunction bipolar transistor (“HBT”) power amplifiers ($1.5 million) and 28V HBT high power amplifiers ($7.0 million).

The nature of the efforts required to develop the acquired IPRD into commercially viable products principally relate to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the products can be produced to meet their design specifications, including functions, features and technical performance requirements.

In valuing the IPRD, the Company considered, among other factors, the importance of each project to the overall development plan, the projected incremental cash flows from the projects when completed and any associated risks. The projected incremental cash flows were discounted back to their present value using an after-tax discount rate of 25%. This discount rate was determined after consideration of the Company’s weighted average cost of capital and the weighted average return on assets. Associated risks include the inherent difficulties and uncertainties in completing each project and thereby achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets.

As part of the acquisition, the Company entered into a sublease with EiC Corporation for 28,160 square feet of space at their facility in Fremont, California. This sublease expired in December 2004 and converted into a month to month lease thereafter. At the end of January 2005 the Company moved the wafer fabrication facility from the Fremont location to its facility in Milpitas, California and ended this sublease.

Telenexus Acquisition

On January 28, 2005, the Company completed its acquisition of Telenexus, Inc. (“Telenexus”). Pursuant to an Agreement and Plan of Merger, dated January 19, 2005, by and between the Company, WJ Newco, LLC (the “WJ Sub”), Telenexus and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton (collectively the “Shareholders”), Telenexus merged with and into the WJ Sub effective on January 29, 2005. The WJ Sub was the survivor in the merger and is a wholly-owned subsidiary of the Company. Telenexus designs, develops, manufactures and markets radio frequency identification (“RFID”) reader products for a broad range of industries and markets. By virtue of the merger, the Company purchased through the WJ Sub all of the assets necessary for the conduct of the RFID business of Telenexus, consisting primarily of, and including, but not limited to RFID modules, baseband processing algorithm technology, applications software and realizations of several reader product designs. The consideration paid by the Company on the closing date in connection with the merger consisted of cash in the amount of $3.0 million, which was paid out of the Company’s cash reserves on the closing date, and 2,333,333 shares of the Company’s common stock valued at $8.2 million at the closing date. Including acquisition costs of $230,000, the aggregate purchase price for the net assets of Telenexus totaled $11.4 million. Of the closing consideration, cash in the amount of $500,000 and 333,333 shares of the Company’s common stock are being held in escrow with respect to any indemnification matter under the merger agreement. The outstanding cash balance of the escrow account less any properly noticed unpaid or contested amounts was to be distributed within two days after October 28, 2005. The Company released the full amount of the cash balance of the escrow account on October 31, 2005. The 333,333 shares in the escrow account less any shares for any properly noticed unpaid or contested amounts will be distributed within five days after July 28, 2006. The fair value of the Company’s common stock was determined based on the average closing price per share of the Company’s common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (January 31, 2005). In addition to the closing consideration, the sellers may be entitled to further compensation of up to $2.5 million in cash and up to 833,333 shares of the Company’s common stock if the Company achieves certain revenue targets by July 28, 2006. Any change in the fair value of the net assets of Telenexus or any additional consideration to the Shareholders will change the amount of the purchase price allocable to goodwill. Two of the Shareholders, Richard J. Swanson and Wilred K. Lau also entered into three-year employment agreements with the Company. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and accordingly the Company’s consolidated financial statements from January 28, 2005 include the impact of the acquisition.

In accordance with SFAS No. 141, the total purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their respective estimated fair values at the acquisition date with the excess purchase price allocated to goodwill. The Company determined that acquiring Telenexus, Inc. was a more cost effective means of developing the RFID products and technology necessary to continue to enhance our RFID reader offerings to further capitalize on market opportunity than developing the products and technology internally. The acquisition also offers the Company the opportunity to shorten the time it takes to bring additional RFID reader products and technology to market. The valuation of the identifiable intangible assets acquired reflects management’s estimates based on, among other factors, a valuation of the intangible assets prepared by an independent third party. The following table summarizes the allocation of the total purchase price of the Telenexus acquisition, as of the date of the acquisition (in thousands):

Net tangible assets	$	504
In-process research and development	3,400
Amortizable intangible assets:
Developed technology	40
Customer relationships	900
Trademarks and trade names	700
Non-competition agreements	400
Goodwill	5,476
Total purchase price	$	11,420

With the exception of the goodwill and IPRD, the identified intangible assets consisting of existing technology, customer relationships, trademarks and trade names and non-competition agreements will be amortized on a straight-line basis over their estimated useful lives, with a weighted average life of approximately eight years. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), goodwill of $5.5 million will not be amortized and will be tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable in accordance with the Company’s policy on impairment analysis.

Prior to the acquisition, the Company and Telenexus had entered into an agreement to jointly design, develop and produce a Personal Computer Memory Card International Association (“PCMCIA”) Type II Multi-Protocol RFID reader. The Company has evaluated the effective settlement of this preexisting executory contract and the associated reacquired right to the use of its technology in accordance with Emerging Issues Task Force (“EITF”) 04-1 “Accounting for Preexisting Relationships between the Parties to a Business Combination.” The Company has determined that the effective settlement of the executory contract and the associated reacquired right to use its technology was neither favorable or unfavorable as the agreement represented fair value when compared to similar market transactions and there were no stated settlement provisions in the contract.

A portion of the purchase price, $3.4 million, was allocated to developed and core technology and IPRD. Developed and core technology and IPRD were identified and valued through extensive interviews, analysis of data provided by Telenexus concerning developmental products, their stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The income method was the primary technique utilized in valuing the developed and core technology and IPRD. Under the income method, fair value reflects the present value of the projected cash flows that are expected to be generated by the products incorporating the current technologies.

Developmental projects that reached technological feasibility were classified as developed and core technology, and the $40,000 value assigned to developed technology was capitalized to be amortized using the straight-line method over a weighted-average period of fourteen months. Developmental projects that had not reached technological feasibility, and had no future alternative uses were classified as IPRD. The $3.4 million value allocated to projects that were identified as IPRD was charged to acquired in-process research and development in the accompanying condensed consolidated statements of operations for the nine months ended October 2, 2005. The value assigned to IPRD comprises the following projects: multi-protocol readers ($1.3 million), Smart readers ($900,000) and Class 3 readers ($1.2 million). The value of these projects was determined by estimating the discounted net cash flows from the sale of the products resulting from the completion of the projects, reduced by the portion of the revenue attributable to developed technology and the percentage of completion of the project.

Products based on multi-protocol reader (‘MPR”) technology are capable of reading tags of different classes (e.g., Class 0, Class 0+, Class 1, and Gen 2 tags) with a single reader. The hardware realization of the MPR products is based on a hardware stack consisting of an interface board, a control board, a radio frequency (“RF”) board and an antenna. A modular construction technique is employed such that differing combinations of boards can be used to produce different products. For example, the same antenna, RF board, and control board can be used with one interface board to provide an Ethernet connection to the host computer, or a different interface board to provide a serial interface to the host. Similarly, different RF boards can be used to provide one, two or four antenna ports for reading tags without changing the control board or interface board. This novel modular construction technique is a part of the MPR technology approach.

Smart reader technology is an extension of the MPR Technology. This technology provides an operating system (e.g., Linux, Windows® CE) in the embedded microprocessor on the interface board. With the previous RFID technologies, the host computer provided virtually every command to the reader. With Smart reader technology, the embedded controller can host middleware applications. These applications can take high-level commands from the host and then provide most of the lower-level commands internal to the reader. Thus relieving much of the command and processing burden from the host computer.

Class 3 tags are fundamentally different from the Class 0, 0+ and 1 tags in that they are battery assisted. This makes them more powerful and capable, and provides longer read range, but at the expense of battery life and cost. They are more appropriate for tracking higher-value assets. The air-interface protocol is different for the Class 3 readers and tags, and to date is not standardized (as is the case for Class 0 and 1 tags).

The Company has currently not identified any pre-acquisition contingencies where a liability is probable and the amount of the liability can be reasonably estimated. If information becomes available to us prior to the end of the purchase price allocation period, which would indicate that a liability is probable and the amount can be reasonably estimated, such items will be included in the purchase price allocation.

5. GOODWILL AND INTANGIBLE ASSETS

In connection with the acquisition of the wireless infrastructure business and associated assets from EiC on June 18, 2004, the Company recorded $1.8 million of goodwill. Adjustments to the EiC goodwill subsequent to the EiC acquisition date, resulted primarily from a $576,000 benefit from the termination settlement of the associated supply agreement with EiC and partially offset by $152,000 of additional registration statement related expenses. In connection with the acquisition of Telenexus acquisition on January 28, 2005, the Company recorded $5.5 million of goodwill. Adjustments to the Telenexus goodwill through September 2005, subsequent to the Telenexus acquisition date, resulted primarily from finalization of direct acquisition costs. This goodwill was based upon the values assigned to the transactions at the time they were announced in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The changes in the carrying value of goodwill as of October 2, 2005 are as follows (in thousands):

	EiC		Telenexus		Total
Balance as of December 31, 2004	$	1,368	$	—	$	1,368
Purchased goodwill	—		5,464		5,464
Adjustments to goodwill	37		12		49
Balance as of October 2, 2005	$	1,405	$	5,476	$	6,881

The Company periodically evaluates its goodwill in accordance with SFAS No. 142 for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business, or significant negative industry or economic trends. If these criteria indicate that the value of the goodwill may be impaired, an evaluation of the recoverability of the net carrying value is made. Irrespective of the aforementioned circumstances where impairment indicators are present, the Company is required by SFAS No. 142 to test its goodwill for impairment at least annually. The Company has chosen the end of its fiscal month of May as the date of its annual impairment test.

In accordance with SFAS No. 142 paragraph 30, “A reporting unit is an operating segment or one level below an operating segment (referred to as a component). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. However, two or more components of an operating segment shall be aggregated and deemed a single reporting unit if the components have similar economic characteristics. An operating segment shall be deemed to be a reporting unit if all of its components are similar, if none of its components is a reporting unit, or if it comprises only a single component. The relevant provisions of Statement 131 and related interpretive literature shall be used to determine the reporting units of an entity.” The Company’s Chief Operating Decision Maker (“CODM”) is the CEO. While the Company’s CODM monitors the sales of various products, operations are managed and financial performance evaluated based upon the sales and production of multiple products employing common manufacturing and research and development resources; sales and administrative support; and facilities. This allows the Company to leverage its costs in an effort to maximize return. The Company believes that any allocation of such shared expenses to various products would be impractical, arbitrary and currently does not make such allocations internally. As such, the Company considers itself a single reporting unit.

The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. SFAS No. 142 paragraph 30 states: “The fair value of an asset (or liability) is the amount at which that asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Thus, the fair value of a reporting unit refers to the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties. Quoted market prices in active markets are the best evidence of fair value and shall be used as the basis for the measurement, if available.” As of June 3, 2005 (the closest trading date prior to the end of the Company’s fiscal month of May) the fair value of the Company was $133.9 million based on a per (common) share price of $2.09 as reported on the NasdaqNM (ticker “WJCI”) and 64,066,380 common shares outstanding. As of June 5, 2005 the Company’s carrying amount, including goodwill was $56.2 million. As the fair value of the Company exceeds its carrying amount, the Company’s goodwill is considered not impaired.

