**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

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| **x**                                                 |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES** |
|-------------------------------------------------------|--------|--------------------------------------------------------------------------------|
| ** **                                            |   | **EXCHANGE ACT OF 1934**                                                       |
| **For the  fiscal year ended December 31, 2006** |
| **OR**                                                |
| **o**                                                 |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE**        |
| ** **                                            |   | **SECURITIES EXCHANGE ACT OF 1934**                                            |

 

**For the transition periodfrom                   to**

**Commissionfile number 000-31337**

**WJ COMMUNICATIONS, INC.**

(Exact name of registrantas 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 telephonenumber, including area code)

Securitiesregistered pursuant to Section 12(b) of the Act:

| **Title  of Each Class**       |   | **Name of Each Exchange on which Registered** |
|--------------------------------|--------|-----------------------------------------------|
| Common Stock,  $0.01 par value |   | NASDAQ Global  Market                         |

 

Securities registeredpursuant to Section 12(g) of the Act:  None

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.   Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.   Yes o   No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.   Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of the Form 10-Kor any amendment to the Form 10-K. o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

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

As of July 2, 2006,the last business day of the registrant’s most recently completed second fiscalquarter, the aggregate market value of voting stock held by non-affiliates ofthe registrant was approximately $45,662,172 (based upon the $1.53 closingprice of the common stock as reported by the NASDAQ Global Market on July 3,2006). Shares of the registrant’s common stock held by each officer anddirector and each person known to the registrant to own 10% or more of theoutstanding voting power of the registrant have been excluded in that suchpersons may be deemed to be affiliates. This determination of affiliate statusis not a determination for other purposes.

As of March 15, 2007there were 68,354,373 shares outstanding of the registrant’s common stock,$0.01 par value.

DOCUMENTSINCORPORATED BY REFERENCE: The information required by Items 10, 11, 12,13 and 14 of Part III of this Report is incorporated by reference to theregistrant’s Form 10-K/A which will be filed no later than 120 daysafter the registrant’s fiscal year ended December 31, 2006.

 

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SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, theshareholders’ annual report, press releases and certain information providedperiodically in writing or orally by the Company’s officers, directors oragents contain certain forward-looking statements within the meaning of thefederal securities laws that also involve substantial uncertainties and risks.These forward-looking statements are not historical facts but rather are basedon current expectations, estimates and projections about our industry, ourbeliefs and our assumptions. Words such as “may,” “anticipates,” “expects,” “intends,”“plans,” “believes,” “seeks” and “estimates” and variations of these words andsimilar expressions, are intended to identify forward-looking statements. Thesestatements are not guarantees of future performance and are subject to risks,uncertainties and other factors, some of which are beyond our control, aredifficult to predict and could cause actual results to differ materially fromthose expressed, implied or forecasted in the forward-looking statements. Inaddition, the forward-looking events discussed in this annual report might notoccur. These risks and uncertainties include, among others, those described inthe section of this report entitled “Risk Factors.”  Readers should alsocarefully review the risk factors described in the other documents that we filefrom time to time with the Securities and Exchange Commission. We assume noobligation to update or revise the forward-looking statements or risks anduncertainties to reflect events or circumstances after the date of this reportor to reflect the occurrence of unanticipated events.

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**WJCOMMUNICATIONS, INC.**

**FORM 10-KANNUAL REPORT**

**FOR THEFISCAL YEAR ENDED DECEMBER 31, 2006**

**TABLEOF CONTENTS**

|           | ** ** | ** **                                                                                                         | ** ** | **Page** | ** ** |
|-----------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|      |       | **PART I**                                                                                                    |       |     |       |   |   |
| Item 1.   |       | Business                                                                                                           |       |     | 4          |   |   |
| Item  1a. |       | Risk  Factors                                                                                                      |       |     | 16         |   |   |
| Item 1b.  |       | Unresolved Staff Comments                                                                                          |       |     | 31         |   |   |
| Item 2.   |       | Properties                                                                                                         |       |     | 31         |   |   |
| Item  3.  |       | Legal  Proceedings                                                                                                 |       |     | 32         |   |   |
| Item 4.   |       | Submission of Matters to a Vote of Security Holders                                                                |       |     | 32         |   |   |   |
|      |       | **PART II**                                                                                                   |       |     |       |   |   |   |
| Item 5.   |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 33         |   |   |   |
| Item 6.   |       | Selected Consolidated Financial Data                                                                               |       |     | 36         |   |   |   |
| Item 7.   |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |     | 38         |   |   |   |
| Item 7a.  |       | Quantitative and Qualitative Disclosure About Market  Risks                                                        |       |     | 55         |   |   |   |
| Item 8.   |       | Consolidated Financial Statements and Supplementary  Data                                                          |       |     | 56         |   |   |   |
| Item 9.   |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       |     | 98         |   |   |   |
| Item 9a.  |       | Controls and Procedures                                                                                            |       |     | 98         |   |   |   |
| Item  9b. |       | Other  Information                                                                                                 |       |     | 99         |   |   |   |
|      |       | **PART III**                                                                                                  |       |     |       |   |   |   |
| Item 10.  |       | Directors, Executive Officers and Corporate Governance                                                             |       |     | 99         |   |   |   |
| Item 11.  |       | Executive Compensation                                                                                             |       |     | 99         |   |   |   |
| Item 12.  |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters     |       |     | 99         |   |   |   |
| Item 13.  |       | Certain Relationships and Related Transactions, and  Director Independence                                         |       |     | 99         |   |   |   |
| Item 14.  |       | Principal Accountant Fees and Services                                                                             |       |     | 99         |   |   |   |
|      |       | **PART IV**                                                                                                   |       |     |       |   |   |   |
| Item 15.  |       | Exhibits and Financial Statement Schedules                                                                         |       |     | 100        |   |   |   |
|      |       | Signatures                                                                                                         |       |     | 104        |   |   |   |
|           |            |                                                                                                                    |            |          |            |  |  |  |  |  |

 

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**PART I**

**Item 1. BUSINESS**

**Overview**

We are a radio frequency (“RF”) semiconductor companyproviding RF product solutions worldwide to communications equipment companies.We design, develop and manufacture innovative, high performance products forboth current and next generation wireless and cable networks, and RFidentification (“RFID”) systems. Our RF product solutions are comprised ofadvanced, highly functional RF semiconductors and components which address theradio frequency challenges of these various systems. We currently generate themajority of our revenue from our products utilized in wireless networks.Revenue from our products used in RF identification systems represents a lesssignificant portion of our current revenue however we believe they representone of our future growth opportunities. The RF challenge is to create productdesigns that function within the unique parameters of different networkarchitectures. Our solution is comprised of design expertise, advanced devicetechnology and the manufacturability of our solution. Our communicationsproducts are used by telecommunication equipment manufacturers supporting andfacilitating mobile communications, enhanced voice services, data and imagetransport. Our objective is to be the leading supplier of innovative RFsemiconductors products.

During the fourth quarter of 2006, we announced ourdecision to cease internal wafer manufacturing in early 2007 and to adopt thefabless semiconductor business model. The fabless semiconductor model is morecost effective than having our own facility due to our limited volume and thecost of developing and supporting our process technologies. There is a viablecommercial wafer foundry market which we plan to access for the production ofour wafers and we may enter into limited process development activities withsome of these vendors to further optimize processes and our products.

In 2004 and 2005 we augmented our technology base anddesign capabilities with two acquisitions. On January 28, 2005 wecompleted our acquisition of Telenexus, Inc. (“Telenexus”). We believe theaddition of Telenexus’ RFID products and technology have enhanced our RFIDreader offerings enabling us to further capitalize on the market opportunity.On June 18, 2004, we completed our acquisition of the wirelessinfrastructure business and associated assets from EiC Corporation, aCalifornia corporation and EiC Enterprises Limited (together “EiC”). We believethat the addition of EiC’s technical expertise further enhances WJ’s strategyof offering customers what we believe to be industry leading products for thewireless infrastructure market.

WJ Communications, Inc. (formerly Watkins JohnsonCompany, “we”, “us”, “our” or the “Company”) was formed after arecapitalization merger with Fox Paine on January 31, 2000. We wereoriginally incorporated in California and reincorporated in Delaware in August 2000.

Our principal executiveoffices are located at 401 River Oaks Parkway, San Jose, California 95134, andour telephone number at that location is (408) 577-6200. OurInternet address is*www.wj.com.*Ourannual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, amendments to those reports and otherSecurities and Exchange Commission, or SEC, filings are available free ofcharge through our website as soon as reasonably practicable after such reportsare electronically filed with, or furnished to, the SEC. The informationcontained on our website is not intended to be part of this report. Our commonstock is listed on the Nasdaq Global Market and traded under the symbol “WJCI”.

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**Industry Background**

Industry  overview

We believe severalimportant trends provide long-term growth opportunities for RF technology inmarkets such as wireless communications and RFID. Market trends that drive thegrowth in demand for high-performance RF products include:

·       *Growth in the number of wireless subscribers and an increase inconsumer demand for advanced data services*. The worldwide wirelesscommunications industry has grown considerably in recent years and continues togrow. At the same time, mobile subscribers are increasingly demanding data andvideo services in addition to traditional voice services. To meet this demand,network operators are building new and upgrading existing mobile networks tooffer greater network capacity and speed to deliver voice, data and videoservices. These next generation wireless networks require new equipment basedon more advanced RF technology.

·       *Potentialbroad deployment of RFID technology*. RFID offers the potential forincreased sales, productivity gains and operational cost savings because itenables real-time knowledge of unique product data than can be delivered byconventional technology, such as real time inventory levels, product type, dateof manufacture, serial number and expiration date. The technology has beensuccessfully used or is in various stages of deployment such as automated tolltag applications, Exxon Mobil’s SpeedpassTM, Wal-Mart’s announced storedeployment and a Department of Defense logistics initiative. We are targetingthe ultra high frequency (“UHF”) reader segment of that market.

*NetworkInfrastructure*

Consumers and businesses are continually seeking improvedconnectivity, mobility, functionality, reliability and bandwidth from voice anddata networks. Increased deployment and use of wireless communications systemsand the rise of cable and wireless Internet applications have also placedadditional demands on network infrastructure.

Wireless communications providers continue to makeinvestments in network infrastructure to expand capacity and offer a broaderrange of services to support the changing needs of end users while reducingtheir operating costs. In addition, wireless network operators and serviceproviders have announced their plans for deployment and are deploying theirnext generation wireless services and networks, referred to in the industry as2.5G and 3G networks. Sprint has announced its commitment to a futuredeployment of another next generation 4G network technology utilizing WiMax(Worldwide Interoperability for Microwave Access) technology and there are anumber of WiMax network trials being conducted on a worldwide basis. These networkswill offer subscribers increased speeds, additional application capabilities,and broader compatible coverage across geographies. To meet these objectives,network operators are building new and upgrading existing mobile networks tooffer greater network capacity and speed to deliver voice and data services.These next generation wireless networks require new equipment based on moreadvanced RF semiconductor technology.

Original equipment manufacturers (“OEMs”) must developsystems to meet the requirements of communications service providers. Inmeeting these requirements, OEMs face significant market and productperformance pressures including lower cost, higher performance, greaterreliability and shorter time to market. OEMs are adopting new approaches indesigning systems to deliver the performance and feature improvements thatservice providers require. In a typical communications system, the principalfunctional blocks are the RF subsystem, which receives, amplifies and transmitssignals, the signal processor, which encodes and decodes digitized signals, andthe antenna. Since the RF subsystem receives the signal, interfaces with thesignal processor, and amplifies and transmits the signal, a system’s 

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performance and signalquality are significantly affected by the RF subsystem. Some OEMs do not havethe internal resources to address every aspect of a system’s RF performance. Tolower their production costs and shorten product development cycles, OEMs areseeking innovative RF components from third-party suppliers. We believe thatthere is a substantial market opportunity for a third-party supplier of highperformance RF components who can meet the needs for flexibility, performanceand value required by OEMs.

RF components aregenerally technically sensitive devices that demand circuit design expertiseand sophisticated process technology. RF components are tightly coupled to aprocess technology to achieve their performance. Although there are multiple RFprocess technologies available to a designer, either through foundries or thesuppliers’ internal wafer fabrication facilities, the complexity of adopting anew technology to the end component performance has resulted in companiesfocusing their efforts in selected product areas which has allowed multiplesuppliers to target different segments of the markets.

*Radio FrequencyIdentification (RFID)*

Radio frequency identification, or RFID, is a genericterm for technologies that use radio waves to automatically identify individualitems. In general, the system consists of an RFID tag, which contains theidentification of the item tagged, and an RFID reader, which sends out a radiosignal to read the information contained on the tag. The RFID tag is made up ofa microchip with an antenna, and it can be either passive or active. PassiveRFID tags contain no internal power source such as a battery. To read a passiveRFID tag, the reader sends out electromagnetic waves. Passive RFID tags drawpower from these electromagnetic waves and use it to power the microchip’scircuits. The microchip modulates the waves that the tag reflects back to thereader and the reader converts the returned waves into digital data. Thedigital data is then passed on to a host computer that can make use of thedata. Active RFID tags operate more or less in the same manner except that thetags have a battery; this internal power supply in the tag allows for activeresponse to the reader as well as active data manipulation on the tag.

Profitable and effective commercial RFID systems havebeen in operation for over a decade. The current market is driven bytraditional applications such as security/access control, automobileimmobilization, toll collection, and transportation. Many other applicationsare in the early adoption phase, including pallet tracking, point of salecommerce and baggage handling. There are notable obstacles to overcome beforesignificant growth can be seen, including but not limited to, acceptableindustry and application standards, cost, end user education, frequencyregulations, power restrictions, indirect channel support and the highlyfragmented competitive environment.

Going forward, the supplychain will begin to drive the RFID market. For example, Wal-Mart Stores Inc.(NYSE: WMT), and the United States Department of Defense mandates for theirrespective suppliers to deliver product RFID tagged at the case and palletlevel is expected to help spur the industry to move beyond experimentation toimplementation. The next level in the supply chain will be item level taggingleading to the need for a high volume of shelf readers so that real timeinventory tracking and shrinkage reduction can be put into place. In our view,the natural evolution for RFID will be into cell phones and other portabledevices for point of sale applications.

**The RF Challenge**

Radio frequency (“RF”) semiconductor technologypresents different engineering challenges than standard semiconductor design.In general, digital semiconductors are created from standard semiconductorcircuit designs that have predictable performance. This permits an automateddesign process. Each RF component, however, has distinctly differentcharacteristics that influence overall system performance in complex ways.Instead of having stable inputs and outputs, the RF circuit characteristics candrift based on process variations, temperature, power supply and othervariables. As a result, 

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performancecharacteristics are unique for each device, and the RF engineer must evaluateand develop new designs on a continuous basis for each system performance leveland air interface standard. In addition to being skilled in semiconductorcircuit design, the RF circuit designer must have a thorough understanding ofsignal processing principles, must understand the totality of the system forwhich the device is intended and must be able to create designs that functionwithin the unique parameters of different wireless system architectures.

The knowledge and skillsrequired to design and manufacture RF semiconductors, components and integratedmodules are unique and can take many years to develop. Manufacturers seekcompanies with the technical skills and engineering resources to design,manufacture and integrate RF semiconductors and the other advanced productsrequired by current and future generations of wireless and cable communicationsequipment.

**The WJCommunications Solution**

With the ability to design and manufacture RFsemiconductors, components, integrated RF modules and interface theseassemblies with other network elements, we enable both current and nextgeneration wireless networks and RFID systems worldwide. Our core technologylies within our advanced RF semiconductor designs.

Our RF expertise covers a broad range of frequenciesused in advanced communications networks today. Our capabilities are comprisedof the following key elements:

·       *RF Design Expertise.* We have been designing RF and microwaveproducts for more than 45 years and have developed significant RF designexpertise. Our team of highly qualified and talented engineering and technicalemployees is capable of applying this expertise to a variety of RF products.These products are optimized to achieve high performance with minimum cost.

·       *Advanced Device Technology.* We have substantial expertise indesigning and manufacturing highly linear semiconductor products that amplifyand transform signals with minimal distortion and interference.

·       *Manufacturability.* Our ability to rapidly convert newtechnologies and designs into completed RF semiconductors, integrated modulesand highly functional components products results from our design, advanceddevice technology and our manufacturing engineering expertise.

**Business Strategy**

Our objective is tobe the leading supplier of innovative RF semiconductor products. To meet thisgoal, we intend to:

·       *Leverage Our Technology Leadership and Our Design and IntegrationExpertise to Grow with Growing Markets.* We intend to target multiplegrowth markets such as power amplifiers, WiMAX and RFID to expand ouraddressable market opportunities. We believe that as data throughputrequirements expand in wireless networks, the ability to meet the RFrequirements becomes increasingly important and the market for RF products willgrow accordingly. We intend to apply our RF design expertise to developadditional leading-edge products in each of the rapidly growing areas of thecommunications markets, focusing on the markets for RF semiconductors, modulesand components. Due to the commonality of RF requirements in RFID and wirelesscommunications networks, we have the flexibility to allocate our design andengineering resources to any or all of these markets and intend to use thisflexibility to take advantage of market opportunities as they arise.

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·       *Maintain and Develop Strong Collaborative Customer Relationships withIndustry Leaders.* We believe our reputation for product quality,technical performance, customer responsiveness, on-time delivery and costcompetitiveness will help us to continue to maintain and develop a loyalcustomer base. We collaborate with many of our customers to design and developnew products for them as they develop new products. We plan to maintain ourcurrent, and develop new, customer relationships with industry leaders withinthe wireless and cable communications and RFID markets.

·       *Acquire and Develop New Technologies.* We intend to continueto augment our existing technology base and design capabilities by acquiringcomplementary technologies, design capabilities, manufacturing processes andproduct offerings for advanced RF solutions. In addition, we intend to continueto focus our research and development efforts on emerging communications and RFtechnologies.