Intangible assets are recorded at cost, less accumulated amortization. The following tables present details of the Company’s purchased intangible assets (in thousands):

As of October 2, 2005:

	Useful			Accumulated
Description	Life	Gross		Amortization		Net
EiC acquisition
Purchased developed technology	5 years	$	200	$	50	$	150

Telenexus acquisition
Purchased developed technology	1.2 years	40		23		17
Customer relationships	7 years	900		87		813
Trademarks and trade names	12 years	700		39		661
Non-competition agreements	4 years	400		67		333

Total identified intangible assets		$	2,240	$	266	$	1,974

As of December 31, 2004:

Useful

Accumulated

Description

Life

Gross

Amortization

Net

EiC acquisition

Purchased developed technology

5 years

200

180

In the three months and nine months ended October 2, 2005, amortization of purchased intangible assets included in cost of goods sold was approximately $19,000 and $53,000, respectively. In the three months and nine months ended October 2, 2005, amortization of purchased intangible assets included in operating expense was approximately $72,000 and $193,000, respectively. In the three months and nine months ended September 26, 2004, amortization of purchased intangible assets included in cost of goods sold was approximately $10,000 for both respective periods. Amortization is computed using the straight-line method over the estimated useful life of the intangible asset. The Company expects that annual amortization of acquired intangible assets to be as follows (in thousands):

Fiscal year:	EiC		Telenexus		Total
2005 (remaining three months)	$	10	$	80	$	90
2006	40		295		335
2007	40		287		327
2008	40		287		327
2009	20		195		215
2010 and beyond	—		680		680
Total amortization	$	150	$	1,824	$	1,974

6. UNAUDITED PRO FORMA RESULTS OF OPERATIONS

The following unaudited pro forma consolidated financial data represents the combined results of operations as if Telenexus’ business had been combined with the Company at the beginning of the respective period. This pro forma financial data includes the straight line amortization of intangibles over their respective estimated useful lives and excludes the write-off of IPRD of $3.4 million (in thousands, except per share amounts):

	Three Months Ended					Nine Months Ended
	Oct. 2,			Sept. 26,		Oct. 2,			Sept. 26,
	2005			2004		2005			2004

Net sales	$	8,094		$	9,609	$	19,969		$	26,565
Loss from operations	$	(3,763	)	$	109	$	(16,421	)	$	(12,994	)
Net income (loss)	$	(3,394	)	$	1,377	$	(15,607	)	$	(4,932	)

Basic net income (loss) per share	$	(0.05	)	$	0.02	$	(0.24	)	$	(0.08	)
Basic average shares	64,516			63,241		64,089			62,528

Diluted net income (loss) per share	$	(0.05	)	$	0.02	$	(0.24	)	$	(0.08	)
Diluted average shares	64,516			68,246		64,089			62,528

The unaudited pro forma results of operations is presented for illustrative purposes only and is not intended to represent what the Company’s results of operations would have been if the acquisition had occurred on those dates or to project the Company’s results of operations for any future period. Since the Company and Telenexus were not under common control or management for any period presented prior to the acquisition, the unaudited pro forma results of operations may not be comparable to, or indicative of, future performance. These results do not reflect any additional costs or cost savings resulting from the acquisition.

7. RECENT ACCOUNTING PRONOUNCEMENTS

On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R eliminates the alternative of applying the intrinsic value measurement provisions of Opinion 25 to stock compensation awards issued to employees. Rather, the new standard requires enterprises to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).

The Company has not yet quantified the effects of the adoption of SFAS 123R, but it is expected that the new standard may result in significant stock-based compensation expense. The pro forma effects on net income and earnings per share if the Company had applied the fair value recognition provisions of original SFAS 123 on stock compensation awards (rather than applying the intrinsic value measurement provisions of Opinion 25) are disclosed above. Although such pro forma effects of applying original SFAS 123 may be indicative of the effects of adopting SFAS 123R, the provisions of these two statements differ in some important respects. The actual effects of adopting SFAS 123R will be dependent on numerous factors including, but not limited to, the valuation model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the requisite service period; and the transition method (as described below) chosen for adopting SFAS 123R.

SFAS 123R will be effective for the Company’s fiscal quarter beginning January 1, 2006, and requires the use of the Modified Prospective Application Method. Under this method SFAS 123R is applied to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (such as unvested options) that are outstanding as of the date of adoption shall be recognized as the remaining requisite services are rendered. The compensation cost relating to unvested awards at the date of adoption shall be based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123. In addition, companies may use the Modified Retrospective Application Method. This method may be applied to all prior years for which the original SFAS 123 was effective or only to prior interim periods in the year of initial adoption. If the Modified Retrospective Application Method is applied, financial statements for prior periods shall be adjusted to give effect to the fair-value-based method of accounting for awards on a consistent basis with the pro forma disclosures required for those periods under the original SFAS 123.

In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed.

Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe that the adoption of SFAS 154 will have a significant effect on its financial statements.

In June 2005, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements” (“EITF 05-6”). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The Company does not believe that the adoption of EITF 05-6 will have a significant effect on its financial statements.

8. BORROWING ARRANGEMENTS

In December of 2000, the Company entered into a revolving credit facility (“Revolving Facility”) with a bank, the terms of which were amended and restated in September 2005. Under the new terms, the Revolving Facility provides for a maximum credit extension of $20.0 million, with a $15.0 million sub-limit, to support letters of credit and matures on November 22, 2005. Interest rates on outstanding borrowings are periodically adjusted based on certain financial ratios and are initially set, at the Company’s option, at LIBOR plus 1.0% or Prime minus 0.5%. The Revolving Facility requires the Company to maintain certain financial ratios and contains limitations on, among other things, the Company’s ability to incur indebtedness, pay dividends and make acquisitions without the bank’s permission. The Company was in compliance with the covenants as of October 2, 2005. The Revolving Facility is secured by substantially all of the Company’s assets. As of October 2, 2005 and December 31, 2004, there were no outstanding borrowings under the Revolving Facility. The Company has letters of credit of $3.2 million available as of October 2, 2005 against which no amounts have been drawn.

9. INVENTORIES

Inventories are stated at the lower of cost, using average-cost basis, or market. Cost of inventory items is based on purchase and production cost including labor and overhead. Write-downs, when required, are made to reduce excess inventories to their estimated net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actual conditions become less favorable than the assumptions used, an additional inventory write-down may be required. Inventories at October 2, 2005 and December 31, 2004 consisted of the following (in thousands):

	October 2,		December 31,
	2005		2004
Finished goods	$	2,180	$	1,944
Work in progress	1,854		2,338
Raw materials and parts	1,226		866
	$	5,260	$	5,148

10. CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and trade receivables. The Company maintains cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company invests in a variety of financial instruments such as money market funds, commercial paper and high quality corporate bonds, and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. At October 2, 2005, Richardson Electronics, Ltd. represented 56% of the total accounts receivable balance, respectively. At December 31, 2004, Richardson Electronics, Ltd. and Celestica represented 46% and 10% of total accounts receivable balance, respectively. The Company performs ongoing credit evaluations and maintains an allowance for doubtful accounts based upon the expected collectibility of receivables.

11. STOCKHOLDERS’ EQUITY

On January 28, 2004, the Company completed a secondary underwritten public offering of 2,000,000 shares of common stock at $5.75 per share, resulting in net proceeds of $10.1 million.

In March 2003, the Company’s Board of Directors (the “Board”) authorized the repurchase of up to $2.0 million of the Company’s common stock. In October 2003, the Board approved an additional $2.0 million to expand this existing share repurchase program increasing the total amount authorized to $4.0 million. Purchases under this stock repurchase program were made in the open market, through block trades or otherwise. Depending on market conditions and other factors, these purchases were commenced or suspended at any time or from time-to-time without prior notice. During the year ended December 31, 2003, $2.8 million was utilized to purchase 1,340,719 shares of the Company’s common stock at a weighted average purchase price of $2.08 per share. All of the purchases were made on the Nasdaq National Market at prevailing open market prices using general corporate funds. This stock repurchase program ended as of the annual shareholder meeting on July 22, 2004. On July 27, 2004 the Company announced that its Board of Directors authorized a new repurchase program of up to $2.0 million of the Company’s common stock. This new program was effective July 27, 2004 and replaced all previous repurchase programs. Under this new program, $920,000 was utilized to purchase 429,053 shares of the Company’s common stock at a weighted average purchase price of $2.12 per share. This program expired on July 26, 2005. The repurchases reduced the Company’s cash and interest income during the period and correspondingly reduced the number of the Company’s outstanding shares of common stock.

STOCK OPTION PLANS — During 2000, the Company’s “2000 Stock Incentive Plan” and “2000 Non-Employee Director Stock Compensation Plan” (collectively the “Plans”) were adopted and approved by the Board and the Company’s stockholders. Under the Plans, the Company may grant incentive awards in the form of options to purchase shares of the Company’s common stock, restricted shares, common stock and stock appreciation rights to participants, which include non-employee directors, officers and employees of and consultants to the Company and its affiliates. On May 22, 2002, the Board approved the adoption of an amendment to the Company’s “2000 Stock Incentive Plan” to increase the number of shares of common stock authorized for issuance from 16,500,000 to 19,000,000 shares. This plan amendment did not affect any other terms of the “2000 Stock Incentive Plan.” On May 29, 2003, the Board approved the adoption of an amendment to the Company’s “2000 Non-Employee Director Compensation Plan” to increase the number of shares of common stock authorized for issuance from 570,000 to 800,000, which was approved by the Company’s stockholders on July 15, 2003 at the Company’s Annual Meeting of Stockholders. Also on May 29, 2003, the Board approved the adoption of a second amendment to the Company’s “2000 Stock Incentive Plan” so that options granted to employees under the “2000 Stock Incentive Plan” will qualify as performance-based compensation under Internal Revenue Code Section 162(m) and thereby not be subject to a deduction limitation. Particularly, the amendment to the “2000 Stock Incentive Plan” provides that no employee or prospective employee shall be granted one or more options within any fiscal year which in the aggregate are for the purchase of more than 3,000,000 shares. The total number of shares of common stock authorized for issuance pursuant to the Plans is 19,800,000 shares.

On May 23, 2001, the Company’s 2001 Employee Stock Incentive Plan (the “Plan”) was adopted and approved by the Board and the Company’s stockholders. The Plan may grant incentive awards in the form of options to purchase shares of the Company’s common stock, restricted shares, common stock and stock appreciation rights to participants, which include employees which are not officers and directors of the Company and its affiliates and consultants to the Company and its affiliates. The total number of shares of common stock reserved and available for grant under the Plan is 2,000,000 shares. Shares subject to award under the Plan may be authorized and unissued shares or may be treasury shares. Stock options may include incentive stock options, nonqualified stock options or both, in each case, with or without stock appreciation rights.

The Company’s stock option plans (“Plans”) provide that options granted under the Plans will have a term of no more than 10 years. Options granted under the Plans have vesting periods ranging from two to four years. The provisions of the Plans provide that under certain circumstances, such as a change in control, the achievement of certain performance objectives, or certain liquidity events, the outstanding option may be subject to accelerated vesting. As of October 2, 2005 the number of shares available for future grants under the above plans was 5,603,024. Stock options may include incentive stock options, nonqualified stock options or both, in each case, with or without stock appreciation rights.

12. NET INCOME (LOSS) PER SHARE CALCULATION

Per share amounts are computed based on the weighted average number of basic and diluted (dilutive stock options) common and common equivalent shares outstanding during the respective periods. The net income (loss) per share calculation is as follows (in thousands, except per share amounts):

	Three Months Ended					Nine Months Ended
	Oct. 2,			Sept. 26,		Oct. 2,			Sept. 26,
	2005			2004		2005			2004

Net income (loss)	$	(3,394	)	$	1,212	$	(18,906	)	$	(5,105	)

Denominator for basic net income (loss) per share:
Weighted average shares outstanding	64,875			60,908		63,979			60,195
Less weighted average shares subject to repurchase	(359		)	—		(119		)	—
Weighted average shares outstanding	64,516			60,908		63,860			60,195

Denominator for diluted net income (loss) per share:
Weighted average shares outstanding	64,516			60,908		63,860			60,195
Effect of dilutive stock options	—			5,005		—			—
Diluted weighted average common shares	64,516			65,913		63,860			60,195

Basic income (loss) per share	$	(0.05	)	$	0.02	$	(0.30	)	$	(0.08	)

Diluted income (loss) per share	$	(0.05	)	$	0.02	$	(0.30	)	$	(0.08	)

For the periods ended October 2, 2005, the incremental shares from the assumed exercise of 10,568,167 of the Company’s stock options outstanding and 222,168 shares as of October 2, 2005 related to contributions under the Employee Stock Purchase Plan for pending purchases were excluded from the calculation of diluted earnings per share because operations resulted in a loss and the effect of such assumed conversion would be anti-dilutive. For the three months ended September 26, 2004, the incremental shares from the assumed exercise of 4,738,550 of the Company’s stock options outstanding were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average share price for the quarter, and therefore their inclusion would have been anti-dilutive. The incremental shares from the assumed exercise of 13,708,113 stock options for the nine months ended September 26, 2004 were not included in computing the diluted per share amounts because the effect of such assumed conversion and issuance would be anti-dilutive as the Company recorded a net loss for that period.

13. RESTRUCTURING CHARGES

Fourth Quarter 2002 Restructuring Plan

Over the course of 2002, the Company began to design and manufacture semiconductors utilizing additional manufacturing technologies at external wafer fabrication foundries. The Company believed that this approach was required in order to continue to offer competitive products and expected that a greater number of its future products would be developed in this fashion. The Company at that time believed that this business strategy offered considerable other advantages such as allowing it to focus its resources on product development and marketing, minimizing capital expenditures, reducing operating expenses, allowing it to continue to offer competitive pricing, reducing time to market, reducing technology and product risks and facilitating the migration of the Company’s products to new process technologies, which reduce costs and optimize performance. On December 17, 2002, the Company’s Board of Directors approved a plan to completely outsource the Company’s internal wafer fabrication within one year and close its own wafer fabrication facility (the “fab closure”), which original plan was subsequently modified in 2003 and 2004 as described below.