**Products andTechnology**

We are committed to being a leader and innovator of RFproducts and believe that we are positioned to provide a broad portfolio of RFtechnology products. Our RF products are comprised primarily of semiconductorsincluding amplifiers, mixers, RF integrated circuits, transistors, chipsets andmulti-chip modules (“MCMs”), and RFID readers and reader modules. Our MCMsintegrate multiple RF semiconductors, process technologies and functions in asingle package allowing us to significantly reduce cost, power consumption andcircuit board space. Our ability to design our semiconductors in multipleprocess technologies enables us to address a variety of end-markets andapplications.

Thefollowing table summarizes the sales from our significant product lines:

| ** **                                       | ** ** | **Year Ended**         | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **December 31,  2006** | ** ** | **December 31,   2005** | ** ** | **December 31,   2004** | ** ** |
| Semiconductor and  RFID (RF products)            |       |                        | $          | 48,686 |   |   |   | $ | 31,201 |   |   |   | $ | 29,808 |   |   |
| Wireless  Integrated Assemblies and Fiber Optics |       |                        | 93         |   |   |   | 396 |   |   |   | 2,528 |   |   |
| Total                                            |       |                        | $          | 48,779 |   |   |   | $ | 31,597 |   |   |   | $ | 32,336 |   |   |

 

*SemiconductorProducts and Process Technologies*

Our semiconductor products include a broad array ofhigh performance semiconductors that we manufacture for our own use as well asfor sale to others. The primary markets for our semiconductor products are thewireless infrastructure markets.

Our semiconductor products are comprised primarily ofamplifiers, mixers, multi-chip modules and transistors. Amplifiers andtransistors increase the level of signals while mixers translate a signal fromone frequency to another. The strength of our semiconductor technology lies inour ability to design and in the case of our gallium arsenide (“GaAs”)semiconductor products, manufacture highly linear products. High linearity isone of the most critical performance parameters for wireless networks andrepresents a semiconductors’ ability to amplify and transform signals withminimal distortion and interference.

We have expertise in designing and manufacturing RFcomponents in multiple process technologies. Some of these processes have beenbuilt in our own manufacturing operations and in other cases we have ourproducts manufactured for us by an outside foundry.

We use thefollowing mature processes to support our current product portfolio. Thesetechnologies are also used actively in new product design now and will be forthe next four to five years.

·       Galliumarsenide metal semiconductor field effect transistor (GaAs MESFET)

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·       Galliumarsenide heterostructure field effect transistor (GaAs HFET)

·       Indiumgallium phosphide heterojunction bipolar transistor (InGaP HBT)

During 2006, we qualified and introduced intoproduction the 28 Volt version of our 12 Volt InGaP HBT process in our internalwafer fabrication facility and are in the qualification phase with our outsidefoundry for this process. This new process technology supports our new andexpanding line of higher-powered amplifier products that operate at highersupply voltages.

In addition to the processes listed above, we designproducts using processes from other outside foundries. Products have beenreleased to market based on technologies from these foundries and more newproducts are being designed using these foundries.

As foundriesupgrade their process technologies, we expect that we will continue our designwork with the latest processes.

·       SiliconOn Insulator (SOI)

·       Integratedcombination of silicon-germanium heterostructure bipolar transistor andcomplementary metal oxide semiconductor (SiGe BiCMOS)

·       Siliconcomplementary metal oxide semiconductor transistor (CMOS),

Finally, we arecontinuously evaluating emerging process technologies for their suitability tofuture product offerings.

**Customers**

Wesell our products principally to our distributor and original equipmentmanufacturers, including their manufacturing subcontractors. We believe that wehave strong relationships with market leaders in all of our target markets. Asample of our revenue-producing customers includes:

| Andrew  Corporation             |   | Lucent Technologies, Inc. |   |   |
|---------------------------------|--------|--------------------------------|--------|--------|
| Celestica                       |   | Motorola                       |   |   |
| Ericsson                        |   | Nokia Networks                 |   |   |
| Elcoteq  Electronics Company    |   | Nortel Networks                |   |   |
| El-Pax                          |   | Powerwave Technologies         |   |   |
| Flextronics                     |   | Richardson Electronics, Ltd.   |   |   |
| Global  Electronics Corporation |   | Samsung Electronics Co. Ltd.   |   |   |
| Huawei  Technologies            |   | Symbol Technologies, Inc. |   |   |
| Intelleflex                     |   | ZTE Corporation                |   |   |

 

We depend on a limitednumber of key customers for a majority of our sales. In 2006, RichardsonElectronics, Ltd, our worldwide distributor of our RF semiconductor products,and Celestica each accounted for more than 10% of our sales and in aggregateaccounted for approximately 60% of our sales. In 2005, Richardson Electronics,Ltd and Celestica each accounted for more than 10% of our sales and inaggregate accounted for approximately 58% of our sales. In 2004, RichardsonElectronic, Ltd and Celestica each accounted for more than 10% of our sales andin aggregate accounted for approximately 63% of our sales. We expect that ourkey customers will continue to account for a substantial portion of our salesin 2007 and in the foreseeable future. These customers and their respectivecontributions to our net revenue have varied and will likely continue to varyfrom period to period. We typically sell products pursuant to purchase ordersthat customers can generally cancel or defer on short notice without incurring asignificant penalty, and currently do not have agreements with any of our keycustomers that contain long-term commitments to purchase specified volumes ofour products.

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**Sales, Marketingand Customer Support**

·       *Direct Sales  *We have a dedicated team of directsales people who are responsible for maintaining relationships with our keycustomers and generating new business with both existing and potentialcustomers. We cultivate strong, direct relationships with our key customersthrough major account teams that are led by our sales professionals and arecomprised of engineers and product managers. These teams are designed toaddress the specific product needs of our key customers.

·       *Distributor  *In June 2002, we entered into aworldwide distributorship agreement with Richardson Electronics, Ltd., a globalprovider of engineered products. This agreement expanded our previousrelationship and includes provisions for joint marketing and promotionalactivities. We directly compensate vendors for the cost of these specificallyidentified goods or services or may reimburse Richardson Electronics, Ltd. ifthey incurred the cost of such specifically identified goods or services on ourbehalf the value of which is substantiated by invoicing from vendors. Our costfor these activities is recorded in selling and administrative expense asadvertising. In addition to Richardson Electronics, Ltd, we have a few selectdistributors and stocking representatives that address specific marketopportunities. The activity with these distributors and stockingrepresentatives is small relative to our activity with Richardson Electronics,Ltd.

·       *Manufacturer Sales Representatives  *Our worldwidenetwork of nine independent manufacturer sales representatives is responsiblefor assisting our direct sales force in calling on potential customers as wellas maintaining relationships with non-major accounts. During 2006 we expandedour direct sales team and direct support of our key customers and expect tode-emphasize the use of our manufacturer sales representatives going forward.

·       *Applications Engineering* * *Our products are highly technical and our customersfrequently consult with us to select a component for a given application,determine product performance under specified conditions unique to theirsystem, or test a product for new applications. To meet the needs of ourcustomers, we provide support in all stages of the sales process, from conceptdefinition and product selection to post-sale support. These services areprovided by our applications engineering organization, which works closely withour sales organization in all pre- and post-sale activities. We intend tocontinue to invest in expanding our applications engineering organization toassist our customers.

·       *International Sales* * *Oursales outside the United States were 52%, 44% and 35% of our total sales in2006, 2005 and 2004, respectively. We believe Asia is one of the fastestgrowing technology markets. In 2005 we opened our Shenzhen office in China. Werecently added a director of Asia Sales and appointed country managers in Chinaand Korea. In 2006 we opened an office in Shanghai, China.

**Manufacturing**

Our wafer manufacturing facility in Milpitas,California has produced a majority of our gallium arsenide semiconductorproducts in the past. We have not been able to fully utilize the capacity ofthis wafer manufacturing facility in the past which has resulted in asignificant cost burden for the Company. We embarked on a strategy to qualifyan outside vendor, Global Communications Semiconductors, for thesemanufacturing processes and in the fourth quarter announced our decision toclose our Milpitas wafer manufacturing facility in early 2007 and to useindependent foundries for the production of our future wafer requirements.  We have previously used and plan to continueusing external wafer foundries for our SiGe, MESFET and InGaP HBT semiconductorproducts. Our semiconductor products are packaged in the Philippines, Malaysia,Thailand and China at vendor facilities.

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Our San Jose, California facility produces our RFIDproducts. We contract with a number of capable surface mount manufacturers forassembly and once the surface mount assembly operations are completed, theproducts are shipped to our facilities for testing and final configuration.

We depend on single or limited source suppliers forthe components and materials used in many of our products, including our SiGeprocessed wafers, 5 Volt, 12 Volt and 28 Volt InGaP HBTprocessed wafers, gallium arsenide wafers, packaging, electronic components andantennas. Although we rely on limited or sole source suppliers for othercomponents and materials, there are typically alternative sources of supplyavailable for them. If in the future we face difficulties obtaining thesecomponents and materials from any of our limited or sole source suppliers, wemay face a delay in the shipment of products which are manufactured using thesecomponents and materials while we identify and qualify an alternative source ofsupply, if available. As a result of these delays, we may fail to satisfycustomer orders and our sales may decline while we look for a suitablealternative supplier.

We are committed to quality of the management systemsgoverning the manufacture of our products and our systems are ISO 9001(revision 2000) certified. The International Organization for Standardization (“ISO”)is a network of the national standards institutes of 148 countries includingthe United States of America. The ISO 9000 family of standards is primarilyconcerned with “quality management,” meaning the systems the organizationutilizes to fulfill:  the customer’s quality requirements, and applicableregulatory requirements, while aiming to enhance customer satisfaction, andachieve continual improvement of its performance in pursuit of theseobjectives. The ISO 9001: 2000 is approved as an American National Standard bythe American Society for Quality.

Our systems are regularlyassessed by independent certifying bodies, through routine quality systemaudits, for adherence to ISO 9001 standards.

**Research andDevelopment**

Our future success dependson our ability to develop new designs, technologies and product enhancements. Wehave assembled a core team of experienced engineers and technologists toaccomplish these objectives. These employees are involved in advancing our coretechnologies, as well as applying these core technologies to our productdevelopment activities in our target markets. In 2006, we established a designcenter in China in addition to our centers in San Jose, California andRichardson, Texas. We have made, and will continue to make, a substantialinvestment in research and development activities. Research and developmentcosts, which are expensed when incurred, were $18.3 million, $18.1 million and$17.2 million for the years 2006, 2005 and 2004, respectively.

**IntellectualProperty**

The protection of our intellectual property iscritical to our success. We rely on patent, copyright, trademark and tradesecret laws, as well as confidentiality procedures and contractual provisions,to protect our proprietary rights. We believe that one of our competitivestrengths is our core competence in engineering, manufacturing andunderstanding our customers and markets, and we take aggressive steps toprotect that knowledge. We have been active in securing patents and enteringinto non-disclosure and confidentiality agreements to protect our proprietarytechnologies and know-how resulting from our ongoing research and development.

We seek patent protection for our unique developmentsin circuit designs, processes and algorithms. We have 24 United States patentsand 15 foreign patents. We currently have a number of patent applicationspending in the United States Patent and Trademark Office and throughout theworld, including 27 patent applications filed world wide by end of 2006. Ourexisting United States patents will expire between June 2007 and October 2022.We have chosen to pursue foreign patent protection in selected foreigncountries. Our failure to pursue foreign protection in certain countries andthe fact that 

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patent rights may beunavailable or limited in some foreign countries could make it easier for ourcompetitors to utilize our intellectual property. We cannot assure you that anypatent will be issued as a result of our pending applications or any futureapplications or that, if issued, these patents will be sufficient to protectour technology. In addition, we cannot assure you that any existing or futureUnited States or foreign patents will not be challenged, invalidated orcircumvented, or that any patent granted will provide us with adequateprotection or any competitive advantages.

We license various technologies from third partiesthat we have integrated into our products. We have a non-exclusive,non-transferable, perpetual license to use particular thin-film technology andtransferable, non-exclusive, perpetual licenses to use particular gallium arsenidetechnology, and technology used in the field of commercial, or non-military, RFcommunications. Although our business does not depend on any of the licenses toa material extent, our failure to maintain these licenses could harm ourbusiness.

We generally enter into non-disclosure agreements withour vendors, customers and licensees. Our employees are generally required toenter into agreements providing for the maintenance of confidentiality and theassignment of rights to inventions made by them while in our employ. Wegenerally control access to the distribution of documentation and otherinformation concerning our intellectual property. We also have entered intonon-disclosure agreements to protect our confidential information delivered tothird parties, in connection with possible strategic partnerships and for otherpurposes.

We have entered into license agreements in connectionwith some of our recent business dispositions with respect to some of ourintellectual property used in these sold businesses. We cannot assure you thatthe other parties to these license agreements will honor the terms of theagreements or aggressively prevent the misappropriation or infringement of ourintellectual property. Further, under these license agreements, some of ourintellectual property may be licensed to one or more of our competitors.

The telecommunicationsindustry is characterized by the vigorous protection and pursuit ofintellectual property rights. We cannot assure you that actions alleginginfringement by us of third-party intellectual property, misappropriation ormisuse by us of third-party trade secrets or the invalidity of the patents heldby us will not be asserted or prosecuted against us, or that any assertions ofinfringement, misappropriation or misuse or prosecutions seeking to establishthe invalidity of our patents will not harm our competitive position orreputation or result in significant monetary expenditures.

**Employees**

We believe that one of ourmost important assets is our base of well-trained and experienced employees. Asof December 31, 2006, we had 221 employees. We expect a substantialreduction in the number of manufacturing related employees in the first half of2007 as we complete the planned closure of our Milpitas wafer manufacturingfacility. None of our employees are covered by collective bargaining agreementsor represented by labor unions, and we have never experienced a work stoppage.We believe our employee relations are good.

**Backlog**

Our backlog is comprisedof standard purchase orders and annual contracts for the delivery of products.For our annual contracts, our major customers provide us with rolling salesforecasts on at least a monthly basis. These forecasts are subject to changes,including changes as a result of changes in market conditions, and couldfluctuate significantly from quarter to quarter. At December 31, 2006, ourbacklog was $8.2 million, compared to $6.7 million at December 31, 2005.We include in our backlog all accepted product purchase orders for whichdelivery has been specified within 90 days, including orders from distributors.We do not recognize revenue from sales through our distributors until thedistributor has sold our product to the end customer. Product orders in ourbacklog are subject to changes in delivery schedules or quantities or tocancellation at the option of the purchaser without significant penalty. Our 

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backlogmay vary significantly from time to time depending upon the level of capacityavailable to satisfy unfilled orders. Accordingly, although useful forscheduling production, we do not believe that backlog as of any particular dateis necessarily indicative of our 2007 results.

**Competition**

The markets for ourproducts are extremely competitive and are characterized by rapid technologicalchange, new product development, product obsolescence and evolving industrystandards. We compete primarily on the basis of product performance and design,reliability, quality, level of integration, delivery, price, customer support,reputation and the availability and breadth of product offerings. In each ofthe markets we serve, we compete primarily with other suppliers of highperformance RF components. We also compete with current and potentialcommunications equipment manufacturers who manufacture RF componentsinternally. We expect increased competition from existing competitors and froma number of companies that may enter the RF component market, as well as futurecompetition from companies that may offer new or emerging technologies. Some ofour competitors are large public companies that have significantly greaterfinancial, technical, marketing and other resources than us. As a result, thesecompetitors may be able to devote greater resources to the development,promotion, sale and support of their products. Furthermore, those of ourcompetitors that have large market capitalization or cash reserves may bebetter positioned than we are to acquire other companies in order to gain newtechnologies or products that may displace our product lines. Many of ourcompetitors operate their own fabrication facilities and have longer operatinghistories and presence in key markets, greater name recognition, largercustomer bases and significantly greater financial, sales and marketing, manufacturing,distribution, technical and other resources than we do. As a result, thesecompetitors may be able to adapt more quickly to new or emerging technologiesand changes in customer requirements or to devote greater resources to thepromotion and sale of their products. Current and potential competitors haveestablished or may establish financial or strategic relationships amongthemselves or with existing or potential customers, resellers or other thirdparties. Accordingly, it is possible that new competitors or alliances amongcompetitors could emerge and rapidly acquire significant market share. Inaddition, competitors may develop technologies that more effectively addressour markets with products that offer enhanced features, lower power requirementsor lower cost. Increased competition could result in pricing pressures,decreased gross margins and loss of market share and may materially andadversely affect our business, financial condition and results of operations.

**BusinessCombinations**

We have completed two acquisitions in connection withthe implementation of our business strategy to acquire and develop new andcomplementary technologies.

On January 28, 2005 we completed our acquisitionof Telenexus, Inc. 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 ownedsubsidiary. Telenexus designs, develops, manufactures and markets radiofrequency identification reader products for a broad range of industries andmarkets. By virtue of the merger, we purchased through the WJ Sub all of theassets necessary for the conduct of the RFID business of Telenexus, consistingprimarily of, and including, but not limited to RFID modules, basebandprocessing algorithm technology, applications software and realizations ofseveral reader product designs. The consideration we paid on the closing datein 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 2,333,333shares of our common stock valued at $8.2 million at the closing date.Including acquisition costs of $230,000, the aggregate purchase price for thenet assets of Telenexus totaled $11.4 million.

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On June 18, 2004, wecompleted our acquisition of the wireless infrastructure business andassociated assets from EiC Corporation, a California corporation and EiCEnterprises Limited (together “EiC”). The aggregate purchase price was $13.3million which included consideration to EiC in the form of payments ofcash of $10.0 million and the issuance of 737,000 shares of our common stockvalued at $2.5 million, as well as acquisition related costs we incurred of$1.2 million and $152,000 of estimated registration statement related expensesreduced by a $576,000 benefit from the termination settlement of the associatedsupply agreement with EiC recognized during our quarter ended December 31,2004.

**Compliance withEnvironmental, Health and Safety Regulations**

We are committed to achieving high standards ofenvironmental quality and product safety, and strive to provide a safe andhealthy workplace for our employees, contractors and the communities in whichwe do business. We have developed environmental, health and safety policies forour business, and internal processes focused on minimizing and properlymanaging any hazardous materials used in our facilities and products.

The manufacture, assembly and testing of our productsrequires the use of hazardous materials that are subject to a broad array ofenvironmental, health and safety laws and regulations. As we continue to useadvanced process technologies, the materials, technologies and productsthemselves become increasingly complex. Our evaluations of new materials foruse in research and development, manufacturing, and assembly and test take intoaccount environmental, health and safety considerations. Many new materialsbeing evaluated for use may be subject to existing or future laws andregulations. Failure to comply with any of the applicable laws or regulationscould result in fines, suspension of production, alteration of fabrication andassembly processes, curtailment of operations or sales, and legal liability.Our failure to properly manage the use, transportation, emission, discharge,storage, recycling or disposal of hazardous materials could subject us tofuture liabilities. Existing or future laws and regulations could require us toprocure pollution abatement or remediation equipment, modify product designs,or incur other expenses. In addition, restrictions on the use of certainmaterials in our facilities or products in the future could have a materialadverse effect on our operations. Compliance with these complex laws andregulations, as well as internal voluntary programs, is integrated into ourmanufacturing and assembly and test processes.

Our former Scotts Valley and Palo Alto sites havesignificant environmental liabilities for which in July 1999 we enteredinto and funded fixed price remediation contracts and obtained cost overrun andunknown pollution conditions insurance coverage. There can be no assurance thatthis insurance will be sufficient to cover all liabilities related to these twosites.

The Scotts Valley site is a federal Superfund site.Chlorinated solvent and other contamination was identified at the site in theearly 1980s, and by the late 1980s we had installed a groundwater extractionand treatment system. In 1991, we entered into a consent decree with the UnitedStates Environmental Protection Agency providing for remediation of the site.In July 1999, we signed a remediation agreement with an environmentalconsulting firm, ARCADIS Geraghty & Miller. Pursuant to thisremediation agreement, we paid $3.0 million in exchange for which ARCADISagreed to perform the work necessary to assure satisfactory completion of ourobligations under the consent decree. The agreement also contains a costoverrun guaranty from ARCADIS up to a total project cost of $15.0 million. Inaddition, the agreement included procurement of a ten-year, claims-madeinsurance policy to cover overruns of up to $10.0 million from RelianceInsurance Company, along with a ten-year, claims-made $10.0 million policy tocover various unknown pollution conditions at the site.

The Palo Alto site is a state Superfund site and iswithin a larger, regional state Superfund site. As with the Scotts Valley site,contamination was discovered in the 1980s, and groundwater extraction andtreatment systems have been operating for several years at both the site andthe regional site. In July 1999, 

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we entered into aremediation agreement with an environmental consulting firm, SECOR. Pursuant tothis remediation agreement, we paid $2.4 million in exchange for which SECORagreed to perform the work necessary to assure satisfactory completion of ourobligations under the applicable remediation orders. The payment included thepremium for a 30-year, claims-made insurance policy to cover costoverruns up to $10.0 million from AIG, along with a ten-year claims-made $10.0million insurance policy to cover various unknown pollution conditions at thesite.

With respect to our remaining current or formerproduction facilities, to date either no contamination of significance has beenidentified or reported to us or the regulatory agency involved has grantedclosure with respect to the identified contamination.

Nevertheless, we may face environmental liabilitiesrelated to these sites in the future which could harm our business.

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**Item 1a. RISKFACTORS**

*You should carefully consider the risks describedbelow before making an investment decision in our securities. These riskfactors are effective as of the date of this Annual Report on Form 10-Kand shall be deemed to be modified or superseded to the extent that a statementcontained in our future filings modifies or replaces such statement. Theforward-looking statements in this Annual Report on Form 10-Kinvolve risks and uncertainties and actual results may differ materially fromthe results we discuss in the forward-looking statements. If any of thefollowing risks actually occur, our business, financial condition or results ofoperations could be materially adversely affected. In that case, the tradingprice of our stock could decline, and you may lose all or part of yourinvestment. The most significant risks and uncertainties known to us that webelieve make an investment in our stock speculative or risky are set forth inthis section. This section does not include those risks and uncertainties thatcould apply to any issuer or any offering.*

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

We have not recorded operating income since 1999, andwe may not be able to achieve revenue or earnings growth or obtain sufficientrevenue to sustain profitability. In 2006 our sales were $48.8 million andwe incurred an operating loss of $10.8 million compared to sales of $31.6 millionand an operating loss of $22.1 million for 2005. In addition, our sales for2004 were $32.3 million and we incurred an operating loss of  $17.3million. Our accumulated deficit was $182.6 million at December 31, 2006.

We expect thatreduced end-customer demand would, and other factors could, adversely affectour operating results in the near term, and we anticipate incurring additionallosses in the future. Other factors that could negatively impact our resultsinclude, but are not limited to:

·       production overcapacity inthe industry, which could reduce the price of our products adversely affectingour sales and margins;

·       rescheduling, reduction orcancellation of significant customer orders, which could cause us to lose salesthat we had anticipated;

·       loss of a key customer;

·       the ability of ourcustomers to manage their inventories, which if not properly managed couldcause our customers to reschedule, reduce or cancel significant orders orreturn our products; and

·       political and economicinstability, foreign conflicts involving or the impact of regional and globalinfectious illnesses (such as outbreaks of SARS and bird flu) in the countriesof our vendors, manufacturers, subcontractors and customers, particularly inthe countries of China, South Korea, Malaysia, Thailand and the Philippines.

We may incur losses forthe foreseeable future, particularly if our revenues do not increasesubstantially or if our expenses increase faster than our revenues. In order toreturn to profitability, we must achieve substantial revenue growth, and wecurrently face an environment of uncertain demand in the markets our productsaddress.

***We operate in the highly cyclical semiconductorindustry which has experienced significant fluctuations in demand.***

The semiconductor industry is highly cyclical and hashistorically experienced significant fluctuations in demand for products. Theindustry has experienced significant downturns, often in connection with, or inanticipation of, maturing product cycles and declines in general economicconditions. These downturns have been characterized by diminished productdemand of end-customers, production overcapacity, high inventory levels andaccelerated erosion of average selling prices.

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We have experienced theseconditions in our business in the past and may experience such downturns in thefuture. Future downturns in the semiconductor industry could seriously impactour revenues and harm our business, financial condition and results ofoperations.

***We depend on Richardson Electronics, Ltd. fordistribution of our RF semiconductor products and the loss of this relationshipcould materially reduce our sales.***

RichardsonElectronics, Ltd. is the worldwide distributor of our RF semiconductorproducts. Richardson Electronics, Ltd. is our largest customer and represents44%, 45% and 52% of sales in 2006, 2005 and 2004, respectively. We cannotassure you that this relationship will improve sales of our products or that itis the most effective method of distribution. If Richardson Electronics, Ltd.fails to successfully market and sell our products, our sales could materiallydecline. Our agreement with this distributor does not require it to purchaseour products and is terminable at any time. If this distribution relationshipis discontinued, our sales could decline significantly.

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

We depend on a small number of customers for amajority of our sales. We currently have two customers which each account formore than 10% of our sales and in aggregate accounted for 60%, 58%, and 63% ofour sales in 2006, 2005, and 2004 respectively. This concentration exposes usto significant risk if either customer was to reduce their level of businesswith us.

In addition, most of oursales result from purchase orders or from contracts that can be cancelled onshort-term notice. Moreover, it is possible that our customers may developtheir 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 a few key customers will continueto account for a substantial portion of our revenue in 2007. The loss of, or areduction in orders from, a significant customer for any reason could cause oursales to decrease.

***A majority of our sales are to customers outside ofthe United States and there are inherent risks associated with sales to ourforeign customers.***

We sell a significantportion of our product to customers outside of the United States. Sales tocustomers outside of the United States accounted for approximately 52%, 44% and35% of our sales in 2006, 2005 and 2004, respectively. Most of our foreignsales are to customers located in China. We expect that sales to customersoutside of the United States will continue to account for a significant portionof 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 tradebarriers, the existence of political, legal and economic instability in foreignmarkets, language and cultural barriers, seasonal reductions in businessactivities, our ability to receive timely payment and collect our accountsreceivable, difficulties in protecting intellectual property rights, currencyfluctuations, and potentially adverse tax consequences, which could adverselyaffect our business and financial results.

***The new markets we are targeting may not grow asforecasted, and we may not be a successful participant in those markets.***

Our growth strategy is based in part on our success inpenetrating new radio frequency identification (“RFID”) markets. These marketscurrently are not a material source of revenue for us, and we cannot assure youthat our new products will succeed. In addition to the risks generally associatedwith new product development and introduction, these products are subject tothe particular risks described below.

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The growth of the RFIDmarket will depend on, among other things, the ability of suppliers to meetsize, portability, cost and power consumption objectives, the ability ofindustry participants to agree on appropriate technology standards and thewillingness of end users to invest in the required equipment and informationsystems. Even if the market does grow as forecasted, our ability tosuccessfully participate in the RFID market will depend upon, among otherthings, our timely development and marketing of appropriate products,attracting the most advantageous industry partnerships, securing any necessaryadditional intellectual property and forming customer relationships. Therefore,we may not be a successful participant in these markets.

***Our dependence on a foundry partner exposes us to arisk of manufacturing disruption or uncontrolled price changes.***

On October 30, 2006, our Board of Directorscommitted us to a restructuring plan to close and exit our Milpitas fabricationfacility during the first quarter of 2007. The Milpitas fabrication facilityproduced a substantial portion of our semiconductor product revenue. Our secondsource for wafers is Global Communication Semiconductors, Inc., ourfoundry partner who will become our sole source as a result of the fab closure.

If the operationsof our foundry partner should be disrupted, or if they should choose not todevote capacity to our products in a timely manner, our business could beadversely impacted, as we might be unable to manufacture some of our productson a timely basis. In addition, the cyclicality of the semiconductor industryhas periodically resulted in disruption of supply. We may not be able to findsufficient capacity at a reasonable price or at all if such disruptions occur.As a result, we face significant risks, including:

·       reduced control overdelivery schedules and quality;

·       longer lead times;

·       the potential lack ofadequate capacity during periods when industry demand exceeds availablecapacity;

·       difficulties finding andintegrating new subcontractors;

·       limited warranties onproducts supplied to us;

·       potential increases inprices due to capacity shortages, currency exchange fluctuations and otherfactors; and

·       potential misappropriationof our intellectual property.

***Third party intellectual property claims could harmour business.***

We occasionally receivecommunications from third parties alleging infringement of patent and otherintellectual property rights. While we are not subject to any current claimsthat we believe could be material, there can be no assurance that materialclaims will not arise in the future. While all of our revenue is derived fromproducts containing our proprietary intellectual property, approximately 7% and9% of our revenue for 2006 and 2005, respectively, was derived from newlydeveloped technologies which could have a higher risk of infringement claims.We intend to vigorously protect our proprietary intellectual property rightswith respect to all of our products. However, we cannot assure you that claimscan be amicably disposed of, and it is possible that litigation could ensue.Litigation could result in substantial costs to us and diversion of ourresources. If we fail to obtain a necessary license or if we do not prevail inpatent or other intellectual property litigation, we could be required todiscontinue 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 harmour business.

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***Our quarterly operating results may fluctuatesignificantly. As a result, we may fail to meet the expectations of securitiesanalysts and investors, which could cause our stock price to decline.***

Our quarterly revenues andoperating results have fluctuated significantly in the past and are expected tovary from quarter to quarter due to a number of the factors described in this “RiskFactors” section and in our public filings, many of which are not within ourcontrol. If our operating results do not meet our publicly stated guidance orthe expectations of securities analysts or investors, our stock price maydecline. For example, during our third quarter 2006 earnings call we providedlower forward guidance and in mid December we pre-announced lowerexpectations for the fourth quarter of 2006. Subsequent to such announcements,the trading price of our common stock declined significantly.

***If we are unable to develop and introduce new RFproducts successfully and in a cost-effective and timely manner or to achievemarket acceptance of our new semiconductors, our operating results would beadversely affected.***

The future successof our business depends on our ability to develop new RF products for existingand new markets, introduce these products in a cost-effective and timely mannerand convince leading equipment manufacturers to select these products fordesign into their own new products. Our quarterly results in the past havebeen, and are expected in the future to continue to be, dependent on theintroduction of new products and the timely completion and delivery of thoseproducts to customers. The development of new semiconductor devices is highlycomplex, and from time to time we have experienced delays in completing thedevelopment and introduction of new products and lower than anticipatedmanufacturing yields in the early production of such products. Our ability todevelop and deliver new semiconductor products successfully will depend onvarious factors, including our ability to:

·       accurately predict marketrequirements and evolving industry standards;

·       accurately define newproducts;

·       timely complete andintroduce new product designs;

·       timely qualify and obtainindustry interoperability certification of our products and the products of ourcustomers into which our products will be incorporated;

·       obtain sufficient foundrycapacity;

·       achieve high manufacturingyields;

·       shift our products to smallergeometry process technologies to achieve lower cost and higher levels of designintegration; and

·       gain market acceptance ofour products and our customers’ products.

If we are not able to develop and introduce newproducts successfully and in a cost-effective and timely manner, our business,financial condition and results of operations would be materially and adverselyaffected.

Our new products generallyare incorporated into our customers’ products at the design stage. We oftenincur significant expenditures for the development of a new product without anyassurance that an equipment manufacturer will select our product for designinto its own product. The value of our semiconductors largely depends on thecommercial success of our customers’ products. We cannot assure you that wewill continue to achieve design wins or that equipment that incorporates ourproducts will be commercially successful.

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***The amount and timing of revenue from newly designedRF products is often uncertain.***

We announce from time totime new products and design wins for new and existing RF products. Achieving adesign win with a customer does not create a binding commitment from thatcustomer to purchase our products. Rather, a design win is solely an expressionof interest by potential customers to purchase our products and is notsupported by binding commitments of any nature. Accordingly, a customer maychoose at any time to discontinue using our products in their designs orproduct development efforts. Even if our products are chosen to be incorporatedinto our customer’s products, we still may not realize significant revenuesfrom that customer if their products are not commercially successful. A designwin may not generate revenue if the customer’s product is rejected by their endmarket. Typically, most new products or design wins have very little impact onnear-term revenue. It may take well over a year before a new product or designwin generates revenue. Once a manufacturer of communications equipment hasdesigned a supplier’s semiconductor into its products, the manufacturer may bereluctant to change its source of semiconductors due to the significant costsassociated with qualifying a new supplier and potentially redesigning itsproduct. Accordingly, our failure to achieve design wins with equipmentmanufacturers, which have chosen a competitor’s semiconductor, could createbarriers to future sales opportunities with these manufacturers.

***Our products typically have lengthy sales cycles andwe may ultimately be unable to recover our investment in new products.***

After we have developed and delivered a RF product toa customer, the customer will usually test and evaluate our product prior todesigning its own equipment to incorporate our product. Our customer may needthree to six months or longer to test, evaluate and adopt our products and anadditional three to nine months or more to begin volume production of equipmentthat incorporates our products. In some cases, it may take significantly longerthan three to nine months before customers commence volume production ofequipment incorporating some of our products. Due to this lengthy sales cycle,we may experience significant delays from the time we increase our expenses forresearch and development, sales and marketing efforts and make investments ininventory until the time that we generate revenue from these products. It ispossible that we may never generate any revenue from these products afterincurring such expenditures. Even if a customer selects our products to incorporateinto its equipment, we have no assurances that the customer will ultimatelymarket and sell its equipment or that such efforts by our customer will besuccessful. The delays inherent in our lengthy sales cycle increase the riskthat a customer will decide to cancel or change its product plans. Such acancellation or change in plans by a customer could cause us to lose sales thatwe had anticipated. In addition, our business, financial condition and resultsof operations could be materially and adversely affected if a significantcustomer curtails, reduces or delays orders during our sales cycle or choosesnot to release equipment that contains our products.

The resources devoted toproduct research and development and sales and marketing may not generatematerial revenue for us, and from time to time, we may need to write off excessand obsolete inventory. If we incur significant marketing and inventoryexpenses in the future that we are not able to recover, and we are not able tocompensate for those expenses, our operating results could be adverselyaffected. In addition, if we sell our products at reduced prices inanticipation of cost reductions and we still have higher cost products ininventory, our operating results would be harmed.

***If we are unable to respond to the rapid technologicalchanges taking place in our industry, our existing products could becomeobsolete and we could face difficulties making future sales.***

The markets in which we compete are characterized byrapidly changing technologies, evolving industry standards and frequentimprovements in products and services. If the technologies supported by ourproducts become obsolete or fail to gain widespread acceptance, as a result ofa change in industry standards or otherwise, we could face difficulties makingfuture sales.

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We must continue to makesignificant investments in research and development to develop productenhancements, new designs and technologies on a cost effective basis. If we areunable to develop and/or gain access to and introduce new products orenhancements in a timely and cost effective manner in response to changingmarket conditions or customer requirements, or if our new products do notachieve market acceptance, our sales could decline. Additionally, initial lowermargins are typically experienced with new products under development.

***Our existing and potential customers operate in anintensely competitive environment, and our success will depend on the successof our customers.***

The companies in ourtarget markets face an extremely competitive environment. Some of the productswe design and sell are customized to work with specific customers’ systems. Ifthe companies with whom we establish business relations are not successful inbuilding their systems, promoting their products, including newrevenue-generating services, receiving requisite approvals and accomplishingthe many other requirements for the success of their businesses, our growthwill be limited. Furthermore, our customers may have difficulty obtaining partsfrom other suppliers causing these customers to cancel or delay orders for ourproducts. In addition, we have limited ability to foresee the competitivesuccess of our customers and to plan accordingly.

***If the wireless communications market fails to grow,or declines, our sales may not grow or may decline.***

Our future growthdepends on the success of the wireless communications market. The rate at whichthis markets will grow is difficult to predict. This market may fail to grow ordecline for many reasons, including:

·       insufficient consumerdemand for wireless products or services;

·       the inability of thevarious communications service providers to access adequate capital to buildtheir networks;

·       inefficiency and poorperformance of wireless communications compared to other forms of broadbandaccess; and

·       real or perceived securityor health risks associated with wireless communications.

If the markets for ourproducts in wireless communications declines, fail to grow, or grows moreslowly than we anticipate, the use of our products may be reduced and our salescould suffer.