Lease Loss – The fab closure would have resulted in additional excess space of approximately 35,000 square feet for which the Company would have had a remaining two year commitment after the anticipated fab closure. The original decision resulted in a lease loss of $4.3 million, comprised of future lease payments net of broker commissions and other facility costs. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space in line with the Company’s best estimate of current market conditions.

During the fourth quarter of 2003 the Company decided that additional time would be needed to effect the complete outsourcing of its internal wafer fabrication due to an unplanned increase in near-term product demand and additional qualification procedures associated with outsourced wafer fabrication. The Company planned to continue to operate its fab through April 2004. As such, the additional four months of rent and facility costs would be incurred as an operating expense resulting in an approximate $364,000 reduction in the lease loss accrual.

During the second quarter of 2004, the Company delayed the closure of its internal wafer fabrication facility (“fab”) for a minimum of three additional months to assess the integration of the EiC acquisition (see note 4) into its existing operations which resulted in an approximate $430,000 reduction in its lease loss accrual. During the third quarter of 2004, the Company decided not to close its fab as the Company believed that integrating the newly acquired fab from EiC with its pre-existing fab will offer the Company certain benefits over outsourcing the pre-existing fab. As such, the Company reversed the remainder of this lease loss accrual of $3.6 million in the second quarter of 2004. The Company continues to evaluate the use of outside wafer fabrication facilities and potential benefits from outsourcing where practicable under the circumstances.

Workforce reduction – As a result of the originally planned fab closure, approximately 10% of the Company’s workforce (20 employees) would have been eliminated, which would have resulted in severance payments of $279,000 during 2004. The Company ultimately paid out $194,000 of the accrued severance to terminated employees. The remaining accrual of $85,000 was reversed upon the Company’s decision not to close the fab.

Impairment of Long Lived Assets – Assets to be held and used – The original 2002 decision to utilize the Company’s internal wafer fabrication equipment and related leasehold improvements for only one more year triggered an impairment under SFAS No. 144. Management measured the recoverability of these assets through a comparison of the carrying amount of these assets to future undiscounted cash flows expected to be generated by these assets over their remaining year of life. As such, the carrying value of these assets were written down to the estimated future cash flows that are directly associated with and that were expected to arise as a direct result of the use and eventual disposition of these assets. Management estimated the future cash flows using a traditional present value approach based on management’s assumptions regarding the intended use of these assets consistent with the Company’s budget and projections as well as the planned eventual disposition of the asset group through sale. Management estimated the disposition value of these assets after consideration of several factors including the condition and management’s intended use of the equipment, offers made for similar equipment the Company intended to sell and the results of an independent third party appraisal.

Management employed a risk-free interest rate commensurate with the Company’s size, capital structure and stock volatility in relation to the overall market. This action resulted in a $4.2 million asset impairment charge in 2002.

Third Quarter 2002 Restructuring Plan

As a result of the prolonged downturn in the telecommunications industry and the uncertainty as to when the telecommunications equipment market will recover, in July 2002 the Company announced a workforce reduction and its second restructuring program in the previous two years.

Workforce reduction – Approximately 22% of the Company’s workforce (50 employees) was eliminated, which resulted in severance payments of $507,000 during the third quarter of 2002.

During the first quarter of 2003, it was determined that one of the employees slated to be terminated would instead be retained for another position. As such, $21,000 of the third quarter 2002 restructuring charge was reversed in 2003.

Lease Loss – In the third quarter of 2002, the Company decided to abandon a portion of its leased facility based on revised anticipated demand for its products and current market conditions. This excess space, for which the Company had a remaining eight year commitment, is located on the first floor of the Company’s current corporate headquarters and originally housed a portion of the Company’s optics and integrated assemblies manufacturing operations. This decision resulted in a lease loss of $10.6 million, comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and an asset impairment charge of $3.2 million for tenant improvements deemed no longer realizable. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space and reflected offsetting assumed sublease income in line with the Company’s best estimate of current market conditions.

During the fourth quarter of 2002, based on a continuing deterioration in the real estate market and difficulties subleasing its available space, the Company revised its assumptions regarding sublease occupancy rates and market rates downward resulting in an additional lease loss of $674,000.

During the fourth quarter of 2003, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and facility costs, the Company revised its lease loss assumptions. $23,000 of the lease loss was reversed as reduced facility costs (mainly property taxes and utilities) were largely offset by reductions in estimated sublease occupancy and market rates.

During the third quarter of 2004, after reviewing current information regarding reduced facility operating costs (predominantly building maintenance costs), the Company revised its lease loss assumptions resulting in a reversal of $377,000 of the lease loss.

As of October 2, 2005, the maximum potential amount of the lease loss for this property is $7.5 million which is partially offset by $86,000 of estimated net sublease income.

Impairment of Long Lived Assets:

Assets held for sale – Due to the prolonged downturn in the telecommunications industry, especially related to the Company’s fiber optics products, management made a decision during the third quarter of 2002 to exit the fiber optics business after current contractual obligations have been satisfied. This decision resulted in a significant overcapacity of certain manufacturing equipment and the Company initiated a plan to sell this equipment. The Company’s excess capacity resulted in a total charge of $3.9 million related to these assets. Assets to be held for sale were measured at the lower of carrying amount or fair value less cost to sell. Management determined fair market value after consideration of several factors including the condition of the equipment, offers made by potential buyers of the equipment and the results of an independent third party appraisal. The majority of these impaired assets were sold in the fourth quarter of 2002.

During the fourth quarter of 2003, management determined that the remaining assets held for sale could not be sold. As such, the assets were scrapped resulting in an additional charge of $151,000.

Assets to be held and used – During the third quarter of 2002, management identified manufacturing equipment exclusively supporting certain in-warranty optics and fixed wireless products as well as manufacturing equipment supporting final orders for certain other optics and fixed wireless products and determined that the estimated future undiscounted cash flows did not support the carrying value of these assets. As such, the carrying value of these assets was written down to the estimated future cash flows that are directly associated with and that are expected to arise as a direct result of the use and eventual disposition of these assets, which management determined after consideration of several factors including the condition and management’s intended use of the equipment, offers made for similar equipment the Company intended to sell and the results of an independent third party appraisal. This action resulted in a $200,000 asset impairment charge.

Third Quarter 2001 Restructuring Plan

Lease Loss and Leasehold Impairment – In September 2001, the Company decided to abandon a leased facility based on revised anticipated demand for its products and current market conditions. This excess facility, for which the Company had a ten year commitment, is located adjacent to the Company’s current corporate headquarters and was originally developed to house additional administrative and corporate offices to accommodate planned expansion. This decision resulted in a lease loss of $7.2 million, comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and an asset impairment charge of $2.6 million on tenant improvements deemed no longer realizable. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space and reflected offsetting assumed sublease income in line with the Company’s best estimate of current market conditions.

During the third and fourth quarters of 2002, based on an overall deteriorating real estate market and difficulties subleasing its available space, the Company revised its assumptions regarding sublease occupancy rates and market rates downward resulting in additional lease loss accruals of $4.5 million and $1.8 million, respectively.

During the fourth quarter of 2003, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and facility costs, the Company revised its lease loss assumptions. $203,000 of additional lease loss was accrued as reductions in estimated sublease occupancy and market rates were partially offset by reduced facility costs (mainly property taxes and utilities).

During the third quarter of 2004, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and increasing facility operating costs, the Company revised its lease loss assumptions resulting in $538,000 of additional lease loss.

As of October 2, 2005, the maximum potential amount of the lease loss for this property is $11.8 million which is partially offset by $953,000 of minimum sublease income commitments under noncancellable sublease rental agreements and $571,000 of estimated net sublease income.

The following table summarizes restructuring accrual activity recorded during the years 2001 though October 2, 2005 (in thousands):

	Q3 2001
	Restructuring			Q3 2002 Restructuring Plan									Q4 2002 Restructuring Plan
	Plan			Workforce						Asset			Workforce						Asset
	Lease Loss			Reduction			Lease Loss			Impairment			Reduction			Lease Loss			Impairment			Total

Q3 2001 charge to expense	$	9,797		$	—		$	—		$	—		$	—		$	—		$	—		$	9,797
Non-cash charges (1)	(2,503		)	—			—			—			—			—			—			(2,503		)
Cash payments	(463		)	—			—			—			—			—			—			(463		)
Balance at December 31, 2001	6,831			—			—			—			—			—			—			6,831

Q3 2002 charge to expense	—			507			13,841			4,087			—			—			—			18,435
Q4 2002 charge to expense	—			—			—			—			279			4,285			4,277			8,841
2002 additional charge	6,283			—			674			—			—			—			—			6,957
Non-cash charges (2)	(22		)	—			(2,930		)	(4,087		)	—			—			(4,277		)	(11,316		)
Cash payments	(1,002		)	(437		)	(290		)	—			—			—			—			(1,729		)
Balance at December 31, 2002	12,090			70			11,295			—			279			4,285			—			28,019

2003 additional charge (credit)	203			(21		)	(23		)	151			—			(364		)	—			(54		)
Non-cash charges	—			—			(15		)	(151		)	—			—			—			(166		)
Cash payments	(782		)	(49		)	(1,316		)	—			(26		)	—			—			(2,173		)
Balance at December 31, 2003	11,511			—			9,941			—			253			3,921			—			25,626

2004 additional charge (credit)	538			—			(377		)	—			(85		)	(3,921		)	—			(3,845		)
Non-cash charges	12			—			30			—			—			—			—			42
Cash payments	(1,003		)	—			(1,233		)	—			(168		)	—			—			(2,404		)
Balance at December 31, 2004	11,058			—			8,361			—			—			—			—			19,419

2005 additional charge (credit)	—			—			—			—			—			—			—			—
Non-cash charges	46			—			6			—			—			—			—			52
Cash payments	(1,057		)	—			(954		)	—			—			—			—			(2,011		)
Balance at October 2, 2005	$	10,047		$	—		$	7,413		$	—		$	—		$	—		$	—		$	17,460

(1) Non-cash charges related to the Q3 2001 Restructuring Plan lease loss represents $2.5 million of tenant improvements deemed no longer realizable.

(2) Non-cash charges related to the Q3 2002 Restructuring Plan lease loss represents $3.2 million of tenant improvements deemed no longer realizable net of a $310,000 write-off of accrued deferred rent.

Of the accrued restructuring charge at October 2, 2005, the Company expects $3.4 million of the lease loss to be paid out over the next twelve months. As such, this amount is recorded as a current liability and the remaining $14.1 million to be paid out over the remaining life of the lease of approximately four years is recorded as a long-term liability.

14. BUSINESS SEGMENT REPORTING

In 1997, the Company adopted SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” As an integrated products provider, the Company currently has one reportable segment. The Company’s Chief Operating Decision Maker (“CODM”) is the CEO. While the Company’s CODM monitors the sales of various products, operations are managed and financial performance evaluated based upon the sales and production of multiple products employing common manufacturing and research and development resources; sales and administrative support; and facilities. This allows the Company to leverage its costs in an effort to maximize return. Management believes that any allocation of such shared expenses to various products would be impractical, and currently does not make such allocations internally.

The CODM does, however, monitor sales by products at a more detailed level than those depicted in the Company’s historical general purpose financial statements. Sales by products representing greater than 10% of Company consolidated sales during at least one of the periods presented are as follows (in thousands):

	Three Months Ended				Nine Months Ended
	Oct. 2,		Sept. 26,		Oct. 2,		Sept. 26,
	2005		2004		2005		2004

Semiconductor and RFID	$	8,044	$	8,379	$	19,548	$	22,122
Wireless Integrated Assemblies and Fiber Optics	50		550		343		2,293
Total	$	8,094	$	8,929	$	19,891	$	24,415

The Company believes it is more meaningful in terms of concentration of risk to combine the sales to manufacturing subcontractors with the end customer who ultimately controls product demand. Sales to individual customers representing greater than 10% of Company consolidated sales during at least one of the periods presented (in thousands):

	Three Months Ended				Nine Months Ended
	Oct. 2,		Sept. 26,		Oct. 2,		Sept. 26,
	2005		2004		2005		2004

Richardson Electronics, Ltd (1)	$	4,968	$	4,561	$	8,638	$	12,335
Celestica	777		701		2,781		2,829

(1) Richardson Electronics Ltd. is the sole worldwide distributor of the Company’s complete line of RF semiconductor products.