***If we or our outsourced manufacturers fail toaccurately forecast component and material requirements, we could incuradditional costs or experience product delays.***

We use rolling forecastsbased on anticipated product orders to determine our component requirements. Itis important that we accurately predict both the demand for our products andthe lead times required to obtain the necessary products and/or components andmaterials. Lead times for components and materials that we, or our outsourcedmanufacturers, order can vary significantly and depend on factors such asspecific supplier requirements, the size of the order, contract terms andcurrent market demand for the components. Since we rely on outsourcedmanufacturers, many of these factors will be outside of our direct managerialcontrol. For substantial increases in production levels, our outsourcedmanufacturers 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 purchasecommitments. We lack visibility into the finished goods inventories of ourcustomers and the end-users. This lack of visibility impacts our ability toaccurately forecast our requirements. If we overestimate our component,material and outsourced manufactured requirements, we may have excessinventory, which would increase our costs. An additional risk for potentialexcess inventory results from our volume purchase commitments with certainmaterial 

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suppliers,which can only be reduced in certain circumstances. Additionally, if weunderestimate our component, material, and outsourced manufacturingrequirements, we may have inadequate inventory, which could interrupt and delaydelivery of our products to our customers. Any of these occurrences wouldnegatively impact our sales and profitability. We have incurred, and may in thefuture incur, charges related to excess and obsolete inventory. These chargesamounted to approximately $1.6 million, $1.0 million and $670,000 in 2006, 2005and 2004, respectively. While these charges may be partially offset bysubsequent sales of previously written-down inventory, there can be noassurance that any such sales will be significant. As we broaden our productlines we must outsource the manufacturing of or purchase a wider variety ofcomponents. In addition, new product lines contain a greater degree ofuncertainty due to a lack of visibility of customer acceptance and potentialcompetition. Both of these factors will contribute a higher level of inventoryrisk in our near future.

***We depend on outsourced manufacturers and single orlimited source suppliers which makes us susceptible to shortages or pricefluctuations that could adversely affect our operating results.***

We currently purchaseseveral key components and materials used in our products from single orlimited source suppliers. These products amounted to 7%, 15% and 5% of ourrevenue in 2006, 2005 and 2004, respectively. Although we do not currently haveany suppliers that are material to our business in 2006, we would expect ourprimary wafer foundry partner in 2007 would be material. In the event one ofour sole source suppliers or outsourced manufacturers are unable to deliver usproducts or unwilling to sell us components or materials, it could harm ourbusiness. It could take us as long as six to twelve months to replace oursingle or limited source suppliers and there can be no assurance that we wouldbe successful. Additionally, we or our outsourced manufacturers may fail toobtain required products and components in a timely manner in the future. Wemay also experience difficulty identifying alternative sources of supply forthe components used in our products or products we obtain through outsourcing.We would experience delays if we were required to test and evaluate products ofpotential alternative suppliers or products we obtain through outsourcing.Furthermore, financial or other difficulties faced by our outsourcedmanufacturers, or suppliers or significant changes in demand for the componentsor materials they use in the products and/or supply to us could limit theavailability of those products, components or materials to us. Thus far we havenot experienced any material delays related to such suppliers, but we cannotassure you that this will continue to be the situation.

***We rely on the significant experience and specializedexpertise of our senior management in our industry and must retain and attractqualified engineers and other highly skilled personnel in a highly competitivejob environment to maintain and grow our business.***

Our performance is substantially dependent on thecontinued services and on the performance of our senior management and ourhighly qualified team of engineers, who have many years of experience andspecialized expertise in our business. We have recently undergone changes inour senior management. Our performance also depends on our ability to retainand motivate our other executive officers and key employees. The loss of theservices of any of our executive officers or of a number of our engineers couldharm our ability to maintain and build our business. We have no “key man” lifeinsurance policies.

Our future success alsodepends on our ability to identify, attract, hire, train, retain and motivatehighly skilled technical, managerial, sales, and marketing personnel. If wefail to attract, integrate and retain the necessary personnel, our ability tomaintain and build our business could suffer significantly.

***Our business is subject to the risks of productreturns, product liability and product defects.***

Products as complex asours frequently contain undetected errors or defects, especially when firstintroduced or when new versions are released. The occurrence of errors couldresult in product returns from and reduced product shipments to our customers.In addition, any failure by our products to properly 

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performcould result in claims against us by our customers. Such failure also couldresult in the loss of or delay in market acceptance of our products or harm ourreputation. Due to the recent introduction of some of our products, we havelimited experience with the problems that could arise with these products. Ifproblems occur or become significant, it could result in a reduction in ourrevenues and increased costs related to inventory write-offs, warranty claimsand other expenses which could have a material and adverse affect on ourfinancial condition.

Our purchase agreementswith our customers typically contain provisions designed to limit our exposureto potential product liability claims. However, the limitation of liabilityprovision contained in these agreements may not be effective as a result offederal, state or local laws or ordinances or unfavorable judicial decisions inthe United States or other countries. Although we maintain insurance to protectagainst claims associated with the use of our products, our insurance coveragemay not adequately cover all claims asserted against us. In addition, evenultimately unsuccessful claims could result in costly litigation, divert ourmanagement’s time and resources and damage our customer relationships.

***We use a number of specialized technologies, some ofwhich are patented, to design, develop and manufacture our products.Infringement of our intellectual property rights could hurt our competitiveposition, harm our reputation and negatively impact our future profitability.***

We regard the protection of our copyrights, patents,service marks, trademarks, trade dress and trade secrets as critical to ourfuture success and rely on a combination of copyright, patent, trademark andtrade secret law, as well as on confidentiality procedures and contractualprovisions, to protect our proprietary rights. We seek patent protection forour unique developments in circuit designs, processes and algorithms. Adequateprotection of our intellectual property rights may not be available in everycountry where our products and services are made available. We intend, as a generalpolicy, to enter into confidentiality and invention assignment agreements withall of our employees and contractors, as well as into nondisclosure agreementswith parties with which we conduct business, to limit access to and disclosureof our proprietary information; however, we have not done so on a uniformbasis. As a result, we may not have adequate remedies to preserve our tradesecrets or prevent third parties from using our technology withoutauthorization. We cannot assure you that all future employees, contractors andbusiness partners will agree to these contracts, or that, even if agreed to,these contractual arrangements or the other steps we have taken to protect ourintellectual property will prove sufficient to prevent misappropriation of ourtechnology or to deter independent third-party development of similartechnologies. If we are unable to execute these agreements or take other stepsto prevent misappropriation of our technology or to deter independentdevelopment of similar technologies, our competitive and financial position andreputation could suffer, and we could be forced to make significantexpenditures.

We regularly file patent applications with the U.S.Patent and Trademark Office and in selected foreign countries covering particularaspects of our technology and intend to prosecute such applications to thefullest extent of the law. Based upon our assessment of our current and futuretechnology, we may decide to file additional patent applications in the future,and may decide to abandon current patent applications. We cannot assure youthat any patent application we have filed or will file will result in an issuedpatent, or, if patents are issued to us, that such patents will provide us withany competitive advantages and will not be challenged by third parties orinvalidated by the U.S. Patent and Trademark Office or foreign patent office.Any failure to protect our existing patents or to secure new patents may limitour ability to protect the intellectual property rights that such patents orpatent applications were intended to cover. Furthermore, the patents of othersmay impair our ability to do business.

We have several registeredtrademarks and service marks, in the United States and abroad, and are in theprocess of registering others in the United States. Nevertheless, we cannotassure you that the U.S. Patent and Trademark Office will grant us theseregistrations. Should we decide to apply to register 

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additionaltrademarks or service marks in foreign countries, there is no guarantee that wewill be able to secure such registrations. The inability to register ordecision not to register in certain foreign countries and adequately protectour trademarks and service marks could harm our competitive position, harm ourreputation and negatively impact our future profitability.

***We must gain accessto improved process technologies.***

For our semiconductorproducts, our future success will depend upon our ability to continue to gainaccess to new and/or improved process technologies in order to adapt toemerging industry standards or competitive market conditions. In the future, wemay be required to transition one or more of our products to processtechnologies with smaller geometries, other materials or higher speed in orderto reduce costs and/or improve product performance. We may not be able to gainaccess to new process technologies in a timely or affordable manner. Inaddition, products based on these technologies may not achieve marketacceptance.

***Due to ourrelationships with foreign vendors, manufacturers, customers andsubcontractors, we are subject to international operational, financial andpolitical risks.***

Weexpect to continue to rely on vendors, manufacturers and subcontractors locatedin China, Malaysia, Thailand, Taiwan and the Philippines. Additionally, weutilize vendors located in such countries in our semiconductor business tosource gallium arsenide (“GaAs”) wafers as raw material in our semiconductorfabrication, to fabricate certain products, to assemble certain products and topackage the majority of our semiconductor die in plastic. Accordingly, we willbe subject to risks and challenges such as:

·       compliance with a wide variety of foreign lawsand regulations:

·       changes in laws and regulations relating to theimport or export of semiconductor products;

·       legal uncertainties regarding taxes, tariffs,quotas, export controls, export licenses and other trade barriers;

·       political and economic instability, foreignconflicts involving or the impact of regional and global infectious illnesses(such as outbreaks of SARS and bird flu) in the countries of these vendors,manufacturers and subcontractors causing delays in our ability to obtain ourproduct;

·       reduced protection for intellectual propertyrights in some countries; and

·       fluctuations in freight rates and transportationdisruptions.

Political and economicinstability and changes in governmental regulations in these areas as well asthe United States could affect the ability of our overseas vendors to supplymaterials or services. Any interruption or delay in the supply of our requiredcomponents, products, materials or services, or our inability to obtain thesecomponents, materials, products or services from alternate sources atacceptable prices and within a reasonable amount of time, could impair ourability to meet scheduled product deliveries to our customers and could causecustomers to cancel orders.

***We face intensecompetition, and, if we do not compete effectively in our markets, we will losesales and have lower margins.***

Thesemiconductor industry is intensely competitive in each of the markets we serveand is characterized by:

·       rapidly changing technology;

·       swift product obsolescence;

·       manufacturing yieldproblems;

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·       price erosion; and

·       limited supplies ofcomponents and materials.

Our end markets arerapidly evolving and intensely competitive, and we expect competition tointensify further in the future. Many of our current and potential competitorshave substantially greater technical, financial, marketing, distribution andother resources than we have. Price competition is intense and the marketprices and margins of products frequently decline after competitors beginmaking similar products. A number of our competitors may have greater namerecognition and market acceptance of their products and technologies.Furthermore, our competitors, or the competitors of our customers, may developnew technologies, enhancements of existing products or new products that offersuperior price or performance features. These new products or technologiescould render obsolete our products or the systems of our customers into whichour products are integrated. If we fail to successfully compete in our markets,our business and operating results would be materially and adversely affected.

***Our growth depends in part on future acquisitions andinvestments in new businesses, products or technologies that involve numerousrisks, including the use of cash and diversion of management’s attention.***

As part of our growthplans, we may make acquisitions of and investments in new businesses, productsand technologies. If we identify an acquisition candidate, we may not be ableto successfully negotiate or finance the acquisition. Even if we are successful,we may not be able to integrate the acquired businesses, products ortechnologies into our existing business and products. As a result of the rapidpace of technological change, we may misgauge the long-term potential of theacquired business or technology or the acquisition may not be complementary toour existing business. Furthermore, potential acquisitions and investments,whether or not consummated, may divert our management’s attention and requireconsiderable cash outlays at the expense of our existing operations. Inaddition, to complete future acquisitions, we may issue equity securities,incur debt, assume contingent liabilities or have amortization expenses andwrite-downs of acquired assets, which could affect our profitability.

***We may not be able to successfully integrate thebusinesses we may acquire in the future, which could harm our business,financial condition and results of operations.***

Our strategyincludes the potential to acquire technology and products through acquisitionsto address our target markets in addition to our internally developedtechnologies. Integrating completed acquisitions into our existing operationsinvolves numerous risks including the following:

·       diversion of management’sattention;

·       potential loss of keypersonnel;

·       ability of the acquiredbusiness to maintain its pre-acquisition revenues and growth rates;

·       ability of the acquiredbusiness to be financially successful or provide desired results; and

·       ability to develop andintroduce new products.

We may not be able tosuccessfully integrate our acquisitions which could harm our business,financial condition and results of operations.

***Changes in the regulatory and market dynamicsenvironment of the communications industry may reduce the demand for our products.***

The deregulation of thetelecommunications industry has resulted in an increased number of serviceproviders. Such increase, coupled with the expanding use of the Internet anddata networking by businesses and consumers, has resulted in the rapid growthof the communications industry. This has led 

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and willlikely continue to lead to intense competition, short product life cycles, and,to some extent, regulatory uncertainty in and outside the United States. Thecourse of the development of the communications industry is difficult topredict. For example, the delays in governmental approval processes that ourcustomers are subject to, such as the issuance of site permits and the auctionof frequency spectrum, have in the past caused, and may in the future cause,the cancellation, postponement or rescheduling of the installation ofcommunications systems by our customers. A reduction in network infrastructureexpenditures could negatively affect the sale of our products. Moreover, in theshort term, deregulation may result in a delay or a reduction in theprocurement cycle because of the general uncertainty involved with thetransition period of businesses.

***If we fail to maintain an effective system of internalcontrols, we may not be able to accurately report our financial results orprevent fraud which could subject us to regulatory sanctions, harm our businessand operating results and cause the trading price of our stock to decline.***

Effective internalcontrols required under Section 404 of the Sarbanes-Oxley Act of 2002 arenecessary for us to provide reliable financial reports and effectively preventfraud. If we cannot provide reliable financial reports or prevent fraud, ourbusiness, reputation and operating results could be harmed. We have in the pastdiscovered, and may in the future discover, areas of our internal controls thatneed improvement. For example,  “materialweaknesses” were identified in our quarter ended December 31, 2005, October 1,2006, and December 31, 2006 which means that there was “a significantdeficiency, or a combination of significant deficiencies, that results in morethan a remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected.” During these periods, thefinance team experienced a high rate of turnover and partially due to theturnover, has been understaffed and had limited training in the Company’sprocesses and procedures. During the second half of 2006, we substantiallyhired a new finance team with an expectation to complete the hiring during thefirst half of 2007. During this period and until we can complete the staffingand training of the finance team, we have a higher risk of deficiencies in ourfinancial reporting. We cannot be certain that the measures we have taken orintend to take will ensure that we maintain adequate controls over ourfinancial processes and reporting in the future. Any failure to implementrequired new or improved controls or difficulties encountered in theirimplementation could subject us to regulatory sanctions, harm our business andoperating results or cause us to fail to meet our reporting obligations.Inferior internal controls could also harm our reputation and cause investorsto lose confidence in our reported financial information, which could have anegative impact on the trading price of our stock.

***Our future profitability could suffer from known orunknown liabilities that we retained when we sold parts of our company.***

In the recent past,we completed the divestiture of all but our current business. In thetransactions in which we sold our other businesses, we generally retainedliability arising from events occurring prior to the sale. Some of theseliabilities were or have since become known to us, such as the environmentalcondition of the production facilities we sold. We may have underestimated thescope of these liabilities, and we may become aware of additional liabilitiesassociated with the following in the future:

·       ownership of the intellectualproperty we have sold;

·       the potential infringementby our sold businesses of the intellectual property of others;

·       the regulatory complianceof our sold defense business;

·       export control compliancewith respect to our defense products purchased by the United States and foreigngovernments; and

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·       product defect claims withrespect to products manufactured by our sold businesses before they were sold.

If these and any otherunknown liabilities and obligations exceed our expectations and establishedreserves, our future profitability could suffer and our capital needs couldincrease.

***If we fail to comply with environmental regulations wecould be subject to substantial fines, we could be required to suspendproduction, alter manufacturing processes or cease operations.***

Two of our former production facilities at ScottsValley and Palo Alto have significant environmental liabilities for which wehave entered into and funded fixed price remediation agreements and obtainedcost-overrun and unknown pollution insurance coverage.

We cannot assure you thatthis insurance will be sufficient to cover all liabilities related to these twosites. In addition, we are subject to a variety of federal, state and localgovernmental regulations relating to the storage, discharge, handling,emission, generation, manufacture and disposal of toxic or other hazardoussubstances used to manufacture our products. In the past, we have been subjectto periodic environmental reviews and audits, which have resulted in minor fines.If we fail to comply with these regulations, substantial fines could be imposedon us, and we could be required to suspend production, alter manufacturingprocesses or cease operations any of which could have a material negativeeffect on our sales, income and business operations.

***If RF emissions pose a health risk, the demand for ourproducts may decline.***

Recent news reports haveasserted that some radio frequency emissions from wireless handsets may belinked to various health concerns, including cancer, and may interfere withvarious electronic medical devices, including hearing aids and pacemakers. Ifit were determined or perceived that RF emissions from wireless communicationsequipment create a health risk, the market for our wireless customers’ productsand, consequently, the demand for our products could decline significantly.

***We may need to raise additional capital in the futurethrough the issuance of additional equity or convertible debt securities or byborrowing money, and additional funds may not be available on terms acceptableto us.***

We believe that the cash, cash equivalents andinvestments on hand, the cash we expect to generate from operations andborrowings under our line of credit will be sufficient to meet our liquidityand capital spending requirements for at least the next twelve months. However,it is possible that we may need to raise additional funds to fund ouractivities during and/or beyond that time. We could raise these funds byselling more stock to the public or to selected investors, or by borrowingmoney.

In addition, even though we may not need additionalfunds, we may still elect to sell additional equity securities or obtain creditfacilities for other reasons. We may not be able to obtain additional funds onfavorable terms, or at all. If adequate funds are not available, we may berequired to curtail our operations significantly or to obtain funds througharrangements with strategic partners or others that may require us torelinquish rights to certain technologies or potential markets. If we raiseadditional funds by issuing additional equity or convertible debt securities,the ownership percentages of existing stockholders would be reduced. Inaddition, the equity or debt securities that we issue may have rights, preferencesor privileges senior to those of the holders of our common stock.

It is possible thatour future capital requirements may vary materially from those now planned. Theamount of capital that we will need in the future will depend on many factors,including:

·       whether we operate on apositive cash flow basis;

·       the market acceptance ofour products;

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·       the levels of promotion andadvertising that will be required to launch our products and achieve andmaintain a competitive position in the marketplace;

·       volume price discounts;

·       our business, product,capital expenditure and research and development plans and product andtechnology roadmaps;

·       the levels of inventory andaccounts receivable that we maintain;

·       capital improvements to newand existing facilities;

·       technological advances;

·       our competitors’ responseto our products; and

·       our relationships withsuppliers and customers.

In addition, we mayrequire additional capital to accommodate planned growth, hiring,infrastructure and facility needs or to consummate acquisitions of otherbusinesses, products or technologies.

***The lease of ourfabrication facility is due to expire and because we plan to hold-over in orderto complete our fab closure we may be at risk for termination of the use of thefacility by the landlord.***

On October 30, 2006,our Board of Directors committed us to a restructuring plan to close and exitour Milpitas fabrication facility during the first quarter of 2007. TheMilpitas fabrication facility currently produces a substantial portion of ourgallium arsenide semiconductor products. Our lease of the fabrication facilityexpired on November 14, 2006 and in accordance with the terms of the leasewe are holding over, whereby the lease converts to a month-to-month lease,until the closure is complete. We plan to produce additional waferinventory at the fabrication facility until closure. During this holdoverperiod, we are at risk for termination of our use of the facility before suchtime as we complete our closing and exiting of the fabrication facility. Ifthis should occur, we might not have enough additional wafer inventory tobuffer any delayed qualifications from customers or ramp-up issues with GlobalCommunication Semiconductors, Inc.

***Our facilities are concentrated in an area susceptibleto ***earthquakes***.***

Our facilities areconcentrated in an area where there is a risk of significant earthquakeactivity. Substantially all of the production equipment that currently accountsfor our sales, as well as planned additional production equipment, is or willbe located in a known earthquake zone. We cannot predict the extent of thedamage that our facilities and equipment would suffer in the event of anearthquake or how such damage would affect our business. We do not maintainearthquake insurance.

**Risks Related toOur Stock**

***Sales of substantial amounts of our common stock byour largest shareholder could adversely affect the market price of our commonstock.***

We registered for resale up to 25,492,044 shares ofcommon stock by Fox Paine Capital Fund, L.P., FPC Investors, LP, WJCoinvestment Fund I, LLC, WJ Coinvestment Fund III, LLC and WJ CoinvestmentFund IV, LLC (together the “Fox Paine Entities”) pursuant to an agreementproviding for registration rights. The Fox Paine Entities are collectively ourlargest stockholder. As of December 31, 2006, the Fox Paine Entitiesbeneficially owned 38% of our common stock which represents approximately 25.5million of our 67.3 million outstanding shares of common stock. Our stock isnot heavily traded and our stock prices can fluctuate significantly. As such,sales of substantial amounts of our common stock into 

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the public market by theFox Paine Entities or perceptions that significant sales could occur, couldadversely affect the market price of our common stock.

Furthermore, future sales of substantial amounts ofcommon stock by our officers, directors and other stockholders, including anysales under a Rule 10b5-1 sales plan, in the public market orotherwise or the awareness that a large number of shares is available for sale,could adversely affect the market price of our common stock. In addition to theadverse effect a price decline would have on holders of our common stock, thatdecline would impede our ability to raise capital through the issuance ofadditional shares of common stock or other equity or convertible debtsecurities.

In addition to the adverseeffect a price decline would have on holders of our common stock, a pricedecline in our common stock could impede our ability to raise capital throughthe issuance of additional shares of common stock or other equity orconvertible debt securities. A price decline in our common stock below theNasdaq minimum bid requirements due to substantial sales of our common stockcould result in our common stock being delisted from the Nasdaq Global Market.Delisting could in turn reduce the liquidity of our common stock and inhibit orpreclude our ability to raise capital.

***If our common stock ceases to be listed for trading onthe NASDAQ Global Market, it may harm our stock price and make it moredifficult to sell shares.***

Our common stock is listed on the NASDAQ Global Marketand their marketplace rules for continued listing require, among otherthings, that the bid price for our common stock not fall below $1.00 per sharefor a period of 30 consecutive trading days. In late October 2005, the bidprice for our common stock was below $1.00 per share for 5 consecutive tradingdays and in April 2003 the bid price for our common stock was below $1.00per share for 30 consecutive trading days. More recently our stock price wasbelow $1.50 per share on most trading days in the first quarter of 2007. Althoughwe have been able to regain compliance in the past, because of the volatilityin our common stock price, there can be no assurance that we will be able tomaintain compliance in the future. If, in the future, our minimum bid price isagain below $1.00 for 30 consecutive trading days, under the current NASDAQGlobal Market rules we will have a period of 180 days to attain complianceby meeting the minimum bid price requirement for 10 consecutive days during thecompliance period.

If our common stock ceasesto be listed for trading on the NASDAQ Global Market, we expect that our commonstock 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 NASDAQCapital Market (formerly known as the NASDAQ SmallCap Market), which also has asimilar $1.00 minimum bid requirement. In addition, our stock could thenpotentially be subject to the Securities and Exchange Commission’s “penny stock”rules, which place additional disclosure requirements on broker-dealers. Theseadditional disclosure requirements may harm your ability to sell shares if itcauses a decline in the ability or willingness of broker-dealers to sell ourcommon stock. We also expect that the level of trading activity of our commonstock would decline if it is no longer listed on the NASDAQ Global Market orNASDAQ Capital Market. As such, if our common stock ceases to be listed fortrading on the NASDAQ Global Market or NASDAQ Capital Market for any reason, itmay harm our stock price, increase the volatility of our stock price and makeit more difficult to sell your shares of our common stock.

***Our largest stockholder has the ability to take actionthat may adversely affect our business, our stock price and our ability toraise capital.***

As of December 31,2006, Fox Paine & Company, LLC (“Fox Paine”) is the indirectbeneficial owner of 38% of our outstanding share capital. As a result, FoxPaine has and will continue to have significant influence over the outcome ofmatters requiring stockholder approval, including:

·       election of all ourdirectors and the directors of our subsidiaries;

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·       amending our charter orby-laws; and

·       agreeing to or preventingmergers, consolidations or the sale of all or substantially all our assets orour subsidiaries’ assets.

Fox Paine’s significant ownership interest could alsodelay, prevent or cause a change in control relating to us which couldadversely affect the market price of our common stock.

Fox Paine’s significant ownership interest could alsosubject us to a class action lawsuit, which could result in substantial costsand divert our management’s attention and financial resources from moreproductive uses. Fox Paine, on September 18, 2002, made a proposal toacquire all of the shares held by unaffiliated stockholders, which wassubsequently withdrawn on March 27, 2003. Prior to Fox Paine’s withdrawalof such proposal, four lawsuits, three of which were purported class actionlawsuits, were filed against us and Fox Paine in connection with such proposal.Among other things, these lawsuits sought an injunction against theconsummation of the proposal and an award of unspecified compensatory damages.These lawsuits were voluntarily dismissed after Fox Paine’s withdrawal of suchproposal without any consideration being required to be paid to the plaintiff’sand each party was obligated to bear its own attorney’s fees, costs andexpenses. We can make no assurance, however, that Fox Paine will not at somepoint in the future make another proposal regarding us and, if so, what theterms and outcome of such proposal might be. If Fox Paine were in the future tomake a proposal involving us then, depending on the terms of such proposal, theresulting transaction could result in litigation, which could adversely affectour business or our stock price.

In addition, Fox Paine receives management fees fromus which could influence their decisions regarding us. Under our managementagreement with Fox Paine, we are obligated to pay Fox Paine a fee in the amountof 1% of the prior year’s income before interest expense, interest income, incometaxes, depreciation and amortization and equity in earnings (losses) ofminority investments, calculated without regard to the fee. Due to our lossesincurred, we have not been required to pay management fees to Fox Paine since2001.

Fox Paine may in the future make significantinvestments in other communications companies. Some of these companies may beour competitors. Fox Paine and its affiliates are not obligated to advise us ofany investment or business opportunities of which they are aware, and they arenot restricted or prohibited from competing with us.

The sale of a substantialnumber of shares of our common stock by Fox Paine or the perception that suchsale could occur, could negatively affect the market price of our common stockand could also materially impair our future ability to raise capital through anoffering of securities. In addition, the sale of a substantial number of sharesof our common stock by Fox Paine could result in the loss of Fox Paine’sservices to us as well as the services of members of Fox Paine on our board ofdirectors which could adversely effect our business.

***Our stock price is highly volatile.***

The market price ofour common stock has fluctuated substantially in the past and is likely tocontinue to be highly volatile and subject to wide fluctuations. Since ourinitial public offering in August 2000, through December 31, 2006,our common stock has traded at prices as low as $0.560 and as high as $59.875per share. These fluctuations have occurred and may continue to occur inresponse to various factors, many of which we cannot control, including:

·       shares sold by the sellingstockholders;

·       quarter-to-quartervariations in our operating results;

·       announcements oftechnological innovations or new products by our competitors, customers or us;

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·       general conditions in thesemiconductor industry and telecommunications and data communications equipmentmarkets;

·       changes in earningsestimates or investment recommendations by analysts;

·       changes in investorperceptions; or

·       changes in expectationsrelating to our products, plans and strategic position or those of ourcompetitors or customers.

In addition, the marketprices of securities on the NASDAQ Global Market and that of our customers andcompetitors have been especially volatile. This volatility has significantlyaffected the market prices of securities for reasons frequently unrelated tothe operating performance of the specific companies. Accordingly, you may notbe able to resell your shares of common stock at or above the price you paid.In the past, companies that have experienced volatility in the market price oftheir securities have been the subject of securities class action litigation.If we were the object of a securities class action litigation, it could resultin substantial losses and divert management’s attention and resources fromother matters.

***We do not expect to pay any dividends for theforeseeable future.***

Although we had cash, cashequivalents and short-term investments of approximately $25.4 million at December 31,2006, we do not anticipate that we will pay any dividends to holders of ourcommon stock in the foreseeable future. Accordingly, investors must rely onsales of their common stock after price appreciation, which may never occur, asthe only way to realize any future gains on their investment. Investors seekingcash dividends should not invest in our common stock.

***The resale of substantial amounts of our common stockthat we issue in acquisitions could harm our stock price.***

We have in the past, andmay in the future, issue shares of our common stock in connection withacquisitions. To date, we have issued an aggregate of 2,442,882 shares of ourcommon stock in connection with the EiC and Telenexus acquisitions. Anadditional 2,540,323 shares could have been issued under the EiC Agreement ifearn-out targets had been met. Since our stock is not heavily traded and ourstock prices can fluctuate significantly, the resale of a substantial number ofshares issued in connection with acquisitions could harm our stock price.

**Item 1b. UNRESOLVEDSTAFF COMMENTS**

Not applicable.

**Item 2. PROPERTIES**

We have three leased sites:  a building inMilpitas, California with over 35,000 square feet,  (our lease of this facility expired on November 14,2006 and in accordance with the terms of the lease we are holding over, wherebythe lease converted to a month-to-month lease, until the fab closure iscomplete), two buildings in San Jose, California totaling over 124,000 squarefeet and leased space in Richardson, Texas for 10,754 square feet. The San Josefacility consists of two buildings: a larger building of approximately 82,000square feet, which has a remaining lease term of approximately 4 years and asmaller building of approximately 42,000 square feet, which has a remaininglease term of approximately 3.5 years. The Fremont facility we acquired as apart of the EiC transaction in June 2004 was shut down during the firstquarter of 2005 after we relocated the manufacturing capacity and associatedpersonnel to our facility in Milpitas and completed our obligations under thissublease agreement.

In September 2001, we decided to abandon thesmaller building at our San Jose facility based on revised anticipated demandfor our products and market conditions and as of December 31, 2006, wehave 

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signed three tenants tocover approximately 100% of such excess leased space. In September 2002,we decided to abandon a portion of the larger building at our San Jose facilitybased on revised anticipated demand for our products and market conditions.This excess space is located on the first floor of our current corporateheadquarters and originally housed a portion of our optics and integratedassemblies manufacturing operations. We are actively seeking tenants to occupythe excess leased space.

We believe that ourpresent facilities are in good condition and suitable for our operations. Wealso believe that we have excess capacity, which more than meets ouranticipated requirements for the foreseeable future.

**Item 3. LEGAL PROCEEDINGS**

From time to time we areinvolved in litigation, regulatory proceedings and claims that are incidentalto the conduct of our business in the ordinary course. While we currentlybelieve that any adverse outcome of such matters would not materially affectour business or financial condition, there can be no assurance that this willultimately be the case.

**Item 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

There were no matters submitted to a vote of securityholders in the fourth quarter of 2006.

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**PART II**

**Item 5.**                        MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

Ourcommon stock is listed on the NASDAQ Global Market and traded under the symbol “WJCI”.Prior to July 1, 2006, this market was called the NASDAQ National Market. Thefollowing table sets forth, for the periods indicated the high and low salesprices as reported on the NASDAQ Global Market for WJ Communications, Inc.common stock.
|                                                  | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------------|------------|----------|------------|---------|------------|
| First Quarter  (through April 3, 2005)      |       | $        | 3.68       |    | $          | 2.18 |   |
| Second Quarter  (through July 3, 2005)      |       | $        | 2.45       |    | $          | 1.68 |   |
| Third Quarter  (through October 2, 2005)    |       | $        | 1.87       |    | $          | 1.18 |   |
| Fourth Quarter  (through December 31, 2005) |       | $        | 1.95       |    | $          | 0.88 |   |
| First Quarter (through April 2, 2006)       |       | $        | 2.57       |    | $          | 1.58 |   |
| Second Quarter  (through July 2, 2006)      |       | $        | 3.10       |    | $          | 1.40 |   |
| Third Quarter  (through October 1, 2006)    |       | $        | 2.17       |    | $          | 1.29 |   |
| Fourth Quarter (through  December 31, 2006) |       | $        | 2.43       |    | $          | 1.38 |   |

 

As of December 31,2006, there were approximately 253 stockholders of record of our common stockaccording to our transfer agent.

**Issuer Purchases of EquitySecurities**

We did not repurchase anyshares of our common stock in the fourth quarter of 2006.

**Dividend Policy**

We did not pay anydividends in 2006 and 2005. We do not intend to pay cash dividends on ourcommon stock for the foreseeable future. Instead, we intend to retain allearnings for use in the operation and expansion of our business. Our board ofdirectors will make any future determination of the payment of dividends basedupon various factors then existing, including, but not limited to, ourfinancial condition, operating results and current and anticipated cash needs.In addition, covenants in our revolving credit facility limit our ability todeclare and pay cash dividends on our common stock.

**Recent Sales of UnregisteredSecurities**

We did not sell any of oursecurities that were not registered under the Securities Act during 2006 thatwere not otherwise previously reported by us on Form 8-K or Form 10-Q.

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**Equity CompensationPlan Information**

**Equity Compensation Table.****  **The following table sets forthinformation as of December 31, 2006, with respect WJ Communication’sequity compensation plans.

| **Plan Category**                                     | ** ** | ** ** | ** ** | **Number of Shares of  Common Stock to be  Issued Upon Exercise  of Outstanding  Options and Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding Options** | ** ** | **Number of Shares of Common  Stock Remaining Available for  Future Issuance Under Equity  Compensation Plans  (Excluding Shares Reflected  in the First Column)** | ** ** |
|------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  Compensation Plans Approved by Stockholders(1)     |       |       | 7,246,125  | (2)                                                                                                                                                          |       |                                                                        | $          | 1.33                                                                                                                                                                                                                                               |       |   |   | 4,215,459 | (3) |   |
| Equity Compensation  Plans Not Approved by Stockholders(4) |       |       | 1,642,155  |                                                                                                                                                         |       |                                                                        | $          | 1.72                                                                                                                                                                                                                                               |       |   |   | 304,972 |   |   |
|                                                            |            |            |            |                                                                                                                                                              |            |                                                                             |            |                                                                                                                                                                                                                                                    |            |  |  |  |  |  |  |  |  |

 

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(1)          The equity compensationplans approved by stockholders are the 2000 Stock Incentive Plan and theamended and restated 2000 Non-Employee Director Stock Compensation Plan.

(2)          Of these shares 366,000options were outstanding under the amended and restated 2000 Non-EmployeeDirector Stock Compensation Plan and 6,880,125 were outstanding under the 2000Employee Stock Incentive Plan.

(3)          Of these shares3,957,615 shares are available for issuance under the 2000 Stock Incentive Planand 257,844 shares are available for issuance under the amended and restated2000 Non-Employee Director Plan.

(4)          Theequity compensation plan not approved by stockholders is the 2001 EmployeeStock Incentive Plan. Key provisions of the plan are:

·       Theplan was adopted by the board of directors on May 23, 2001 and waseffective on that date. The plan will terminate on May 23, 2011, however,awards outstanding at that time will not be affected or impaired by the plan’stermination;

·       Participation is limited toour employees or affiliates who are not directors or officers of the Company orany of its affiliates at the time a particular award is made;

·       Stock options granted mayinclude incentive stock options, restricted stock, nonqualified stock optionsand stock appreciation rights or any combination thereof;

·       The plan shall beadministered by the Board or any committee that has been designated by theboard;

·       The term of each stockoption may in no event be more than 10 years; and

·       Upon a change of controltransaction as described in the plan, the committee may, in its solediscretion, do one or more of the following;

·        shorten the period duringwhich stock options are exercisable, provided they remain exercisable for atleast 30 days after the date notice of the shortening is given to theparticipants;

·        accelerate any vestingschedule to which a stock option or restricted stock award is subject;

·        arrange to have thesurviving or successor entity or any parent entity thereof assume therestricted stock awards and the stock options or grant replacement options withappropriate adjustments in the exercise prices and adjustments in the numberand kind of securities 

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issuable upon exercise oradjustments so that the stock options or their replacements represent the rightto purchase the shares of stock, securities or other property, including cash,as may be issuable or payable as a result of the change of control transactionwith respect to or in exchange for the number of shares of common stockpurchasable and receivable upon exercise of the stock options had such exerciseoccurred in full prior to the change of control transaction; or

·        cancel stock options orunvested stock awards upon payment to the participants in cash, with respect toeach stock option or restricted stock award to the extent then exercisable orvested, including, if applicable, any stock options or restricted stock awardsas to which the vesting schedule has been accelerated by decision of thecompensation committee because of the change of control transaction, of an amountthat is the equivalent of the excess of the fair market value of the commonstock at the effective time of the change of control transaction over, in thecase of stock options, the exercise price of the stock option.