Sales to unaffiliated customers by geographic area are as follows (in thousands):

	Three Months Ended				Nine Months Ended
	Oct. 2,		Sept. 26,		Oct. 2,		Sept. 26,
	2005		2004		2005		2004

United States	$	5,667	$	6,044	$	11,352	$	16,128
Export sales from United States:
China	1,104		733		3,951		2,297
Republic of Korea	410		43		1,181		564
Europe	355		684		1,089		2,042
Other	558		1,425		2,318		3,384
Total	$	8,094	$	8,929	$	19,891	$	24,415

Long-lived assets located outside of the United States are insignificant.

15. INCOME TAXES

The Company in accordance with SFAS No. 5 “Accounting for Contingencies” has established certain reserves for various federal, state and international income tax exposures. During the quarter ended October 2, 2005, the Company recorded a tax benefit of $123,000 as the statute had expired on certain estimated federal tax exposures during the current quarter. As of October 2, 2005 the balance of the income tax contingency liability is $1.8 million.

During the three months ended September 26, 2004, we recorded an additional tax benefit of $1.1 million resulting from a revision of our estimated tax liability due to our receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns. The tax benefit for the nine months ended September 26, 2004 of $7.7 million also included a tax benefit of $6.5 million resulting from the first quarter 2004 revision of our estimated tax liability based on the audit of the Company’s 1996 through 2000 tax returns.

16. CONTINGENCIES

Environmental Remediation

Our current operations are subject to federal, state and local laws and regulations governing the use, storage, disposal of and exposure to hazardous materials, the release of pollutants into the environment and the remediation of contamination. The Company has an accrued liability of $73,000 as of October 2, 2005 to offset estimated program oversight, remediation actions and record retention costs. In the second quarter of 2005 the accrued liability was reduced by $100,000 when it was determined that the probability of an assessment for a prior violation was remote. Expenditures charged against the provision totaled $2,000 and $9,000 for the nine month periods ended October 2, 2005 and September 26, 2004, respectively and totaled $14,000, $11,000 and $4,000 in 2004, 2003 and 2002, respectively.

The Company continues to be in compliance with the remedial action plans being monitored by various regulatory agencies at its former Palo Alto and Scotts Valley sites. The Company has entered into funded fixed price remediation contracts and obtained cost-overrun and unknown pollution conditions insurance coverage. The Company believes that it is remote that it would incur any liability beyond which it has recorded. The Company does ultimately retain responsibility for these environmental liabilities in the unlikely event that the environmental firm and the insurance company do not meet their obligations.

With respect to our remaining current or former production facilities, to date either no contamination of significance has been identified or reported to us or the regulatory agency involved has granted closure with respect to the identified contamination. Nevertheless, we may face environmental liabilities related to these sites in the future.

Indemnification

As part of the Company’s normal ongoing business operations and consistent with industry practice, the Company enters into numerous agreements with other parties, which apportion future risks among the parties to the transaction or relationship governed by the agreements. One method of apportioning risk is the inclusion of provisions requiring one party to indemnify the other against losses that might otherwise be incurred by the other party in the future. Many of the Company’s agreements contain an indemnity or indemnities that require us to perform certain acts, such as remediation, as a result of the occurrence of a triggering event or condition. The Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in the context of contracts entered into by the Company, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of representations and covenants related to such matters as title to assets sold, certain IP rights, specified environmental matters, and certain income taxes. In each of these circumstances, payment by the Company is conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, which procedures typically allow the Company to challenge the other party’s claims. Further, the Company’s obligations under these agreements may be limited in terms of time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments made by the Company.

The nature of these numerous indemnity obligations are diverse and each has different terms, business purposes, and triggering events or conditions. Consistent with customary business practice, any particular indemnity obligation incurred is the result of a negotiated transaction or contractual relationship for which we have accepted a certain level of risk in return for a financial or other type of benefit. In addition, the indemnities in each agreement vary widely in their definitions of both triggering events and the resulting obligations contingent on those triggering events. It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on the Company’s business, financial condition or results of operations and the Company is unable to estimate the maximum potential impact of these indemnification provisions on its future results of operations.

As permitted under Delaware law, our certificate of incorporation provides that we will indemnify our officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity, to the fullest extent permitted by Delaware law. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has director and officer insurance coverage that reduces its exposure and enables it to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

Other Contingencies

In addition to the above matters, the Company is involved in various legal actions which arose in the ordinary course of its business activities. Management does not currently believe that the final resolution of these matters will ultimately have a material impact on the Company’s results of operations or financial position.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS

Special Notice Regarding Forward-Looking Statements. The following discussion and analysis contains forward-looking statements including financial projections, statements as to the plans and objectives of management for future operations, and statements as to our future economic performance, financial condition or results of operations. These forward-looking statements are not historical facts but rather are based on current expectations, estimates, projections about our industry, our beliefs and our assumptions. Words such as “may,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks” and “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. Our actual results may differ materially from those projected in these forward-looking statements as a result of a number of factors, including, but not limited to, the continuation or worsening of poor economic and market conditions in our industry and in general, technological innovation in the wireless communications markets, the availability and the price of raw materials and components used in our products, the demand for wireless systems and products generally as well as those of our customers and changes in our customer’s product designs. Readers of this report are cautioned not to place undue reliance on these forward-looking statements.

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes and other disclosures included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 30, 2005. Except for historic actual results reported, the following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties. See “Special Notice Regarding Forward-looking Statements” above and the “Risk Factors” section of this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 30, 2005 for a discussion of certain factors that could cause future actual results to differ from those described in the following discussion.

OVERVIEW

We are a radio frequency (“RF”) semiconductor company providing radio frequency product solutions worldwide to communications equipment companies and service providers. We design, develop and manufacture innovative, high performance products for both current and next generation wireless and wireline networks and RF identification systems. Our radio frequency product solutions are comprised of advanced, highly functional RF semiconductors, components and integrated assemblies which address the radio frequency challenges of these various systems. We currently generate the majority of our revenue from our products utilized in wireless and wireline networks. Our revenue from our products used in RF identification systems represents a less significant portion of our current revenue however we believe they represent areas of future growth opportunity. The radio frequency challenge is to create product designs that function within the unique parameters of different wireless system architectures. Our solution is comprised of design expertise, advanced device technology and manufacturability. Our commercial communications products are used by telecommunication and broadband cable equipment manufacturers supporting and facilitating mobile communications, enhanced voice services, data and image transport. Our objective is to be the leading supplier of innovative RF semiconductors products.

We have continued to augment our existing technology base and design capabilities with two recent acquisitions. On January 28, 2005 we completed our acquisition of Telenexus, Inc. (“Telenexus”). We believe the addition of Telenexus’ RFID products and technology will allow us to continue to enhance our RFID reader offerings to further capitalize on market opportunity. On June 18, 2004, we completed our acquisition of the wireless infrastructure business and associated assets from EiC Corporation, a California corporation and EiC Enterprises Limited (together “EiC”). We believe that the addition of EiC’s technical expertise further enhances WJ’s strategy of offering customers what we believe to be industry leading products for the wireless infrastructure market.

WJ Communications, Inc. (formerly Watkins-Johnson Company, “we,” “us,” “our” or the “Company”) was founded in 1957 in Palo Alto, California, and for many years we focused on RF microwave devices for defense electronics and space communications systems. Beginning in the 1990s, we began applying our RF design, semiconductor technology and integration capabilities to address the growing opportunities for commercial communications products. We believe that our track record of designing high quality, reliable products and our long-standing relationships with industry-leading customers are important competitive advantages. We were originally incorporated in California and reincorporated in Delaware in August 2000.

Our principal executive offices are located at 401 River Oaks Parkway, California 95134, and our telephone number at that location is (408) 577-6200. Our Internet address is www.wj.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other Securities and Exchange Commission, or SEC, filings are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. The information contained on our website is not intended to be part of this report. Our common stock is listed on the Nasdaq National Market and traded under the symbol “WJCI”.

Acquisitions

We have completed two acquisitions in connection with the implementation of our business strategy to acquire and develop new and complementary technologies.

On January 28, 2005 we completed our acquisition of Telenexus, Inc. (“Telenexus”). Pursuant to an Agreement and Plan of Merger, dated January 19, 2005, by and between us, WJ Newco, LLC (the “WJ Sub”), Telenexus and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton. Telenexus was merged with and into the WJ Sub effective on January 29, 2005. The WJ Sub was the survivor in the merger and is our wholly-owned subsidiary. Telenexus designs, develops, manufactures and markets radio frequency identification (“RFID”) reader products for a broad range of industries and markets. By virtue of the merger, we purchased through the WJ Sub all of the assets necessary for the conduct of the RFID business of Telenexus, consisting primarily of, and including, but not limited to RFID modules, baseband processing algorithm technology, applications software and realizations of several reader product designs. The consideration we paid on the closing date in connection with the merger consisted of cash in the amount of $3.0 million, which was paid out of our cash reserves on the closing date, and 2,333,333 shares of our common stock valued at $8.2 million at the closing date. Including acquisition costs of $230,000, the aggregate purchase price for the net assets of Telenexus totaled $11.4 million. Of the closing consideration, cash in the amount of $500,000 and 333,333 shares of our common stock are being held in escrow with respect to any indemnification matter under the merger agreement. The outstanding cash balance of the escrow account less any properly noticed unpaid or contested amounts was to be distributed within two days after October 28, 2005. We released the full amount of the cash balance of the escrow account on October 31, 2005. The 333,333 shares in the escrow account less any shares for any properly noticed unpaid or contested amounts will be distributed within five days after July 28, 2006. The fair value of our common stock was determined based on the average closing price per share of our common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (January 31, 2005). In addition to the closing consideration, the sellers may be entitled to further compensation of up to up to $2.5 million in cash and up to 833,333 shares of our common stock if we achieve certain revenue targets by July 28, 2006. Any change in the fair value of the net assets of Telenexus or any additional consideration to the Shareholders will change the amount of the purchase price allocable to goodwill. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”).

On June 18, 2004, we completed our acquisition of the wireless infrastructure business and associated assets from EiC Corporation, a California corporation and EiC Enterprises Limited (together “EiC”). The aggregate purchase price was $13.3 million which included consideration to EiC in the form of payments of cash of $10.0 million and the issuance of 737,000 shares of our common stock valued at $2.5 million, as well as acquisition related costs we incurred of $1.2 million and $152,000 of estimated registration statement related expenses reduced by a $576,000 benefit from the termination settlement of the associated supply agreement with EiC recognized during our quarter ended December 31, 2004. In connection with the acquisition, $1.5 million in cash and 294,118 shares of common stock have been held in escrow as security against certain financial contingencies. On March 30, 2005, we made a claim against the escrow

account for unpaid invoices issued under the supply agreement. We received those funds on May 4, 2005. The uncontested amount was released to EiC on April 5, 2005 per the escrow agreement and the residual balance of the $1.5 million was released to EiC on May 4, 2005. The 294,118 shares in the escrow account less any shares for any properly noticed unpaid or contested amounts will be distributed within five days after March 31, 2006. On November 23, 2004 we filed a registration statement registering for resale by the seller of up to 442,882 shares of our common stock issued in the acquisition.

In addition to the closing consideration, EiC was originally entitled to further consideration of up to $7.0 million and $7.0 million in cash and shares of our common stock if certain revenue and gross margin targets were achieved by March 31, 2005 and March 31, 2006, respectively. We have determined that the revenue and gross margin targets were not met for the nine month period ending March 31, 2005. EiC subsequently notified us that it disagrees with our conclusion that the revenue and gross margin targets were not met for the nine month period ending March 31, 2005. While we believe EiC’s assertions are without merit and has notified EiC of such, there can be no assurances as to the eventual outcome of this matter.

If we achieve certain revenue targets by March 31, 2006, we will be obligated to pay EiC the remaining contingent consideration of up to $7.0 million, ninety percent (90%) in our common stock and ten percent (10%) in cash. The number of shares of our common stock to be delivered is to be determined by dividing the value in dollars of the portion payable in our common stock by the average closing price of our common stock, as quoted on the NASDAQ National Market, during the ten consecutive trading days ending one trading day before the end of the period covered by the payment, provided, however, that in the event that the calculation of the average closing price results in a price per share for the first payment that would be less than $5.00 or for the second payment that would be less than $6.00, then we, at our option, in our sole discretion, may elect to make the payment part or all in cash and the balance, if any, in shares of our common stock. If EiC receives such consideration, the amounts will be recorded as an increase to goodwill. The fair value of our common stock was determined based on the average closing price per share of our common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (June 21, 2004). The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”).

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a continuous basis, we evaluate all our significant estimates including those related to doubtful accounts receivable, inventory valuation, impairment of long-lived assets, income taxes, restructuring including accruals for abandoned lease properties, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstance, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and such differences could be material.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Business Combinations

We allocate the purchase price of acquired companies to the tangible and intangible assets acquired and in-process research and development based on their estimated fair values. Such valuations require management to make significant estimations and assumptions, especially with respect to intangible assets.

Critical estimates in valuing certain intangible assets include but are not limited to: future expected cash flows from acquired developed technologies and patents, expected costs to develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed, customer contracts, customer

lists, distribution agreements, also the brand awareness and the market position of the acquired products and assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” This SAB requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees.

Effective for our second quarter ended July 3, 2005, we changed the application of our revenue recognition policy regarding our distributors. We had previously recognized revenue upon shipment to our distributors less estimated reserves for distributor right of return, authorized price reductions for specific end-customer sales opportunities and price protection based on known events and historical trends. Effective for our second quarter ended July 3, 2005, we recognize revenue from our distribution channels when our distributors have sold the product to the end customer. Historically, we have received stock rotation requests from our distributors that were within the amounts estimated and contractually allowed with only one exception of an insignificant amount. However, the most recent request for stock rotation during our second quarter ended July 3, 2005 was higher than the amount contractually allowed. Our management, with the concurrence of our Audit Committee, believes the increasing percentage of new products introduced by us makes it likely that stock rotation reserves will continue to be difficult to estimate based on historical patterns and contractual provisions. Based on this change in facts and circumstances and our management’s future expectations, we believe that we can no longer reasonably estimate the amount of future returns from our distributors as of July 3, 2005. Accordingly, recognition of revenue and associated cost of sales on shipments to distributors is deferred until the resale to the end customer. This change in application resulted in a $4.1 million revenue deferral in our second quarter of 2005. Although revenue is deferred until resale, title of products sold to distributors transfers upon shipment. Accordingly, shipments to distributors are reflected in the consolidated balance sheets as accounts receivable and a reduction of inventories at the time of shipment. Deferred revenue and the corresponding cost of sales on shipments to distributors are reflected in the consolidated balance sheet on a net basis as “Deferred margin on distributor inventory.” For further discussion, see note 3 to the unaudited condensed consolidated financial statements included elsewhere in the Form 10-Q.

Through the quarter ended April 3, 2005, revenues from our distributors were recognized upon shipment based on the following factors: our sales price is fixed or determinable by contract at the time of shipment, payment terms are fixed at shipment and are consistent with terms granted to other customers, the distributor has full risk of physical loss, the distributor has separate economic substance, we have no obligation with respect to the resale of the distributor’s inventory, and we believed we could reasonably estimate the potential returns from our distributor based on their history and our visibility in the distributor’s success with its products and into the market place in general. In accordance with Financial Accounting Standards Board (“FASB”) Statement No. 48 “Revenue Recognition When Right of Return Exists”, we accrued a reserve based on our reasonable estimate of future returns based on historical trends and contractual limitations. Per contractual agreement, the distributor may return product three times per year under the following conditions: the total value of inventory returned shall not exceed an amount equal to 5% of the total value of the distributor’s stock on hand of our products as reported in the prior month’s inventory report, the inventory is returned no earlier than 6 months and no later than 24 months from the date of the original invoice date and the product’s packaging has not been opened or any alteration or modification has been performed on the part. As of September 26, 2004, our distributor stock rotation reserve was $226,000. As of December 31, 2004, 2003 and 2002, our distributor stock rotation reserve was $338,000, $196,000 and $247,000, respectively.

Beginning in September 2003, we entered into a program where the distributor would receive a credit if it sold specific product at a reduced price to specific end-customers pre-authorized by us. We maintain a log of all such pre-authorized price reductions which we accrue as a reduction to revenue in the period that the pre-authorization occurs per issue 4 of EITF 01-9 “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” As of October 2, 2005 and September 26, 2004, our Ship & Debit Allowance was $19,000 and $21,000, respectively. As of December 31, 2004, 2003 and 2002, our Ship & Debit Allowance was $5,000, $29,000 and $0, respectively.

If we reduce the prices of our products as negotiated with the distributor, the distributor may receive a credit for the difference between the price paid by the distributor and the reduced price on applicable unsold products remaining in the distributor’s inventory on the effective date of the price reduction assuming that inventory is less than 24 months old as determined by the original invoice date. When we recognized revenue upon shipment to our distributors, we reserved for distributor price protection per issue 4 of EITF 01-9 based on specific identification of our initiated price reductions and the associated reported distributor inventory. There were no such price reductions during the three months ended April 3, 2005 and in 2004, 2003 or 2002.

We may enter into contracts to perform research and development for others meeting the requirements of Statement of Financial Accounting Standards No. 68 “Research and Development Arrangements”. Revenue under development agreements is recognized when applicable contractual non-refundable milestones have been met, including deliverables, and in any case, does not exceed the amount that would be recognized using the percentage-of-completion method in accordance with Accounting Research Bulletin 45 “Long-Term Construction Type Contracts” using the relevant guidance in the American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Given the duration and nature of these development contracts, we believe that recognizing revenue under the percentage completion method best represents the legal and economic results of contract performance on a timely basis. The costs associated with development agreements are included in cost of goods sold. The achievement of contractual milestones is evidenced by written documentation provided by the customer in accordance with the applicable terms and conditions of each contract. In any period, progress on the contract is based on input measures (direct labor dollars, direct material costs and direct outside processing costs) in the ratio of costs incurred to total estimated costs. Estimated costs to complete are provided by engineering personnel directly involved in the development program and are reviewed by management and finance personnel for reasonableness given the known facts and circumstances. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. If different conditions were to prevail such that accurate estimates could not be made, then the use of the completed contract method would be required and the recognition of all revenue and costs would be deferred until the project was completed. Such a change could have a material impact on our results of operations. If we bill the customer prior to performing services under the development agreement, the amounts are recorded as deferred revenue. We recorded revenue of $64,000 and $692,000 under development agreements in the three and nine months ended October 2, 2005, respectively. We have no deferred revenue at October 2, 2005. No comparable amounts were included in the periods ended September 26, 2004.

Write-down of Excess and Obsolete Inventory

We write down our inventory for estimated obsolete or unmarketable inventory for the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Management specifically identifies obsolete products and analyzes historical usage, forecasted production generally based on a rolling eighteen month demand forecast, current economic trends and historical write-offs when evaluating the valuation of our inventory. Due to rapidly changing customer forecasts and orders, additional write-downs of excess or obsolete inventory, while not currently expected, could be required in the future. In addition, the sale of previously written down inventory could result from significant unforeseen increases in customer demand.

Valuation of Intangible Assets and Goodwill

We periodically evaluate our intangible assets and goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Intangible assets include goodwill and purchased technology. Factors we consider important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, or significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset over its remaining useful life is made. If this evaluation indicates that the intangible asset is not recoverable, the net carrying value of the related

intangible asset will be reduced to fair value, and the remaining amortization period may be adjusted. Any such impairment charge could be significant and could have a material adverse effect on our reported financial statements if and when an impairment charge is recorded. If an impairment charge is recognized, the amortization related to intangible assets would decrease during the remainder of the fiscal year.

Income Taxes

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5 “Accounting for Contingencies” we have established reserves for income tax contingencies. These reserves relate to various tax years subject to audit by tax authorities including our tax filings for 1996 to 2000. The reserves represent our best estimate of the probable amount for our liability of income taxes. The actual liability could differ significantly from the amount of the reserve, which could have a material effect on our results of operations. The tax benefit for the year ended December 31, 2004 of $7.7 million resulted primarily from a revision of our estimated income tax contingency liability due to our receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns.

In addition, as part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves us estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet.

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

Restructuring

During fiscal 2002 and 2001, we recorded significant restructuring charges representing the direct costs of exiting certain product lines or businesses and the costs of downsizing our business. Such charges were established in accordance with Emerging Issues Task Force Issue 94-3 (“EITF 94-3”) “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” and Staff Accounting Bulletin No. 100, “Restructuring and Impairment Charges.” These charges include abandoned leased properties comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and asset impairment charges on tenant improvements deemed no longer realizable. In determining these estimates, we make certain assumptions with regards to our ability to sublease the space and reflect offsetting assumed sublease income in line with our best estimate of current market conditions. Should there be a further significant change in market conditions, the ultimate losses on these could be higher and such amount could be material. During 2002, we recorded restructuring charges of $27.9 million related to restructuring activities initiated in 2002 and also recorded additional charges of $6.3 million related to restructuring activities initiated in 2001, primarily due to changes in estimated sublease income. During 2003, we revised our lease loss accrual downward for an estimated four months of additional operation of our wafer fab and reduced facility costs at our other two abandoned facilities. This reversal was largely offset by an additional lease loss accrual for reductions in estimated sublease occupancy and market rates. During 2004, we recorded a reversal of $4.0 million related to our assessment and decision to not close our internal wafer fabrication facility (“fab”) as we believed at the time that integrating the newly acquired fab from EiC with our pre-existing fab offered the Company certain benefits over outsourcing the pre-existing fab. As such, we reversed $3.9 million of our lease loss accrual and $85,000 of our severance accrual. This credit was partially offset by an additional $161,000 lease loss accrual as we revised our lease loss assumptions for our facilities based on reductions in sublease occupancy rates and a net increase in facility operating costs. We continue to evaluate the use of outside wafer fabrication facilities and potential benefits from outsourcing where practicable under the circumstances.

The leased property abandonments have resulted in an average per year benefit of $3.1 million in reduced lease expense and $677,000 in reduced amortization of leasehold improvements which will continue through 2010. The leased property abandonments had no effect on our future cash flows. The collective asset impairments have resulted in an average per year benefit of $2.6 million in reduced depreciation expense of manufacturing equipment which will continue over the next three years ending in 2007. The equipment deemed excess in 2002 was ultimately sold for $1.8 million. Otherwise, the asset impairments had no effect on our future cash flows. The workforce reductions have resulted in reduced wages and benefits of $2.7 million per year with a corresponding reduction in cash flows. In total the restructuring plans have benefited our results of operations on average as follows since 2002: $5.7 million reduction in cost of goods sold, $1.1 million reduction in research and development expense and $2.4 million reduction in selling and administrative expense. Except for changes in the sublease estimates noted above, actual results to date have been consistent, in all material respects, with our assumptions at the time of the restructuring charge.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Factors we consider that could trigger an impairment review include the following: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of our use of the acquired assets or the strategy for our overall business; significant negative industry or economic trends; or significant technological changes, which would render equipment and manufacturing processes obsolete. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of these assets to future undiscounted cash flows expected to be generated by these assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected cash flows and should different conditions prevail, material write downs of our long-lived assets could occur.

CURRENT OPERATIONS

For The Periods Ended October 2, 2005 Compared to September 26, 2004

Sales – We recognized $8.1 million and $8.9 million in sales for the three months ended and $19.9 million and $24.4 million in sales for the nine months ended October 2, 2005 and September 26, 2004, respectively. For the respective three month periods, total sales decreased 9% due primarily to the decrease in sales from our wireless integrated assemby and fiber optic products while sales of our semiconductor and RFID products remained relatively unchanged. The decrease in total sales, as well as the decrease in our semiconductor sales, for the respective nine month periods primarily reflects a change in the application of our revenue recognition policy from revenue recognition upon shipment to our distributors to revenue recognition when our distributors have sold the product to the end customer. Our management, with the concurrence of our Audit Committee, believes the increasing percentage of new products introduced by us makes it likely that stock rotation reserves will continue to be difficult to estimate based on historical patterns and contractual provisions as evidenced by the most recent request for stock rotation during our second quarter ended July 3, 2005 which was higher than the amount contractually allowed and previously estimated. Based on this change in facts and circumstances and our management’s future expectations, we believe that we can no longer reasonably estimate the amount of future returns from our distributors as of July 3, 2005. Accordingly, recognition of revenue and associated cost of sales on shipments to distributors is deferred until the resale to the end customer. This change in application resulted in a $4.1 million revenue deferral in our second quarter of 2005 which is reflected in the nine months ended October 2, 2005. For further discussion, see note 3 to the unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q. These decreases were mitigated by our expanded RFID product offering due to our acquisition of Telenexus (representing $95,000 and $1.1 million of our sales in the three and nine months ended October 2, 2005) and our increasing sales in Asia (particularly China, which increased 51% and 72% in the comparable three and nine month periods and Korea, which increased 854% and 109% in the comparable three and nine month periods). Over the comparable nine month periods, we have experienced only an approximate 1% decrease in the average selling price of our semiconductor products due to competitive pressure as newer products with a higher average selling price are becoming a greater percentage of our product mix. The three and nine month periods ended September 26, 2004 included $550,000 and $2.3 million of revenue from our wireless integrated assemby and fiber optic products. As these products have reached the end of their product life cycle, they only represented $50,000 and $343,000 of our sales in the three and nine months ended October 2, 2005.