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**Item 6.        SELECTED CONSOLIDATED FINANCIAL DATA**

Thefollowing selected consolidated financial data should be read in conjunctionwith the consolidated financial statements and notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andother financial data included elsewhere in this report. The statements ofoperations data for the years ended December 31, 2006, 2005 and 2004 andthe selected balance sheet data as of December 31, 2006 and 2005 arederived from our audited consolidated financial statements which are includedelsewhere in this annual report on Form 10-K. The statements ofoperations data for the years ended December 31, 2003 and 2002 and theselected consolidated balance sheet data as of December 31, 2004, 2003 and2002 are derived from our audited consolidated financial statements which arenot included in this annual report on Form 10-K. The historicalresults are not necessarily indicative of results to be expected for any futureperiod.

| ** **                                                                                 | ** **                   | **Year Ended December 31,**                         | ** **    |
|--------------------------------------------------------------------------------------------|------------------------------|--------------------------------------------------------------------|---------------|
| ** **                                                                                 | ** **                   | **2006**                                                           | ** **    | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                 | ** **                   | **(in thousands, except per share data)** | ** **    |
| **Consolidated Statements of  Operations Data:**                                           | ** **                   | ** **                                                         | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales, net                                                                                 | ** **                   | $                                                                  | 48,779        |   | $ | 31,597 |   | $ | 32,336 |   | $ | 26,565 |   | $ | 40,156 |   |
| Cost of goods sold                                                                         | ** **                   | 23,704                                                             |          | 16,906 |   | 15,278 |   | 15,495 |   | 28,892 |   |
| Gross profit                                                                               | ** **                   | 25,075                                                             |          | 14,691 |   | 17,058 |   | 11,070 |   | 11,264 |   |
| Operating  expenses:                                                                       | ** **                   |                                                               |          |   |   |   |   |   |   |   |   |
| Research and development                                                                   | ** **                   | 18,329                                                             |          | 18,070 |   | 17,238 |   | 16,882 |   | 17,882 |   |
| Selling and administrative                                                                 | ** **                   | 17,869                                                             |          | 15,295 |   | 12,503 |   | 10,251 |   | 11,167 |   |
| Acquired in-process research and development(1)                                            | ** **                   | —                                                             |          | 3,400 |   | 8,500 |   | — |   | — |   |
| Recapitalization merger(2)                                                                 | ** **                   | —                                                             |          | — |   | — |   | 680 |   | 509 |   |
| Restructuring charges (reversals)(3)                                                       | ** **                   | (286                                                               | )        | — |   | (3,845 | )  | (54 | )  | 34,233 |   |
| Total operating expenses                                                                   | ** **                   | 35,912                                                             |          | 36,765 |   | 34,396 |   | 27,759 |   | 63,791 |   |
| Loss from operations                                                                       | ** **                   | (10,837                                                            | )        | (22,074 | )  | (17,338 | )  | (16,689 | )  | (52,527 | ) |
| Interest income                                                                            | ** **                   | 1,241                                                              |          | 1,048 |   | 682 |   | 755 |   | 1,218 |   |
| Interest expense                                                                           | ** **                   | (83                                                                | )        | (96 | )  | (104 | )  | (117 | )  | (142 | ) |
| Other income—net                                                                      | ** **                   | (91                                                                | )        | 14 |   | 5 |   | 1,094 |   | 16 |   |
| Loss before income taxes                                                                   | ** **                   | (9,770                                                             | )        | (21,108 | )  | (16,755 | )  | (14,957 | )  | (51,435 | ) |
| Income tax benefit                                                                         | ** **    | (1,366                                                             | )   | (120 | )    | (7,674 | )   | (647 | )   | — |   |
| Net loss                                                                                   | ** **                   | $                                                                  | (8,404        | )  | $ | (20,988 | )  | $ | (9,081 | )  | $ | (14,310 | )  | $ | (51,435 | ) |
| Basic and diluted net loss per share                                                       | ** **                   | $                                                                  | (0.13         | )  | $ | (0.33 | )  | $ | (0.15 | )  | $ | (0.25 | )  | $ | (0.91 | ) |
| Shares used to  calculate loss from continuing operations per share—basic and diluted | ** **                   | 66,408                                                             |          | 64,162 |   | 60,397 |   | 56,835 |   | 56,291 |   |

 

| ** **                                     | ** ** | **December 31,**   | ** ** |
|------------------------------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| **Selected Consolidated Balance  Sheet Data:** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                      |       | $                       | 17,024     |   | $ | 14,169 |   | $ | 24,392 |   | $ | 10,900 |   | $ | 43,524 |   |
| Short-term investments                         |       | 8,399                   |       | 16,052 |   | 18,732 |   | 49,232 |   | 21,221 |   |
| Working capital                                |       | 22,969                  |       | 28,362 |   | 46,724 |   | 58,748 |   | 71,431 |   |
| Total assets                                   |       | 53,233                  |       | 61,644 |   | 69,733 |   | 79,820 |   | 95,548 |   |
| Total  stockholders’ equity               |       | 26,922                  |       | 31,117 |   | 41,297 |   | 36,239 |   | 49,618 |   |
|                                                |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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1)               During 2005, $3.4million of the purchase price for the acquisition of Telenexus, Inc. wasallocated to acquired in-process research and development expense (“IPRD”).

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During2004, $8.5 million of the purchase price for the acquisition of the wirelessinfrastructure business and associated assets from EiC was allocated to IPRD.

Forfurther discussion, see Management’s Discussion and Analysis of FinancialCondition and the Results of Operations under the caption “Acquired In-processResearch and Development Expenses” included elsewhere in this Form 10-K.

2)               Our 2003 and 2002recapitalization merger and other expense is a non-recurring expenditurecomprised of expenses incurred by the special committee to our Board ofDirectors to review a proposal from an affiliate, Fox Paine & CompanyLLC to acquire all of the shares of the Company’s common stock held byunaffiliated stockholders. In 2003, Fox Paine & Company LLC withdrewits proposal.

3)               The 2006restructuring benefit relates to a severance accrual of approximately $174,000in connection with the Milpitas fab shutdown offset by reversals ofrestructuring accruals of approximately $460,000. For further discussion of ourrestructuring charges, see Note 12 to the consolidated financial statementsincluded elsewhere in this Form 10-K.

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**Item 7.**                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS

*Special Notice Regarding Forward-LookingStatements. The following discussion and analysis contains forward-lookingstatements including financial projections, statements as to the plans andobjectives of management for future operations, and statements as to our futureeconomic performance, financial condition or results of operations. Theseforward-looking statements are not historical facts but rather are based oncurrent expectations, estimates, projections about our industry, our beliefsand our assumptions. Words such as “may,” “anticipates,” “expects,” “intends,” “plans,”“believes,” “seeks” and “estimates” and variations of these words and similarexpressions are intended to identify forward-looking statements. Our actualresults may differ materially from those projected in these forward-lookingstatements as a result of a number of factors, including, but not limited to,those factors described in “Risk Factors” above. Readers of this report arecautioned not to place undue reliance on these forward-looking statements.*

*The following discussion should be read in conjunctionwith our consolidated financial statements and related disclosures includedelsewhere in this annual report on Form 10-K. Except for historicactual results reported, the following discussion may contain predictions,estimates and other forward-looking statements that involve a number of risksand uncertainties. See “Special Notice Regarding Forward-looking Statements”above and “Risk Factors” above for a discussion of certain factors that couldcause future actual results to differ from those described in the followingdiscussion.*

**Overview**

We are a radio frequency (“RF”) semiconductor companyproviding RF product solutions worldwide to communications equipment companies.We design, develop and manufacture innovative, high performance products forboth current and next generation wireless and cable networks, and RFidentification (“RFID”) systems. Our RF product solutions are comprised ofadvanced, highly functional RF semiconductors, components and integratedassemblies which address the radio frequency challenges of these varioussystems. We currently generate the majority of our revenue from our productsutilized in wireless networks. Revenue from our products used in RFidentification systems represents a less significant portion of our currentrevenue however we believe they represent one of our future growthopportunities. The RF challenge is to create product designs that functionwithin the unique parameters of different wireless system architectures. Oursolution is comprised of design expertise, advanced device technology andmanufacturability. Our communications products are used by telecommunicationequipment manufacturers supporting and facilitating mobile communications,enhanced voice services, data and image transport. Our objective is to be theleading supplier of innovative RF semiconductors products.

During the fourth quarter of 2006, we announced ourdecision to cease internal wafer manufacturing in early 2007 and to adopt thefabless semiconductor business model. The fabless semiconductor model is morecost effective than having our own facility due to our limited volumes and thecost of developing and supporting our process technologies. There is a viablecommercial wafer foundry market which we plan to access for the production ofour wafers and we may enter into limited process development activities withsome of these vendors to further optimize the processes and our products.

In 2004 and 2005 we augmented our technology base anddesign capabilities with two acquisitions. On January 28, 2005 wecompleted our acquisition of Telenexus, Inc. (“Telenexus”). We believe theaddition of Telenexus’ RFID products and technology will allow us to continueto enhance our RFID reader offerings to further capitalize on the marketopportunity. On June 18, 2004, we completed our acquisition of thewireless infrastructure business and associated assets from EiC Corporation, aCalifornia corporation and EiC Enterprises Limited (together “EiC”). We believethat the addition of EiC’s technical expertise further enhances WJ’s strategyof offering customers what we believe to be industry leading products for thewireless infrastructure market.

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WJ Communications, Inc. (formerly Watkins JohnsonCompany, “we”, “us”, “our” or the “Company”) was formed after arecapitalization merger with Fox Paine on January 31, 2000. We wereoriginally incorporated in California and reincorporated in Delaware in August 2000.

Our principal executiveoffices are located at 401 River Oaks Parkway, San Jose, California 95134, andour telephone number at that location is (408) 577-6200. OurInternet address is*www.wj.com.*Ourannual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, amendments to those reports and otherSecurities and Exchange Commission, or SEC, filings are available free ofcharge through our website as soon as reasonably practicable after such reportsare electronically filed with, or furnished to, the SEC. The informationcontained on our website is not intended to be part of this report. Our commonstock is listed on the NasdaqGlobal Market and traded under the symbol “WJCI”.

*Sales*

We sell our products to a broad group ofcommunications original equipment manufacturers (“OEMs”) and their suppliersand subcontractors. Our major customers provide forecasted demand on at least amonthly basis, which assists us in managing our inventory requirements. Theseforecasts, however, are subject to changes, including changes as a result ofmarket conditions, and could fluctuate from quarter to quarter.

A majority of our sales in 2006 were to customersoutside of the United States. Sales to customers outside of the United Statesaccounted for approximately 52%, 44% and 35% of our sales in 2006, 2005 and2004, respectively. Most of our foreign sales were to customers located inChina.

We depend on a small number of customers for amajority of our sales. Sales to our customers, which individually account formore than 10% of our total annual sales were, in aggregate, 60%, 58% and 63% ofour sales in December 31, 2006, 2005 and 2004, respectively. We havediversified our customer base over the last few years and intend to furtherdiversify our customer base and product offering in the future. However, weanticipate that we will continue to sell a majority of our products to arelatively small group of customers.

In addition, most of oursales result from purchase orders or contracts that can be cancelled onshort-term notice. Delays in manufacturing or supply procurement or otherfactors, including general market slow downs, have caused and could potentiallycontinue to cause cancellation, reduction or delay in orders by or in shipmentsto a significant customer. If the markets for our products decline, fail togrow, or grow more slowly than we anticipate, the use of our products may bereduced with a significant negative impact on our sales, earnings, inventoryvaluations and cash flow. Generally, the selling prices of our products tend todecrease over time as a result of increased volumes or general competitivepressures and in general we expect that prices will continue to decline as aresult of volume increases or these competitive pressures.

*Cost of Goods Sold*

Our cost of goods sold consists primarily of directand indirect costs to produce our products and any write-downs for excess orobsolete product that we do not believe we will be able to sell.

We recognize cost of goodssold upon recognition of revenue. We recognize losses on contracts, includingpurchase order commitments, when identified. We have not recognized such lossesduring 2006, 2005 or 2004.

*Research andDevelopment*

Research and developmentexpense represents wages, supplies and allocated overhead costs to design,develop and improve products and processes. These costs are expensed asincurred. We generate revenues 

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fromdevelopment contracts with customers that have enabled us to accelerate our ownproduct development efforts. Such development revenues have only partiallyfunded our product development activities, and we generally retain ownership ofthe products developed under these arrangements. As a result, we classify alldevelopment costs related to these contracts as research and developmentexpenses.

*Selling andAdministrative*

Selling and administrativeexpense consists primarily of wages, travel and facility costs incurred by andother expenses allocated to our selling and administrative departments. Sellingand administrative expense also includes manufacturer representatives anddistributor sales commissions, trade show and advertising expenses and fees andexpenses of legal, accounting, and other professional consultants.

**Critical AccountingPolicies and Estimates**

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

We believe the followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements. SeeNote 2 to the consolidated financial statements included elsewhere in this Form 10-Kfor a detailed discussion of all our significant accounting policies.

*BusinessCombinations*

We allocate the purchase price of acquired companiesto the tangible and intangible assets acquired and in-process research anddevelopment based on their estimated fair values. Such valuations requiremanagement to make significant estimations and assumptions, especially withrespect to intangible assets.

Critical estimates invaluing certain intangible assets include but are not limited to: futureexpected cash flows from acquired developed technologies and patents, expectedcosts to develop the in-process research and development into commerciallyviable products and estimating cash flows from the projects when completed,customer contracts, customer lists, distribution agreements, also the brandawareness and the market position of the acquired products and assumptionsabout the period of time the brand will continue to be used in the combinedcompany’s product portfolio. Management’s estimates of fair value are basedupon assumptions believed to be reasonable, but which are inherently uncertainand unpredictable.

*Revenue Recognition*

We recognize revenue in accordance with SEC StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition.”  This SABrequires that four basic criteria must be met before revenue can berecognized:  (1) persuasive evidence of an arrangement exists; (2) deliveryhas occurred or services rendered; (3) the fee is fixed or determinable;and (4) collectibility is reasonably assured. Determination of criteria (3) and

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(4) are based onmanagement’s judgments regarding the fixed nature of the fee charged forproducts 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 regardingour distributors. We had previously recognized revenue upon shipment to ourdistributors less estimated reserves for distributor right of return,authorized price reductions for specific end-customer sales opportunities andprice protection based on known events and historical trends. Effective for oursecond quarter ended July 3, 2005, we recognize revenue from ourdistribution channels when our distributors have sold the product to the endcustomer. Historically, we have received stock rotation requests from ourdistributors that were within the amounts estimated and contractually allowedwith only one exception of an insignificant amount. However, the request forstock rotation during our second quarter ended July 3, 2005 was higherthan the amount contractually allowed. Our management, with the concurrence ofour Audit Committee, believed the increasing percentage of our new productintroductions makes it likely that stock rotation reserves will continue to bedifficult to estimate based on historical patterns and contractual provisions.Based on this change in facts and circumstances and our management’s futureexpectations, we believed that we could no longer reasonably estimate theamount of future returns from our distributors as of July 3, 2005. Accordingly,beginning in our second quarter of 2005, recognition of revenue and associatedcost of sales on shipments to distributors is deferred until the resale to theend customer. This change in application resulted in a $4.1 million revenue deferralin our second quarter of 2005. Although revenue is deferred until resale, titleof products sold to distributors transfers upon shipment. Accordingly,shipments to distributors are reflected in the consolidated balance sheets asaccounts receivable and a reduction of inventories at the time of shipment. Deferredrevenue and the corresponding cost of sales on shipments to distributors arereflected in the consolidated balance sheet on a net basis as “Deferred marginon distributor inventory.”  For furtherdiscussion, see Note 2 to the consolidated financial statements includedelsewhere in this Form 10-K.

Through the quarter ended April 3, 2005, revenuesfrom our distributors were recognized upon shipment based on the followingfactors:  our sales price was fixed or determinable by contract at thetime of shipment, payment terms were fixed at shipment and were consistent withterms granted to other customers, the distributor had full risk of physicalloss, the distributor had separate economic substance, we had no obligationwith respect to the resale of the distributor’s inventory, and we believed wecould reasonably estimate the potential returns from our distributor based ontheir history and our visibility in the distributor’s success with its productsand into the market place in general. In accordance with Financial AccountingStandards Board (“FASB”) Statement No. 48 “Revenue Recognition When Rightof Return Exists”, we accrued a reserve based on our reasonable estimate offuture returns based on historical trends and contractual limitations. As of April 3,2005, our distributor stock rotation reserve was $178,000.

Beginning in September 2003, we entered into aprogram where the distributor would receive a credit if it sold specificproduct at a reduced price to specific end-customers pre-authorized by us. Wemaintain a log of all such pre-authorized price reductions which we accrue as areduction to revenue in the period that the pre-authorization occurs per issue4 of EITF 01-9 “Accounting for Consideration Given by a Vendor to aCustomer (Including a Reseller of the Vendor’s Products).”  Through thequarter ended April 3, 2005, the Ship & Debit Allowance wasoffset solely by an offset to revenue. Since we began recognizing revenue fromour distribution channels only when our distributors have sold the product tothe end customer, the Ship & Debit allowance will offset revenue onlywhen the products with pre-authorized price reductions have shipped to theend-customer otherwise it will offset “Deferred margin on distributorinventory.” As of December 31, 2006 and 2005 our Ship &Debit Allowance was $249,000 and $34,000, respectively.

If we reduce the prices of our products as negotiatedwith the distributor, the distributor may receive a credit for the differencebetween the price paid by the distributor and the reduced price on applicableunsold products remaining in the distributor’s inventory on the effective dateof the price reduction 

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assuming that inventory isless than 24 months old as determined by the original invoice date. When werecognized revenue upon shipment to our distributors, we reserved fordistributor price protection per issue 4 of EITF 01-9 based on specificidentification of our initiated price reductions and the associated reporteddistributor inventory. There were no such price reductions in the years ended December 31,2006, 2005 or 2004.