Cost of Goods Sold – Our cost of goods sold for the three months ended October 2, 2005 was $3.8 million, a decrease of $762,000 or 17% as compared with cost of goods sold of $4.5 million in the three months ended September 26, 2004. For the nine months ended October 2, 2005 our cost of goods sold was $11.0 million equaling the cost of goods sold of $11.0 million in the nine months ended September 26, 2004. During the three months and nine months ended October 2, 2005, cost of goods sold were 47% and 55% as a percentage of sales which compares to 51% and 45% in the corresponding prior year periods. The decrease in our cost of goods sold as a percentage of sales for the comparable three month periods primarily reflects direct cost reductions in the product line we acquired from EiC Corporation we achieved after additional experience as well as direct cost reductions in our PCMCIA Type II RFID Read Card product line due to increased volume production. The increase in our cost of goods sold as a percentage of sales for the comparable nine month periods primarily reflects the decrease in sales in the same periods due to the change in application of our revenue recognition policy regarding sales to our distributors resulting in a $4.1 million revenue deferral in our second quarter of 2005 relative to the unabsorbed fixed overhead costs related to underutilization of our existing wafer fabrication facility.

We continue to experience unabsorbed overhead costs related to underutilization of our existing wafer fabrication facility. While prior restructuring programs have mitigated some of our unabsorbed overhead through the write down of excess facilities and equipment, we will still have fixed manufacturing costs that these efforts will not impact until we can further reduce excess capacity. We typically generate a lower gross margin on new product introductions which we expect to be a higher percentage of our sales mix going forward. Over time, we typically become more efficient relative to new products through learning and increased volumes as well as through improved yields. New product lines also contain a greater degree of inventory risk due to uncertainty regarding a lack of visibility and predictability of customer demand and potential competition.

Research and Development – Our research and development expense for the three months ended October 2, 2005 was $4.5 million, an increase of $97,000 or 2% as compared with research and development expense of $4.4 million in the three months ended September 26, 2004. For the nine months ended October 2, 2005 our research and development expense was $13.6 million, an increase of $1.0 million or 8% as compared with research and development expense of $12.6 million over the same period last year. The increase in absolute dollars in the three months ended October 2, 2005 is primarily related to the increased engineering staff and new product development related to the products we acquired from Telenexus which was partially offset by a decrease in overall overhead. The increase in absolute dollars in the nine months ended October 2, 2005 is primarily related to the increased engineering staff and new product development efforts related to the products and processes we acquired from EiC, the increased engineering staff and new product development related to the products we acquired from Telenexus and increased spending on design consulting services which was partially offset by a decrease in overall overhead. During the three months and nine months ended October 2, 2005, research and development expenses were 55% and 68% as a percentage of sales which compares to 49% and 52% in the corresponding prior year periods. As a percentage of sales, the increase in research and development expense in both comparable periods in 2005 reflects the factors noted above as well as the decrease in sales in the same relative periods. Product research and development is essential to our future success and we expect to continue to make investments in new product development and engineering talent. For the remainder of 2005 we will focus our research efforts and resources on RF semiconductor development which target multiple growth markets such as RFID while expanding our addressable market opportunities in wireless communications and broadband cable. We will also explore process capabilities of third party foundries and develop products under new process technologies such as SiGe BiCMOS.

Selling and Administrative – Selling and administrative expense for the three months ended October 2, 2005 was $3.6 million or 45% of sales, an increase of $109,000 or 3% as compared with selling and administrative expense of $3.5 million or 39% of sales in the three months ended September 26, 2004. For the nine months ended October 2, 2005 selling and administrative expenses were $11.6 million or 59% of sales, an increase of $2.3 million or 25% as compared with selling and administrative expense of $9.3 million or 38% of sales in the nine months ended September 26, 2004. The increase in absolute dollars during the three month period is primarily related to a $380,000 charge related to severance, $231,000 increase in legal fees resulting from additional corporate governance requirements and a $190,000 increase related to the acquired administrative operations of Telenexus. These increased costs were partially offset by a $117,000 decrease in salaries and wages. The increase in absolute dollars during the nine month period is primarily related to a $1.2 million charge for a former CEO separation agreement, a $547,000 increase related to the acquired administrative operations of Telenexus, $445,000 of professional fees related to a potential strategic business combination which we decided not to consummate, a $392,000 increase in accounting and legal fees resulting from additional corporate governance requirements, $380,000 charge related to severance, and a $285,000 increase in external sales representatives commission due to the increase in semiconductor sales over the prior year’s period. These increased costs were partially offset by a $267,000 decrease in bonus expense, a $127,000 decrease in insurance premiums, a $100,000 reduction in the accrued liability for environmental remediation when it was determined that the probability of an assessment for a prior violation was remote and the recovery of $75,000 of previously reserved accounts receivable as compared to an additional reserve of $63,000 for receivables whose collection was determined to be doubtful recorded during the nine months ended September 26, 2004. The three and nine month periods ending September 26, 2004 included severance of $594,000 due to a stock compensation charge resulting from the modification of two option agreements (extension of the option exercise period). As a percentage of sales, the increase in selling and administrative expense in both comparable periods in 2005 reflects the factors noted above as well as the decrease in sales in the same relative periods.

Acquired In-process Research and Development Expenses – During the first quarter of 2005, $3.4 million of the purchase price for the acquisition of Telenexus, Inc. was allocated to acquired in-process research and development expense (“IPRD”). Projects that qualify as in-process research and development represent those that have not yet reached technological feasibility and have no future alternative use. Technological feasibility is defined as being equivalent to a beta-phase working prototype in which there is minimal remaining risk relating to the development. The value assigned to

IPRD charge comprises the following projects: multi-protocol readers ($1.3 million), Smart readers ($900,000) and Class 3 readers ($1.2 million). As of October 2, 2005, the estimated aggregate cost to complete these projects was $486,000, $1.2 million and $857,000, respectively which is expected to occur during our fourth quarter of 2005 through our fourth quarter of 2006. The value of these projects was determined by estimating the discounted net cash flows from the sale of the products resulting from the completion of the projects, reduced by the portion of the revenue attributable to developed technology and the percentage of completion of the project. Actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisition. The assumptions consist primarily of expected completion dates for the IPRD projects, estimated costs to complete the projects, and revenue and expense projections for the products once they have entered the market. Our assumptions for the multi-protocol reader project at the time of the acquisition include an estimated completion date of the project in 2006 at a cost of approximately $938,000, estimated future revenue of $23.4 million over an estimated product life cycle of 7 years, and the following average financial metrics over the life of the product: gross margin of 40% during the first two years increasing to 55% by year five and remaining constant throughout the remainder of the estimation periods, average operating expenses of 19% and a 41% tax rate. Our assumptions for the Smart reader project at the time of the acquisition include an estimated completion date of the project in 2006 at a cost of approximately $1.3 million, estimated future revenue of $31.3 million over an estimated product life cycle of 10 years, and the following average financial metrics over the life of the product: gross margin of 40% during the first two years increasing to 55% by year five and remaining constant throughout the remainder of the estimation periods, average operating expenses of 19% and a 41% tax rate. Our assumptions for the Class 3 reader project at the time of the acquisition include an estimated completion date of the project in 2006 at a cost of approximately $857,000, estimated future revenue of $21.6 million over an estimated product life cycle of 8 years, and the following average financial metrics over the life of the product: gross margin of 40% during the first two years increasing to 55% by year five and remaining constant throughout the remainder of the estimation periods, average operating expenses of 17% and a 41% tax rate. A discount rate of 25% was employed to determine the discounted net cash flow for all projects.

During the second quarter of 2004, $8.5 million of the purchase price for the acquisition of the wireless infrastructure business and associated assets from EiC was allocated to acquired in-process research and development expense (“IPRD”). Projects that qualify as in-process research and development represent those that have not yet reached technological feasibility and have no future alternative use. Technological feasibility is defined as being equivalent to a beta-phase working prototype in which there is no remaining risk relating to the development. The IPRD charge related to the EiC acquisition which was made up of two projects: 12V heterojunction bipolar transistor (“HBT”) power amplifiers and 28V HBT high power amplifiers which had an assigned value of $1.5 million and $7.5 million, respectively. As of December 31, 2004, we have completed both the 12V and 28V HBT high power amplifier process development projects. The value of these projects was determined by estimating the discounted net cash flows from the sale of the products resulting from the completion of the projects, reduced by the portion of the revenue attributable to developed technology and the percentage of completion of the project. Actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisition. The assumptions consist primarily of expected completion dates for the IPRD projects, estimated costs to complete the projects, and revenue and expense projections for the products once they have entered the market. Our assumptions for the 12V HBT project at the time of the acquisition include an estimated completion date of the project in early 2005 at a cost of approximately $223,000, estimated future revenue of $17.5 million over an estimated product life cycle of 7.5 years, and the following average financial metrics over the life of the product: gross margin of 50%, operating expenses of 23% and a 40% tax rate. A discount rate of 25% was employed to determine the discounted net cash flow. Our assumptions for the 28V HBT project at the time of the acquisition include an estimated completion date of the project in early 2005 at a cost of approximately $160,000, estimated future revenue of $189.6 million over an estimated product life cycle of 16.5 years, and the following average financial metrics over the life of the product: gross margin of 50%, operating expenses of 23% and a 40% tax rate. A discount rate of 25% was employed to determine the discounted net cash flow.

The nature of the efforts to develop the acquired in-process research and development into commercially viable products principally relates to the completion of all prototyping and testing activities that are necessary to establish that the product can meet its design specification including function, features and technical performance requirements. Therefore, the amount allocated to in-process research and development has been charged to operations.

Restructuring reversals – For the three months ended September 26, 2004 we recorded a credit of $3.4 million related to our decision to not close our internal wafer fabrication facility (“fab”) as we believed that integrating the newly acquired

fab from EiC with our pre-existing fab offered the Company certain benefits over outsourcing the pre-existing fab. As such, we reversed approximately $3.5 million of our lease loss accrual and $85,000 of our severance accrual which was recorded in the three months and nine months ended September 26, 2004. Also during the quarter ended September 26, 2004, we revised our lease loss assumptions for our facilities based on reductions in sublease occupancy rates and current facility costs. As such we accrued approximately $161,000 of additional lease loss which was recorded in the three and nine months ended September 26, 2004. During the three months ended June 27, 2004 we delayed the closure of our internal wafer fabrication facility for a minimum of three months to assess the integration of the acquisition into our existing operations which resulted in an approximate $430,000 reduction in our lease loss accrual which is recorded in the nine months ended September 26, 2004. For further discussion, see note 13 to the unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.

Interest Income – Interest income primarily represents interest earned on cash equivalents and short-term available-for-sale investments. Our interest income in the three months ended October 2, 2005 was $272,000, an increase of $105,000 or 63% as compared with interest income of $167,000 in the three months ended September 26, 2004. For the nine months ended October 2, 2005 our interest income was $773,000, an increase of $287,000 or 59% as compared with interest income of $486,000 in the nine months ended September 26, 2004. This relative dollar increase in both comparative periods resulted from an increase in interest rates offsetting a decrease in average funds available for investment.

Interest Expense – Our interest expense for the three months ended October 2, 2005 was $29,000, an increase of $9,000 or 45% as compared with interest expense of $20,000 for the three months ended September 26, 2004. For the nine months ended October 2, 2005 our interest expense was $77,000, a slight increase of $5,000 as compared with interest expense of $72,000 for the nine months ended September 26, 2004. Interest expense for all periods relates to maintenance fees associated with our revolving credit facility and outstanding letters of credit.

Income Tax Benefit – During the quarter ended October 2, 2005, we recorded a tax benefit of $123,000 as the statute had expired on certain estimated federal tax exposures during the current quarter. During the three months ended September 26, 2004, we recorded an additional tax benefit of $1.1 million resulting from a revision of our estimated tax liability due to our receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns. The tax benefit for the nine months ended September 26, 2004 of $7.7 million also included a tax benefit of $6.5 million resulting from the first quarter 2004 revision of our estimated tax liability based on the audit of the Company’s 1996 through 2000 tax returns. Beginning in 2002, it was determined that it was not more likely than not that any additional deferred tax assets would be realized through the application of carryforward claims.

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and short-term investments at October 2, 2005 totaled $32.8 million, a decrease of $10.3 million or 24% compared to the balance of $43.1 million at December 31, 2004.

In December of 2000, we entered into a revolving credit facility (“Revolving Facility”) with a bank, the terms of which were amended and restated in September 2005. Under the new terms, the Revolving Facility provides for a maximum credit extension of $20.0 million with a $15.0 million sub-limit to support letters of credit and matures on November 22, 2005. Interest rates on outstanding borrowings are periodically adjusted based on certain financial ratios and are initially set, at our option, at LIBOR plus 1.0% or Prime minus 0.5%. The Revolving Facility requires us to maintain certain financial ratios and contains limitations on, among other things, our ability to incur indebtedness, pay dividends and make acquisitions without the bank’s permission. The Revolving Facility is secured by substantially all of our assets. We were in compliance with the covenants as of October 2, 2005. As of October 2, 2005 and December 31, 2004, there were no outstanding borrowings under the Revolving Facility. The Company has letters of credit of $3.2 million available as of October 2, 2005 against which no amounts have been drawn. There are fees associated with maintaining our revolving credit facility and outstanding letters of credit we are required to pay our lenders even if we do not borrow.

Net Cash Used in Operating Activities – Net cash used in operations was $8.0 million and $8.9 million in the nine months ended October 2, 2005 and September 26, 2004, respectively. Net loss in the nine months ended October 2, 2005 and September 26, 2004 was $18.9 million and $5.1 million, respectively.

The most significant cash item impacting the difference between net loss and cash flows used in operations in the first nine months of 2005 was $482,000 provided by working capital. The $482,000 provided by working capital primarily relates to a $1.6 million decrease in receivables and a $864,000 decrease in other assets which were partially offset by a $2.0 million decrease in restructuring liabilities. Our receivables decreased $1.6 million as our shipments during the first nine months of 2005 were more evenly distributed throughout the period, allowing for increased collections within the period. The $864,000 decrease in other assets resulted from the collection of a $576,000 contract termination settlement and the collection of $489,000 interest receivable (primarily purchased interest) related to our investment in marketable securities and short-term available-for-sale investments which were partially offset by a $269,000 increase in pre-paid expenses. The $2.0 million decrease in restructuring liabilities primarily relates to payments against the remaining lease loss accrual. Non-cash items included in net loss in the nine months ended October 2, 2005 included $2.3 million of depreciation and amortization, $3.4 million of IPRD related to our acquisition of Telenexus, Inc. and $3.7 million related to an increase in our deferred margin on distributor inventory due to our change in the application of our revenue recognition policy from revenue recognition upon shipment to our distributors to revenue recognition when our distributors have sold the product to the end customer during our second quarter ending July 3, 2005. For further discussion, see note 3 to the unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.

The most significant cash item impacting the difference between net loss and cash flows used in operations in the first nine months of 2004 was $4.1 million used in working capital. The $4.1 million used in working capital primarily relates to a $1.2 million increase in receivables, a $1.7 million decrease in restructuring liabilities, and a decrease of $436,000 in income taxes payable. Our receivables increased $1.2 million due to increased shipments during the third quarter of 2004. The $1.6 million decrease in restructuring liabilities primarily relates to payments against the remaining lease loss accrual. The decrease of $436,000 in income taxes payable relates to payments resulting from an audit of our 1996 through 2000 returns. Non-cash items included in net loss in the nine months ended September 26, 2004 included $2.1 million of depreciation and amortization, $8.5 million of IPRD related to our acquisition of the wireless infrastructure business and associated assets from EiC and $7.7 million related to a decrease in our income tax liability. The $7.7 million decrease in our income tax liability resulted from a revised estimate related to the audit of our 1996 through 2000 tax returns.

Net Cash Provided by Investing Activities – Net cash provided by investing activities was $2.4 million and $15.0 million in the nine months ended October 2, 2005 and September 26, 2004, respectively. In the first nine months of 2005, we realized $33.6 million in proceeds from the sale and maturities of our short-term investments which was partially offset by $27.9 million used to purchase short-term investments and $3.2 million to acquire Telenexus, Inc. including associated acquisition costs. In the first nine months of 2004, we realized $72.2 million in proceeds from the sale and maturities of our short-term investments which was partially offset by $45.7 million used to purchase short-term investments and $11.2 million to acquire the wireless infrastructure business and associated assets from EiC including associated acquisition costs. During 2005, we expect to invest approximately $1.0 million to $2.0 million in capital expenditures of which $473,000 was purchased in the first nine months. We have funded our capital expenditures from cash, cash equivalents and short-term investments and expect to continue to do so throughout 2005.

In conjunction with our recent acquisitions, we may be required to pay further compensation in the EiC acquisition of up to $7.0 million in cash (10%) and shares (90%) if specific revenue targets are achieved by March 31, 2006 and in the Telenexus acquisition, of up to $2.5 million in cash and up to 833,333 shares if certain revenue targets are achieved by July 28, 2006. We expect to fund these payments, if earned, from our cash, cash equivalents and short-term investments, cash flows and borrowings to the extent available.

Net Cash Provided by Financing Activities – Net cash provided by financing activities totaled $862,000 and $10.5 million in the nine months ended October 2, 2005 and September 26, 2004, respectively. In the first nine months of 2005, we received net proceeds of approximately $1.1 million from the sale of our common stock to employees through our employee stock purchase and option plans which was partially offset by $214,000 used to repurchase our common stock from our former CEO to cover the income tax withholding on his purchase of 328,500 shares of restricted stock. In the first nine months of 2004, we received net proceeds of $10.2 million related to our secondary public offering of 2.0 million newly issued shares of our common stock and $712,000 from the sale of our common stock to employees through our employee stock purchase and option plans which was partially offset by $267,000 of cash used to repurchase our common stock under our stock repurchase program.

Based on our current plans and business conditions, we believe that our existing cash, cash equivalents and short-term investments together with available borrowings under our line of credit will be sufficient to meet our liquidity and capital spending requirements for at least the next twelve months. Thereafter, we will utilize our cash, cash flows and borrowings to the extent available and, if desirable or necessary, we may seek to raise additional capital through the sale of debt or equity. There can be no assurances, however, that future borrowings and capital resources will be available on favorable terms or at all. Our cash flows are highly dependent on demand for our products, timing of orders and shipments with key customers and our ability to manage our working capital, especially inventory and accounts receivable, as well as controlling our production and operating costs in line with our revenue.

Contractual Obligations

Our contractual obligations and the effect those obligations are expected to have on our liquidity and cash flows are set forth in “Management’s Discussion and Analysis of Results of Operations and Financial Condition” of our annual report on Form 10-K for the year ended December 31, 2004. There have been no material changes to the disclosures therein in the nine months ended October 2, 2005.

Off-Balance Sheet Arrangements

We do not have any special purpose entities or off-balance sheet financing arrangements except for certain operating leases discussed in note 11 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2004.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates. We do not use derivative financial instruments for speculative or trading purposes.

Cash, Cash Equivalents and Investments — Cash and cash equivalents consist of money market funds and commercial paper acquired with remaining maturity periods of 90 days or less and are stated at cost plus accrued interest which approximates market value. Short-term investments consist primarily of high-grade debt securities (A rating or better) with maturity greater than 90 days from the date of acquisition and are classified as available-for-sale. Short-term investments classified as available-for-sale are reported at fair market value with unrealized gains or losses excluded from earnings and reported as a separate component of stockholders’ equity, net of tax, until realized. These available-for-sale securities are subject to interest rate risk and will rise or fall in value if market interest rates change. They are also subject to short-term market risk. We have the ability to hold our fixed income investments until maturity, and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.

The following table provides information about our investment portfolio and constitutes a “forward-looking statement.” For investment securities, the table presents principal cash flows and related weighted average interest rates by expected maturity dates.

			Weighted
	Expected Maturity		Average Interest
Expected Maturity Dates	Amounts		Rate
	(in thousands)
Cash equivalents:
2005	$	18,130	3.46	%
Short-term investments:
2005	3,969		3.67	%
2006	9,207		3.79	%
Fair value at October 2, 2005	$	13,176

Item 4. CONTROLS AND PROCEDURES

Attached as exhibits 31.1 and 31.2 to this Form 10-Q are certifications of WJ Communication’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We conducted an evaluation (the “Evaluation”), under the supervision and with the participation of our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (“Disclosure Controls”) as of the end of the period covered by this report pursuant to Rule 13a-15 of the Exchange Act. Based on this Evaluation, our CEO and CFO concluded that our Disclosure Controls were effective as of the end of the period covered by this report.

Changes in Internal Controls

We have evaluated our internal control over financial reporting (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act), and there have been no changes in our internal control over financial reporting during the most recent fiscal quarter, that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

RISK FACTORS

You should carefully consider the risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 30, 2005 and described herein below before making an investment decision in our securities. Set forth below are the specific risk factors which have been updated to reflect material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2004. The forward-looking statements in this Quarterly Report on Form 10-Q involve risks and uncertainties and actual results may differ materially from the results we discuss in the forward-looking statements. If any of the risks we have described in the “Risk Factors” section and elsewhere in our SEC filings actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our stock could decline, and you may lose all or part of your investment. The most significant risks and uncertainties known to us that we believe make an investment in our stock speculative or risky are set forth in this section. This section does not include those risks and uncertainties that could apply to any issuer or any offering.

We have a history of losses, we may incur future losses, and if we are unable to achieve profitability our business will suffer and our stock price may decline.

We have not recorded operating income since 1999, our operating losses have been increasing and we may not be able to achieve revenue or earnings growth or obtain sufficient revenue to sustain profitability. In the nine months ended October 2, 2005 our sales were $19.9 million and we incurred an operating loss of $19.7 million compared to sales of $24.4 million and an operating loss of $13.2 million for the nine months ended September 26, 2004. In addition, our sales for the year ended December 31, 2004 were $32.3 million compared to $26.6 million for 2003. We incurred an operating loss of $17.3 million for the year ended December 31, 2004 compared to $16.7 million for 2003.

We expect that current reduced end-customer demand will, and other factors could, continue to adversely affect our operating results in the near term and we anticipate incurring additional losses in the future. Other factors could include, but are not limited to:

• production overcapacity in the industry which could cause us to have to reduce the price of our products adversely affecting our sales and margins;

• rescheduling, reduction or cancellation of significant customer orders which could cause us to lose sales that we had anticipated;

• any loss of a key customer;

• the ability of our customers to manage their inventories which if not properly managed could cause our customers to reschedule, reduce or cancel significant orders or return our products; and

• political and economic instability in, foreign conflicts involving or the impact of regional and global infectious illnesses (such as outbreaks of SARS and bird flu) of our vendors, manufacturers, subcontractors and customers particularly in the countries of China, South Korea, Malaysia and the Philippines.

We may incur losses for the foreseeable future, particularly if our revenues do not increase substantially or if our expenses increase faster than our revenues. In order to return to profitability, we must achieve substantial revenue growth and we currently face an environment of uncertain demand in the markets our products address.

We depend on Richardson Electronics, Ltd. for distribution of our RF semiconductor products and the loss of this relationship could materially reduce our sales.

Richardson Electronics, Ltd. is the sole worldwide distributor of our complete line of RF semiconductor products. This sole distributor is our largest semiconductor customer and our sales to Richardson Electronics, Ltd. represent 48% and 56% of our semiconductor sales (43% and 50% of total sales) for the nine months ended October 2, 2005 and September 26, 2004, respectively. In the nine months ended October 2, 2005 our revenue from Richardson Electronics was adversely effected by a change in the application of our revenue recognition policy from revenue recognition upon shipment to revenue recognition

when our distributors have sold the product to the end customer. This change in application resulted in a $4.0 million revenue deferral in our second quarter of 2005. For further discussion, see note 3 to the unaudited condensed consolidated financial statements included elsewhere in the Form 10-Q. We cannot assure you that this exclusive relationship will improve sales of our semiconductor products or that it is the most effective method of distribution. If this sole distributor fails to successfully market and sell our products, our semiconductor sales could materially decline. Our agreement with this distributor does not require it to purchase our products and is terminable at any time. If this distribution relationship is discontinued, our RF semiconductor sales could materially decline.