We may enter intocontracts to perform research and development for others meeting therequirements of Statement of Financial Accounting Standards No. 68 “Researchand Development Arrangements”. Revenue under these development agreements isrecognized when applicable contractual non-refundable milestones have been met,including deliverables, and in any case, does not exceed the amount that wouldbe recognized using the percentage-of-completion accounting method based on theactual physical completion of work performed and the ratio of costs incurred tototal estimated costs to complete the contract in accordance with AccountingResearch Bulletin 45 “Long-Term Construction Type Contracts” using the relevantguidance in the American Institute of Certified Public Accountants Statement ofPosition (“SOP”) 81-1, Accounting for Performance of Construction-Typeand Certain Production-Type Contracts. For contracts including significantsoftware development efforts, the provisions of SOP 97-2 “SoftwareRevenue Recognition” are also followed. Given the duration and nature of thesedevelopment contracts, we believe that recognizing revenue under the percentagecompletion method best represents the legal and economic results of contractperformance on a timely basis. Losses on contracts are recognized whendetermined. Revisions in estimates are reflected in the period in which theconditions become known. These development contracts with customers haveenabled us to accelerate our own product development efforts. Such developmentrevenues have only partially funded our product development activities, and wegenerally retain ownership of the products developed under these arrangements.As a result, we classify all development costs related to these contracts asresearch and development expenses. The achievement of contractual milestones isevidenced by written documentation provided by the customer in accordance withthe applicable terms and conditions of each contract. In any period, progresson the contract is based on input measures (direct labor dollars, directmaterial costs and direct outside processing costs) in the ratio of costsincurred to total estimated costs. Estimated costs to complete are provided byengineering personnel directly involved in the development program and arereviewed by management and finance personnel for reasonableness given the knownfacts and circumstances. A number of internal and external factors can affectour estimates, including labor rates, utilization and efficiency variances andspecification and testing requirement changes. If different conditions were toprevail such that accurate estimates could not be made, then the use of thecompleted contract method would be required and the recognition of all revenueand costs would be deferred until the project was completed. Such a changecould have a material impact on our results of operations. If we bill thecustomer prior to performing services under the development agreement, theamounts are recorded as deferred revenue. Our balance of deferred revenuewas $424,000 and nil at December 31, 2006 and December 31, 2005,respectively.

*Stock-basedCompensation*

We adopted the provisions of, and account forstock-based compensation in accordance with, SFAS 123R effective January 1,2006. We elected the modified-prospective method, under which prior periods arenot revised for comparative purposes. Under the fair value recognition provisionsof this statement, stock-based compensation cost is measured at the grant datebased on the fair value of the award and is recognized as expense on astraight-line basis over the requisite service period, which is the vestingperiod.

We use the Black-Scholes option-pricing model todetermine the fair value of stock options and employee stock purchase planshares. The determination of the fair value of stock-based payment awards onthe date of grant using an option-pricing model is affected by our stock priceas well assumptions regarding a number of complex and subjective variables.These variables include our expected stock price 

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volatility over the termof the awards, actual and projected employee stock option exercise behaviors,risk-free interest rate and expected dividends.

We estimate the expected term of options granted byreviewing annual historical employee exercise behavior of option grants withsimilar vesting periods and the expected life assumptions of semiconductor peercompanies. Our estimate of pre-vesting option forfeitures is based onhistorical pre-vest termination rates and those of semiconductor peer companiesand we record stock-based compensation expense only for those awards that areexpected to vest. We considered (along with our own actual experience) theforfeiture rates of semiconductor peer companies due to our lack of extensivehistory. Our volatility assumption is forecasted based on our historicalvolatility over the expected term. We base the risk-free interest rate that weuse in the option-pricing model on U.S. Treasury zero-coupon issues withremaining terms similar to the expected term on the options. We do notanticipate paying any cash dividends in the foreseeable future and thereforeuse an expected dividend yield of zero in the option-pricing model. We arerequired to estimate forfeitures at the time of grant and revise thoseestimates in subsequent periods if actual forfeitures differ from thoseestimates. All share based payment awards are amortized on a straight-linebasis over the requisite service periods of the awards, which are generally thevesting periods.

If factors change and we employ different assumptionsfor estimating stock-based compensation expense in future periods or if wedecide to use a different valuation model, the future periods may differsignificantly from what we have recorded in the current period and couldmaterially affect our operating loss, net loss and net loss per share. Inaddition, we have issued options, restricted stock and performance acceleratedrestricted stock units whose vesting is based on the achievement of specifiedperformance targets. Stock-based compensation expense for these awards isrecognized when achievement of the performance targets is probable, except forthe performance accelerated restricted stock units where stock basedcompensation expense is recognized both on a graded vesting basis and whenachievement of the performance targets is probable. As a result of theunpredictability of the vesting of the performance-based options, restrictedstock and performance accelerated restricted stock units, our stock-basedcompensation expense is subject to fluctuation. The guidance in SFAS 123R andSAB 107 is relatively new. The application of these principles may be subjectto further interpretation and refinement over time. There are significantdifferences among valuation models, and there is a possibility that we willadopt different valuation models in the future. This may result in a lack ofconsistency in future periods and materially affect the fair value estimate ofstock-based payments. It may also result in a lack of comparability with othercompanies that use different models, methods and assumptions.

See Notes 2 and 8 to the condensed consolidated financialstatements for further information regarding the SFAS 123R disclosures.

*Write-down ofExcess and Obsolete Inventory*

We write down ourinventory for estimated obsolete or unmarketable inventory for the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions. Management specificallyidentifies obsolete products and analyzes historical usage, forecastedproduction generally based on a rolling twelve-month demand forecast, currenteconomic trends and historical write-offs when evaluating the valuation of ourinventory. Due to rapidly changing customer forecasts and orders, additionalwrite-downs of excess or obsolete inventory, while not currently expected,could be required in the future. Alternatively, the sale of previously writtendown inventory could result from unforeseen increases in customer demand.

*Valuation ofIntangible Assets and Goodwill*

We periodically evaluateour intangible assets and goodwill in accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” for indications of impairment whenever events orchanges in 

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circumstancesindicate that the carrying value may not be recoverable. Intangible assetsinclude goodwill and purchased technology. Factors we consider important thatcould trigger an impairment review include significant under-performancerelative to historical or projected future operating results, significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business, or significant negative industry or economic trends. If thesecriteria indicate that the value of the intangible asset may be impaired, anevaluation of the recoverability of the net carrying value of the asset overits remaining useful life is made. If this evaluation indicates that theintangible asset is not recoverable, the net carrying value of the relatedintangible asset will be reduced to fair value, and the remaining amortizationperiod may be adjusted. Any such impairment charge could be significant andcould have a material adverse effect on our reported financial statements ifand when an impairment charge is recorded. If an impairment charge isrecognized, the amortization related to intangible assets would decrease duringthe remainder of the fiscal year.

*Income Taxes*

In accordance with SFAS No. 5 “Accounting forContingencies,” the Company has established certain reserves for variousfederal, state and international income tax exposures. The reserves representour best estimate of the probable amount for our liability of income taxes,interest and penalties. The actual liability could differ significantly fromthe amount of the reserve, which could have a material effect on our results ofoperations. The tax benefit for the year ended December 31, 2006 of $1.4million resulted from a revision of our estimated tax liability based on thestatute of limitations expiration of certain estimated state tax exposuresduring 2006. As of December 31, 2006 the balance of the contingent incometax liability is $419,000.

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

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

*Restructuring*

During fiscal 2002 and 2001, we recorded significantrestructuring charges representing the direct costs of exiting certain productlines or businesses and the costs of downsizing our business. Such charges wereestablished in accordance with the then applicable accounting standards:Emerging Issues Task Force Issue 94-3 (“EITF 94-3”) “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (Including Certain Costs Incurred in a Restructuring)” and StaffAccounting Bulletin No. 100, “Restructuring and Impairment Charges.” Thesecharges include abandoned leased properties comprised of future lease paymentsnet of anticipated sublease income, broker commissions and other facilitycosts, and asset impairment charges on tenant improvements deemed no longerrealizable. In determining these estimates, we make certain assumptions withregards to our ability to sublease the space and reflect offsetting assumedsublease income in line with our best estimate of current market conditions.Should there be a further significant change in market conditions, the ultimatelosses on these could be 

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higher and such amountcould be material. Except for changes in the sublease estimates we have made fromtime to time, actual results to date have been consistent, in all materialrespects, with our assumptions at the time of the restructuring charges.

On October 30, 2006, the Company’s Board ofDirectors committed the Company to a restructuring plan to close and exit theCompany’s Milpitas fabrication facility (“fab”) during the first quarter of2007. The Milpitas fab produces some of the Company’s gallium arsenidesemiconductor products and has substantial excess capacity. The Company’s leaseof the fab expired on November 14, 2006 and in accordance with the termsof the lease the Company is continuing the lease on a month-to-month basisuntil the closure is complete. The 2006 restructuring benefit and reversals areestablished in accordance with the provisions of SFAS No. 146 “Accountingfor Costs Associated with Exit or Disposal Activities”.

The Company formed astrategic foundry relationship with Global CommunicationSemiconductors, Inc. (“GCS”) to second-source the manufacturing of itsGaAs and InGaP HBT wafers and GCS will become the sole source for theseproducts after closing of the Milpitas fab. The Company plans to produceadditional wafer inventory from its Milpitas fab to be used as a buffer in theevent of delayed qualifications from customers or ramp-up issues with GCS.

*Impairment ofLong-Lived Assets*

In accordance with Statement of Financial AccountingStandards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” we review long-lived assets for impairment whenever eventsor changes in circumstances indicate that the carrying amount of such assetsmay not be recoverable. Factors we consider that could trigger an impairmentreview include the following: significant underperformance relative to expectedhistorical or projected future operating results; significant changes in themanner of our use of the acquired assets or the strategy for our overallbusiness; significant negative industry or economic trends; or significanttechnological changes, which would render equipment and manufacturing processesobsolete. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of these assets to future undiscounted cashflows expected to be generated by these assets. If such assets are consideredto be impaired, the impairment to be recognized is measured by the amount bywhich the carrying amount of the assets exceeds the fair value of the assets.

Significant managementjudgment is required in the forecasting of future operating results which areused in the preparation of projected cash flows and should different conditionsprevail, material write downs of our long-lived assets could occur.

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**Current Operations**

Thefollowing table sets forth certain statements of operations data expressed as apercentage of sales for the periods indicated. As a result of our new products,changing market conditions and other factors, the historical percentages andcomparisons set forth below may not reflect our expected future operations.

| ** **                                          | ** ** | **Percentage of Sales**          | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
| ** **                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Consolidated Statements  of Operations Data:        |       |                                       |       |   |   |   |   |
| Sales, net                                          |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of goods sold                                  |       | 48.6                                       |       | 53.5 |   | 47.2 |   |
| Gross profit                                        |       | 51.4                                       |       | 46.5 |   | 52.8 |   |
| Operating  expenses:                                |       |                                       |       |   |   |   |   |
| Research and development                            |       | 37.6                                       |       | 57.2 |   | 53.3 |   |
| Selling and administrative                          |       | 36.6                                       |       | 48.4 |   | 38.7 |   |
| Acquired in-process research & development |       | —                                     |       | 10.7 |   | 26.3 |   |
| Restructuring charge (reversals)                    |       | (0.6                                       | )          | — |   | (11.9 | ) |
| Total operating expenses                            |       | 73.6                                       |       | 116.3 |   | 106.4 |   |
| Loss from operations                                |       | (22.2                                      | )          | (69.8 | ) | (53.6 | ) |
| Interest income                                     |       | 2.5                                        |       | 3.3 |   | 2.1 |   |
| Interest expense                                    |       | (0.1                                       | )          | (0.3 | ) | (0.3 | ) |
| Other income—net                               |       | (0.2                                       | )          | — |   | — |   |
| Loss before income taxes                            |       | (20.0                                      | )          | (66.8 | ) | (51.8 | ) |
| Income tax benefit                                  |       | 2.8                                        |       | 0.4 |   | 23.7 |   |
| Net loss                                            |       | (17.2                                      | )%         | (66.4 | )% | (28.1 | )% |

 

**Comparison of YearsEnded December 31, 2006, 2005 and 2004**

**Sales**

We recognized sales of $48.8 million, $31.6 million and $32.3 million in 2006, 2005 and 2004,respectively. The increase in sales in 2006 is due to the substantial increasein demand for our products in the wireless infrastructure market particularlyrelated to the growth of 3G systems. This increased demand was particularlystrong in Asia where sales increased 69% and Europe where sales increased 209%.Part of the sales growth in Asia and Europe is attributable to our directshipments to our distributor’s newly established overseas stocking hubs ratherthan shipping through the distributor’s stocking hub in the United States whichgives us greater visibility to end customer demand. Over the comparabletwelve-month periods, we have experienced an approximate 1% decrease in the mixweighted average selling price of our semiconductor products. Units shipped in2006 increased to 23.9 million units from 17.0 million units in 2005.  Sales in the comparable period in 2005 werealso impacted by the change in application of our revenue recognition policyregarding sales to our distributors resulting in a $4.1 million revenuedeferral in our second quarter of 2005. For further discussion, see Note 2 tothe condensed consolidated financial statements included elsewhere in thisForm 10-K.

Semiconductor and RFID sales during 2005 were $31.2million, representing 99% of total sales which was a $1.4 million or 5%increase in comparison to the comparable 2004’s sales of $29.8 million (92% oftotal sales). The increase in our semiconductor and RFID sales during 2005primarily related to our increasing sales in Asia (particularly China, whichincreased 29% and Korea, which increased 196%), our expanded product offeringdue to our acquisition of the wireless infrastructure business from EiCCorporation (representing $3.8 million of our semiconductor and RFID sales in2005 compared to $3.4 million in 2004 after the acquisition in June 2004)and an increase in our expanded RFID product offering 

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due to our acquisition ofTelenexus representing $1.2 million of our sales in 2005. During 2005, we haveexperienced an approximate 4% decrease in the average selling price of oursemiconductor products due to competitive pressure. The increase in our 2005sales was partially offset by a change inthe application of our revenue recognition policy from revenue recognition uponshipment to our distributors to revenue recognition when our distributors havesold the product to the end customer as discussed above under “CriticalAccounting Policies and Estimates”.

The increase in our semiconductor and radio frequency identification(“RFID”) sales in 2005 mitigated the declines in our wireless integratedassembly and fiber optic sales reflecting our strategic decision to focus ourcompetitive advantage and dedicate our resources to the radio frequency (“RF”)semiconductor market

Based on the same trends,we currently believe that our revenue will be in the range of $52 million to$55 million for 2007.

**Cost of Goods Sold**

Our cost of goods sold for 2006 was $23.7 million, anincrease of $6.8 million or 40% as compared with cost of goods sold of $16.9million in 2005. Our cost of goods sold for 2005 increased by $1.6 million or11% as compared with cost of goods sold of $15.3 million in 2004. As apercentage of sales, our cost of goods sold decreased to 49% in 2006 from 54% in2005 which increased from 47% in 2004. The 2006 decrease in our cost of goodssold as a percentage of sales reflects a favorable change in our product salesmix to higher margin semiconductor products. This decrease was partially offsetby inventory write-downs to reduce excess inventories to their estimated netrealizable value amounting to $1.6 million for 2006. The majority of the excessinventory write-down related to a faster than anticipated industry transitionto lead-free parts.  We also revised ourdepreciation estimates for certain equipment in the wafer fabrication facilityresulting in increased depreciation of $337,000 in the fourth quarter over whatthe depreciation amount would have been. See note 12 to the consolidatedfinancial statements for further information on our restructuring plan to closeand exit our Milpitas fabrication facility in the first quarter of 2007. The2005 increase in our cost of goods sold as a percentage of sales and inabsolute dollars reflected an increase percentage of newer products in ourproduct mix, which had not yet achieved the volumes, or yields of our moremature products

With our transition to afabless semiconductor manufacturing model and as our cost saving initiativesare realized, we expect cost of goods sold will decrease as a percentage ofsales on a full year basis, continuing the trend we demonstrated through 2006.

**Research andDevelopment**

Our 2006 research and development expense was $18.3million, an increase of $259,000 or 1% as compared with our research anddevelopment expense of $18.1 million for 2005. Our research and development for2005 increased by $832,000 or 5% as compared with research and developmentexpense of $17.2 million in 2004. The increase in research and developmentexpense in 2006 is primarily related to stock compensation expense related tothe adoption of SFAS 123R, additional effort on engineering developmentagreements, increased spending on design consulting services and engineeringwafer processing at outside foundries and which was partially offset by adecrease in overall overhead. The increase in expense in 2005 is primarilyrelated to the increased engineering staff and new product development effortsrelated to the products we acquired from Telenexus and increased spending ondesign consulting services which was largely offset by a decrease in overalloverhead.

The increase in research and development expense as apercentage of sales from 2004 to 2005 reflects the factors noted above as wellas the decrease in sales. We generate revenues from development contracts withcustomers that have enabled us to accelerate our own product developmentefforts. Such 

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development revenues haveonly partially funded our product development activities, and we generallyretain ownership of the products developed under these arrangements. As aresult, we classify all development costs related to these contracts asresearch and development expenses. We recorded revenue of $770,000 and $832,000under such development agreements in 2006 and 2005, respectively.

Product research anddevelopment is essential to our future success and we expect to continue makinginvestments in new product development and engineering talent. In 2007 we willcontinue to focus our research efforts and resources on semiconductordevelopment targeting multiple growth markets such as RF amplifiers, mixer andconverters for wireless infrastructure, Base Station Power amplifiers, WiMAXand RFID. We will also explore process capabilities of third party foundries anddevelop products under new process technologies such as SiGe BiCMOS. We expectexpenditures for new product development to increase although we expect adecrease in overall R&D expense during 2007 as a result of significantlyreducing process development costs as we move towards a fabless semiconductormanufacturing model.