We depend upon a small number of customers that account for a high percentage of our sales and the loss of, or a reduction in orders from, a significant customer could result in a reduction of sales.

We depend on a small number of customers for a majority of our sales. We currently have two customers, Richardson Electronics, Ltd. and Celestica, which each accounted for more than 10% of our sales and in aggregate accounted for 57% of our sales for the nine months ended October 2, 2005. We had two customers, Richardson Electronics and Celestica, which each accounted for more than 10% of our sales and in aggregate accounted for 62% of our sales for the nine months ended September 26, 2004. Sales to Richardson Electronics accounted for 43% and 50% of our sales for the nine months ended October 2, 2005 and September 26, 2004, respectively. Sales to Celestica accounted for 14% and 12% of our sales for the nine months ended October 2, 2005 and September 26, 2004, respectively.

In the nine months ended October 2, 2005 our revenue from Richardson Electronics was adversely effected by a change in the application of our revenue recognition policy from revenue recognition upon shipment to revenue recognition when our distributors have sold the product to the end customer. This change in application resulted in a $4.0 million revenue deferral in our second quarter of 2005. For further discussion, see note 3 to the unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q. The increase in our sales to Celestica over the relative nine month periods is related to an increasing business practice of original equipment manufacturers to outsource a greater percentage of their manufacturing.

In addition, most of our sales result from purchase orders or from contracts that can be cancelled on short-term notice. Moreover, it is possible that our customers may develop their own products internally or purchase products from our competitors. Also, events that impact our customers, for example wireless carrier consolidation, can adversely affect our sales. We expect that our key customers will continue to account for a substantial portion of our revenue in 2005. The loss of or a reduction in orders from a significant customer for any reason could cause our sales to decrease.

Third party intellectual property claims could harm our business.

We occasionally receive communications from third parties alleging infringement of patent and other intellectual property rights. While we are not subject to any current claims that we believe could be material, there can be no assurance that material claims will not arise in the future. While all of our revenue is derived from products containing our proprietary intellectual property, approximately 6% and 3% of our revenue for the nine month periods ended October 2, 2005 and September 26, 2004, respectively and approximately 5% of our 2004 revenue is derived from newly developed technologies which could be particularly vulnerable to infringement claims. We intend to vigorously protect our proprietary intellectual property rights with respect to all of our products. However, we cannot assure you that claims can be amicably disposed of, and it is possible that litigation could ensue. Litigation could result in substantial costs to us and diversion of our resources. If we fail to obtain a necessary license or if we do not prevail in patent or other intellectual property litigation, we could be required to discontinue selling the affected products, to seek to develop non-infringing technologies, which may not be feasible, and to pay monetary damages, any of which could harm our business.

If we or our outsourced manufacturers fail to accurately forecast component and material requirements, we could incur additional costs or experience product delays.

We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary products and/or components and materials. Lead times for components and materials that we, or our outsourced manufacturers, order can vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. To the extent that we rely on outsourced manufacturers, many of these factors will be outside of our direct managerial control. For substantial increases in production levels, our outsourced manufacturers and some suppliers may need six months or more lead time. As a result, we may be required to make financial commitments in the form of purchase commitments. We lack visibility into the finished goods inventories of our customers and the end-users. This lack of visibility impacts our ability to accurately forecast our requirements. If we overestimate our component, material and outsourced manufactured requirements, we may have excess inventory, which would increase our costs. An additional risk for potential excess inventory results from our volume purchase commitments with certain material suppliers, which can only be reduced in certain circumstances. Additionally, if we underestimate our component, material, and outsourced manufactured requirements, we may have inadequate inventory, which could interrupt and delay delivery of our products to our customers. Any of these occurrences would negatively impact our sales and profitability. We have incurred, and may in the future incur, charges related to excess and obsolete inventory. These charges amounted to $334,000 and $685,000 in the nine month periods ended October 2, 2005 and September 26, 2004, respectively and $670,000, $251,000 and $212,000 for the years ended December 31, 2004, 2003 and 2002, respectively. While these charges may be partially offset by subsequent sales of previously written-down inventory, there can be no assurance that any such sales will be significant. As we broaden our product lines we must outsource the manufacturing of or purchase a wider variety of components. In addition, new product lines contain a greater degree of uncertainty due to a lack of visibility of customer acceptance and potential competition. Both of these factors will contribute a higher level of inventory risk in our near future.

We depend on outsourced manufacturers and on single or limited source suppliers for some of the key components and materials in our products, which makes us susceptible to shortages or price fluctuations that could adversely affect our operating results.

We typically purchase our components and materials through purchase orders, and we have no guaranteed supply arrangements with any of our suppliers. We currently purchase several key components and materials used in our products from single or limited source suppliers. These products amounted to 11% and 3% of our revenue for the nine month periods ended October 2, 2005 and September 26, 2004, respectively and 5%, 5% and 2% of our revenue for the years ended December 31, 2004, 2003 and 2002, respectively. Although we do not currently have any suppliers that are material to our business, in the event one of our sole source suppliers or outsourced manufacturers are unable to deliver us products or unwilling to sell us components or materials, it could harm our business. It could take us as long as 6 to 12 months to replace our single or limited source suppliers and there can be no assurance that we would be successful. Additionally, we or our outsourced manufacturers may fail to obtain required products and components in a timely manner in the future. We may also experience difficulty identifying alternative sources of supply for the components used in our products or products we obtain through outsourcing. We would experience delays if we were required to test and evaluate products of potential alternative suppliers or products we obtain through outsourcing. Furthermore, financial or other difficulties faced by our outsourced manufacturers, or suppliers or significant changes in demand for the components or materials they use in the products and/or supply to us could limit the availability of those products, components or materials to us. Thus far we have not experienced any material delays related to such suppliers, but we cannot assure you that this will continue to be the situation. To the extent that our dependence on outsourcing continues to increase in the future, our corresponding risks will be greater.

We rely on the significant experience and specialized expertise of our senior management in our industry and must retain and attract qualified engineers and other highly skilled personnel in a highly competitive job environment to maintain and grow our business.

Our performance is substantially dependent on the continued services and on the performance of our senior management and our highly qualified team of engineers, who have many years of experience and specialized expertise in our business.

We have recently undergone changes in our senior management. Our performance also depends on our ability to retain and motivate our other executive officers and key employees. The loss of the services of any of our executive officers or of a number of our engineers could harm our ability to maintain and build our business. We have no “key man” life insurance policies.

Our future success also depends on our ability to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, marketing and customer service personnel. If we fail to attract, integrate and retain the necessary personnel, our ability to maintain and build our business could suffer significantly. Additionally, California State law can create unique difficulties for a California based company attempting to enforce covenants not to compete with employees which could be a factor in our future ability to retain key management and employees in a competitive environment.

There are inherent risks associated with sales to our foreign customers.

We sell a significant portion of our product to customers outside of the United States. Sales to customers outside of the United States accounted for approximately 43% and 34% of our sales in the nine month periods ended October 2, 2005 and September 26, 2004, respectively and approximately 35%, 32% and 34% of our sales in the years ended December 31, 2004, 2003 and 2002, respectively. We expect that sales to customers outside of the United States will continue to account for a significant portion of our sales. Although all of our foreign sales are denominated in U.S. dollars, such sales are subject to certain risks, including, among others, changes in regulatory requirements, the imposition of tariffs and other trade barriers, the existence of political, legal and economic instability in foreign markets, language and cultural barriers, seasonal reductions in business activities, our ability to receive timely payment and collect our accounts receivable, currency fluctuations, and potentially adverse tax consequences, which could adversely affect our business and financial results.

If our common stock ceases to be listed for trading on the NASDAQ National Market, it may harm our stock price and make it more difficult for you to sell your shares.

Our common stock is listed on the NASDAQ National Market and their marketplace rules for continued listing require, among other things, that the bid price for our common stock not fall below $1.00 per share for a period of 30 consecutive trading days. In late October 2005 the bid price for our common stock was below $1.00 per share for five consecutive trading days and as recently as April, 2003 the bid price for our common stock was below $1.00 per share for thirty consecutive trading days. Although we have been able to regain compliance in the past, because of the volatility in our common stock price, there can be no assurance that we will be able to maintain compliance in the future. While there are steps that we may be able to take to address this situation in the future, including a reverse stock split or share repurchase, we cannot assure you that our stock will maintain such minimum bid price requirement or that we will be able to meet or maintain all of the NASDAQ National Market continued listing requirements in the future. If, in the future, our minimum bid price is again below $1.00 for 30 consecutive trading days, under the current NASDAQ National Market rules we will have a period of 180 days to attain compliance by meeting the minimum bid price requirement for 10 consecutive days during the compliance period.

If our common stock ceases to be listed for trading on the NASDAQ National Market for failure to meet the minimum bid price requirement, we expect that our common stock would be traded on the NASD’s Over-the-Counter Bulletin Board (OTC-BB) unless NASDAQ grants an additional grace period for transfer to the NASDAQ Capital Market (formerly known as the NASDAQ SmallCap Market), which also has a similar $1.00 minimum bid requirement. In addition, our stock could then potentially be subject to the Securities and Exchange Commission’s “penny stock” rules, which place additional disclosure requirements on broker-dealers. These additional disclosure requirements may harm your ability to sell your shares if it causes a decline in the ability or willingness of broker-dealers to sell our common stock. We also expect that the level of trading activity of our common stock would decline if it is no longer listed on the NASDAQ National Market or NASDAQ Capital Market. As such, if our common stock ceases to be listed for trading on the NASDAQ National Market or NASDAQ Capital Market for any reason, it may harm our stock price, increase the volatility of our stock price and make it more difficult for you to sell your shares of our common stock.

PART II — OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

We are currently involved in litigation and regulatory proceedings incidental to the conduct of our business and expect that we will be involved in other litigation and regulatory proceedings from time to time. While we believe that any adverse outcome of such pending matters will not materially affect our business or financial condition, there can be no assurance that this will be the case.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At our Annual Meeting of Stockholders held on July 20, 2005 our stockholders:

(a) Elected each of the following eight nominees as directors, each to serve for a one-year term and to hold office until their successors are duly elected and qualified. The vote for each director was as follows:

Nominee	For	Withheld
W. Dexter Paine, III	55,597,928	3,448,072
Liane J. Pelletier	56,994,034	2,051,966
Bruce W. Diamond	56,996,334	2,049,666
Dag F. Wittusen	58,797,621	248,379
Jack G. Levin	58,795,665	250,335
Michael E. Holmstrom	58,797,721	248,279
Catherine P. Lego	58,030,030	1,015,970
Jan Loeber	58,798,965	247,035

Michael R. Farese, Ph.D. was originally a nominee for director but resigned his positions as Chief Executive Officer and President and declined to stand for re-election prior to the Annual Meeting of Stockholders. We currently have a vacancy on the Board of Directors.

(b) Ratified the appointment of Deloitte & Touche, LLP as the Company’s independent auditors for the fiscal year 2005 by the votes indicated:

For		Against		Abstain
59,010,128		18,695		17,177

Item 5. OTHER INFORMATION

Not applicable.

Item 6. EXHIBITS

(a) Exhibits

The exhibits listed on the following index to exhibits are filed as part of this Form 10-Q.

Incorporated by Reference

Exhibit

Filing

Filed

Number

Exhibit Description

Form

File No

Exhibit

Date

Herewith

10.1

Employment offer letter, dated as of July 18, 2005, by and between the Company and Mark S. Knoch.

8-K

000-31337

10.1

8/4/05

31.1

Certification of Bruce W. Diamond, Chief Executive Officer (principal executive officer), pursuant to Rule 13a-14/15d-14(a) of the Securities Exchange Act of 1934.

31.2

Certification of Rainer N. Growitz, Chief Financial Officer (principal financial officer), pursuant to Rule 13a-14/15d-14(a) of the Securities Exchange Act of 1934.

32.1

Certification of Bruce W. Diamond, Principal Executive Officer, Pursuant To 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of Rainer N. Growitz, Principal Financial Officer, Pursuant To 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California, on the 10th day of November 2005.

		WJ COMMUNICATIONS, INC.
		(Registrant)


Date	November 10, 2005	By:	/s/ BRUCE W. DIAMOND
			Bruce W. Diamond
			President and Chief Executive Officer
			(principal executive officer)


Date	November 10, 2005	By:	/s/ RAINER N. GROWITZ
			Rainer N. Growitz
			Interim Chief Financial Officer
			Vice President of Finance and Corporate Secretary
			(principal financial officer)