**Selling andAdministrative**

Selling and administrative expense for 2006 was $17.9million or 37% of sales, an increase of $2.6 million or 17% as compared withselling and administrative expense of $15.3 million or 48% of sales in2005. During 2005 selling and administrative expense increased by$2.8 million or 22% as compared with selling and administrative expense of$12.5 million or 39% of sales in 2004. The increase in expense during 2006resulted from $656,000 increase in stock compensation expense related to theadoption of SFAS 123R, $637,000 intangible asset write off related to ourdecision to cease the use of the Telenexus trademark and trade names intangibleasset in favor of using the WJ Communications brand to market our RFIDproducts, $102,000 increase in salaries and wages due to increases in staffing,$353,000 increase in bonus, a $386,000 increase in professional service fees,$253,000 increase in travel expenses due to increased focus on our customers,$219,000 increase in recruiting fees related to staffing, and partially offsetby $448,000 decrease in severance payments to realign our workforce to ourcurrent objectives.

The increase in expenseduring 2005 related to a $1.2 million charge for a former CEO separationagreement, a $754,000 increase related to the acquired administrativeoperations of Telenexus, $445,000 of professional fees related to a potentialstrategic business combination which we decided not to consummate, a $412,000increase in legal fees resulting from additional corporate governancerequirements, a $646,000 charge related to severance and a $398,000 increase inexternal sales representatives commission due to the increase in semiconductorsales over the prior year’s period. These increased costs were partially offsetby a $267,000 decrease in bonus expense and a $156,000 decrease in insurancepremiums.

**Acquired In-processResearch and Development Expenses**

During 2005, $3.4 million of the purchase price forthe acquisition of Telenexus, Inc. was allocated to acquired in-processresearch and development expense (“IPRD”). Projects that qualify as in-processresearch and development represent those that have not yet reachedtechnological feasibility and have no future alternative use. Technologicalfeasibility is defined as being equivalent to a beta-phase working prototype inwhich there is minimal remaining risk relating to the development which theseprojects did not possess at the time of the acquisition. The value assigned toIPRD charge comprised the following projects:  multi-protocol readers($1.3 million), Smart readers ($900,000) and Class 3 readers ($1.2million). The value of these projects was determined by estimating thediscounted net cash flows from the sale of the products resulting from thecompletion of the projects, reduced by the portion of the revenue attributableto developed technology and the percentage of completion of the project. As of December 31,2006, these projects have been substantially completed within our estimatedcost.

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During 2004, $8.5 millionof the purchase price for the acquisition of the wireless infrastructurebusiness and associated assets from EiC was allocated to acquired in-processresearch and development expense (“IPRD”). Projects that qualify as in-processresearch and development represent those that have not yet reachedtechnological feasibility and have no future alternative use. Technologicalfeasibility is defined as being equivalent to a beta-phase working prototype inwhich there is no remaining risk relating to the development.

**RestructuringCharges**

On October 30, 2006, the Company committed to arestructuring plan to close and exit the Company’s Milpitas fabricationfacility (“fab”) during the first quarter of 2007. The Milpitas fab produces asubstantial portion of the Company’s gallium arsenide semiconductor productsand has substantial excess capacity. The Company’s lease of the fab expired on November 14,2006 and in accordance with the terms of the lease the Company is continuingthe lease on a month-to-month basis until the closure is complete.

The Company formed a strategic foundry relationshipwith Global Communication Semiconductors, Inc. (“GCS”) to second-sourcethe manufacturing of its GaAs and InGaP HBT wafers and GCS will become the solesource for these products after closing of the Milpitas fab. The Company plansto produce additional wafer inventory from its Milpitas fab to be used as abuffer in the event of delayed qualifications from customers or ramp-up issueswith GCS.

During the fourth quarter of 2006, $174,000 wasrecognized related to employee severance under the Fourth Quarter 2006Restructuring Plan, which was offset by reversals of restructuring accurals of approximately$460,000.

During 2004, we reversedthe lease loss associated with our internal wafer fabrication facility (“fab”)and remaining severance accrual under the Third Quarter 2002 and Fourth Quarter2002 Restructuring Plans due to our assessment and subsequent decision to notclose our fab as we believed at that time that integrating the newly acquiredfab from EiC with our pre-existing fab will offer the Company certain benefitsover outsourcing the pre-existing fab. This reversal was partially offset by anet increase in the lease loss accrual for our other leased facilities based onreductions in sublease occupancy rates and a net increase in facility operatingcosts.

**Interest Income**

Interest income representsinterest earned on cash equivalents and short-term available-for-saleinvestments. In 2006 our interest income was $1.2 million, an increase of$193,000 or 18% as compared with interest income of $1.0 million in 2005. Thisincrease resulted from an increase in interest rates offsetting a decrease inaverage funds available for investment. Our interest income for 2005 of $1.0million increased $366,000 or 54% as compared with interest income of $682,000in 2004. This increase also resulted from an increase in interest rates offsettinga decrease in average funds available for investment.

**Interest Expense**

Interest expense for 2006was $83,000, a decrease of $13,000 or 14% as compared with interest expense of$96,000 in 2005. Interest expense for 2005 was a decrease of $8,000 or 8% ascompared with interest expense of $104,000 in 2004. Interest expense for allperiods relates to fees associated with our revolving credit facility andoutstanding letters of credit.

**Income Tax Benefit**

In 2006 we recorded a nettax benefit of $1.4 million resulting from a revision of our estimated taxliability based on the statute of limitations expiration of certain estimatedstate tax exposures during 2006. 

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The taxbenefit for 2005 of $120,000 resulted as the statute of limitations had expiredon certain estimated federal tax exposures. In 2004, we recorded a tax benefitof $7.7 million resulted from a revision of our estimated income taxcontingency liability due to our receipt of the final assessment from theInternal Revenue Service related to the audit of the Company’s 1996 through2000 tax returns. As of December 31, 2006, the balance of the contingentincome tax liability was $419,000.

**Liquidity and Capital Resources**

Cash, cash equivalents andshort-term investments at December 31, 2006 were $25.4 million, a decreaseof $4.8 million or 16% compared to the balance of $30.2 million at December 31,2005.

On January 23, 2007,WJ Communications, Inc. (the “Company”) entered into a fifth amendmentwhich extends the maturity date from January 21, 2007 to June 30,2008 of its Amended and Restated Loan and Security Agreement (the “CreditFacility”) between Comerica Bank and the Company dated September 23, 2003and as amended June 13, 2005, July 12, 2005, September 28, 2005,and December 27, 2005. Comerica also provided the Company with a letteragreement that, starting on January 22, 2007, the Company had a 30-daygrace period until the credit facility automatically expired during whichperiod the credit facility remained in full force without lapse or termination.Interest rates on outstanding borrowings are periodically adjusted based oncertain financial ratios and are initially set, at our option, at LIBOR plus2.0% or Prime less 0.25%. The Revolving Facility requires us to maintaincertain financial ratios, (such as a minimum unrestricted cash balance and aminimum tangible net worth), and contains limitations on, among other things,our ability to incur indebtedness, pay dividends and make acquisitions withoutthe bank’s permission. The Revolving Facility is secured by substantially allof our assets. We were in compliance with the covenants as of December 31,2006. As of December 31, 2006 and December 31, 2005, there were nooutstanding borrowings under the Revolving Facility. We have letters of creditof $3.2 million available as of December 31, 2006 and 2005 that are beingused as collateral on our leased facilities.

**Net Cash Used by Operating Activities**

Net cash used byoperations was $4.8 million,  $10.4million and $15.4 million in 2006, 2005 and 2004, respectively. Net loss in2006, 2005 and 2004 was $8.4 million, $21.0 million and $9.1 million,respectively.

The most significant cashitem impacting the difference between net loss and cash flows used inoperations in 2006 was $2.4 million used by working capital. The $2.4 millionused by working capital primarily relates to a $2.6 million decrease inrestructuring liabilities and a $455,000 increase in inventories. The $2.6million decrease in restructuring liabilities primarily relates to paymentsagainst the remaining lease loss accrual. The $455,000 increase in inventoriesresulted from decreased cycle time in our wafer fabrication process and a $1.6 millionwrite-down to reduce excess inventories to their net realizable values.Non-cash items included in net loss in 2006 included $3.6 million ofdepreciation and amortization, $2.3 million of stock-based compensation expenseand $637,000 of intangible asset impairment.

The most significant cashitem impacting the difference between net loss and cash flows used inoperations in 2005 was $223,000 used by working capital. The $223,000 used byworking capital primarily relates to a $2.7 million decrease in restructuringliabilities which were partially offset by a $1.6 million increase in accrualsand accounts payable and a $516,000 decrease in inventories. The $2.7 milliondecrease in restructuring liabilities primarily relates to payments against theremaining lease loss accrual. The $1.6 million increase in accruals andaccounts payable relates primarily to the timing of payments within terms.Non-cash items included in net loss in 2005 included $3.1 million ofdepreciation and amortization and $3.4 million of IPRD related to ouracquisition of Telenexus, Inc.

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The most significant cashitem impacting the difference between net loss and cash flows used inoperations in 2004 was $7.6 million used in working capital. The $7.6 millionused in working capital primarily relates to a $2.3 million increase inreceivables, a $2.4 million decrease in restructuring liabilities, a $1.0million increase in other assets and a decrease of $867,000 in income taxcontingency liability. Our receivables increased $2.3 million due to increasedshipments during the fourth quarter of 2004. The $2.4 million decrease inrestructuring liabilities primarily relates to payments against the remaininglease loss accrual. The increase in other assets of $1.0 million is primarilydue to a $576,000 accrual of a settlement related to the termination of thesupply agreement with EiC (see Note 4 to the consolidated financial statementsincluded elsewhere in this Form 10-K) and a $560,000 increase inaccrued interest receivable related to our investments. The decrease of$867,000 in income taxes payable relates to payments resulting from an audit ofour 1996 through 2000 returns. Non-cash items included in net loss in 2004included $2.8 million of depreciation and amortization, $8.5 million of IPRDrelated to our acquisition of the wireless infrastructure business andassociated assets from EiC and $7.7 million related to a decrease in our incometax contingency liability resulted from a revised estimate of our taxcontingency liability related to the audit of our 1996 through 2000 tax returnsas a result of our receipt of the final assessment from the Internal RevenueService.

**Net Cash Provided(Used) by Investing Activities**

Net cash provided (used) by investing activities was$5.8 million, ($1.5) million and $18.2 million in 2006, 2005 and 2004, respectively.In 2006, we realized $29.6 million in proceeds from the sale and maturities ofour short term investments which was partially offset by $21.9 million used topurchase short-term investments and $2.1 million to invest in property, plantand equipment. In 2005, we used $34.9 million to purchase short-terminvestments, $3.2 million to acquire Telenexus, Inc. including associatedacquisition costs and $1.5 million to purchase equipment which was partiallyoffset by $37.6 million in proceeds we realized from the sale andmaturities of our short-term investments. In 2004, we realized $89.2 million inproceeds from the sale of short term investments which was partially offset by$59.3 million used to purchase short-term investments, $10.7 million of acquisitionand costs related to the EiC transaction (see Note 4 to the consolidatedfinancial statements included elsewhere in this Form 10-K) and$878,000 to invest in property, plant and equipment. During 2007, we expect toinvest approximately $4.0 million to $5.0 million in capital expenditures. Wehave funded our capital expenditures from cash, cash equivalents and short-terminvestments and expect to continue to do so during 2007

In conjunction with ouracquisitions, we may be required to pay additional consideration related to theachievement of specific revenue and gross margin targets. With respect to EiC,we determined that the revenue and gross margin targets that had to be achievedby March 31, 2005 and 2006 respectively were not achieved. We communicatedour conclusion to EiC and they notified us that they disagree with ourconclusions. We believe EiC’s assertions are without merit. Should we berequired to pay the additional consideration, it may be up to $14.0 million incash (10%) and shares (90%). With respect to Telenexus, we determined that therevenue targets that had to be achieved by October 28, 2006 were notachieved and we communicated our conclusion to the selling shareholders. TheTelenexus selling shareholders had thirty days to review and possibly contestour calculation. The Telenexus selling shareholders did not so notify us duringthe thirty day period.

**Net Cash Providedby Financing Activities**

Net cash provided by financing activities totaled $1.8million, $1.7 million and $10.7 million in 2006, 2005 and 2004,respectively. In 2006, we received net proceeds of $2.1 million from the saleof our common stock to employees through our employee stock purchase andoptions plans. In 2005, we received net proceeds of approximately $1.9 millionfrom the sale of our common stock to employees through our employee stockpurchase and option plans which was partially offset by $201,000 representing117,439 

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shares of our common stockwithheld from our former CEO to cover the income tax withholding on his receiptof 328,500 shares of restricted stock in connection with a severance agreementand $49,000 representing shares withheld from other employees. In 2004, wereceived net proceeds of $10.2 million related to our secondary public offeringof 2 million newly issued shares of our common stock and $1.5 million fromthe sale of our common stock to employees through our employee stock purchaseand option plans which was partially offset by $920,000 of cash used torepurchase our common stock under our stock repurchase program which expired onJuly 26, 2005 (see Note 8 to the consolidated financial statementsincluded elsewhere in the Form 10-K).

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

**ContractualObligations**

Thefollowing table summarizes our contractual obligations at December 31,2006 and the effect those obligations are expected to have on our liquidity andcash flow in future periods (in thousands):

| ** **                       | ** ** | **Payments due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| Capital lease  obligations       |       | $                                         | 19         |   | $ | 19 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Operating lease  obligations(1)  |       | 16,441                                    |       | 4,324 |   |   | 8,858 |   |   |   | 3,259 |   |   |   | — |   |   |
| Purchase  obligations(2)         |       | 3,212                                     |       | 3,200 |   |   | 12 |   |   |   | — |   |   |   | — |   |   |
| Total(4)                         |       | $                                         | 19,672     |   | $ | 7,543 |   |   | $ | 8,870 |   |   |   | $ | 3,259 |   |   |   | $ | — |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          We lease our twofacilities, including our executive offices in San Jose, California, underlease agreements that expire at various dates through 2011. Total future leaseobligations as of December 31, 2006, were $16.1 million, of which $10.5million was recorded as a liability for certain facilities that were includedin our restructuring accrual (current and long-term). The Milpitas facilitylease expired on November 14, 2006, and we are continuing to make leasepayments under the holdover provisions of the lease until we close the facilityin 2007.

(2)          Purchase obligations areprimarily orders for raw material, processed silicon wafers and assembly andtest services. While the purchase orders are generally cancelable withoutpenalty, certain vendor agreements provide for percentage-based cancellationfees or minimum restocking charges based on the nature of the product orservice. We expect to receive and pay for these materials and services withinthe next six months.

(3)          The only component ofOther Long-Term Liabilities that requires us to make cash payments is arestructuring accrual of $10.5 million relating to the future operating leasepayments on certain facilities that were included in our restructuring plans(See Note 12 to the consolidated financial statements included elsewhere inthis Form 10-K). We will make these payments through 2011. Weincluded these amounts in the operating lease total in the table above.Excluding payments under the operating lease component included in therestructuring accrual, the other components of Other Long-Term Liabilities donot contractually require us to make cash payments and primarily consist ofestimated operating costs on restructured facilities, deferred rent andestimated environmental costs

52

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(4)          The table above does notinclude possible contractual obligations related to our acquisition inJune 2004 of the wireless infrastructure business and associated assetsfrom EiC  which could have required theCompany to pay further consideration of up to $14 million if specific revenueand gross margin targets were achieved by March 31, 2005 and 2006. TheCompany has determined that the revenue and gross margin targets were not metfor both of the periods and this was communicated to EiC. EiC subsequentlynotified the Company that it disagrees with the Company’s conclusions. Whilethe Company believes EiC’s assertions were without merit and has notified EiCof such, there are no assurances as to the eventual outcome of this matter.

For purposes of the table above, obligations for thepurchase of goods or services are defined as agreements that are enforceableand legally binding and that specify all significant terms, including: fixed orminimum quantities to be purchased; fixed, minimum or variable priceprovisions; and the approximate timing of the transaction. Our purchase ordersare based on our current manufacturing needs and are typically fulfilled by ourvendors within short time horizons. We have additional purchase orders (notincluded in the table above) that represent authorizations to purchase ratherthan binding agreements. We do not have significant agreements for the purchaseof raw materials or other goods specifying minimum quantities or set pricesthat exceed our expected requirements.

The expected timing ofpayment of the obligations discussed above is estimated based on currentinformation. Timing of payments and actual amounts paid may be differentdepending on the time of receipt of goods or services or changes to agreed-uponamounts for some obligations.

**Off-Balance SheetArrangements**

We do not have any specialpurpose entities or off-balance sheet financing arrangements except foroperating leases as discussed in Note 10 to the consolidated financialstatements included elsewhere in this Form 10-K.

**Change in FilerStatus**

Commencing with thisannual report on Form 10-K we are no longer deemed to be anaccelerated filer because our public float was below the required threshold asof the last business day of our most recently completed second fiscal quarter.As a result of becoming a non-accelerated filer, we are permitted to elect tosuspend Sarbanes-Oxley Section 404 obligations to provide a management’sreport on internal control over financial reporting and related auditorattestation report. If we are still a non-accelerated filer in 2007 we would bepermitted to suspend the auditor attestation report for fiscal year 2007. Wehave elected to suspend our reporting obligations under Section 404 whichelection was approved by the Audit Committee. During the period we arepermitted to suspend our reporting obligations under Section 404, weestimate that such election will save approximately $175,000 annually inexternal costs.

**Other Matters**

***Recent Accounting Pronouncements***—In July 2006, the FASB issued Financial Interpretation No. 48,Accounting for Uncertainty in Income Taxes, (“FIN 48”) as an interpretation ofFASB Statement No. 109, Accounting for Income Taxes (“SFAS 109”). ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. FIN 48 is effective for usbeginning January 1, 2007. Differences between the amounts recognized inthe statements of financial position prior to the adoption of FIN 48 and theamounts reported after adoption should be accounted for as a cumulative-effectadjustment recorded to the beginning balance of retained earnings. 

53

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***The Company is currently evaluating the impact of adoptingFIN 48 on our Consolidated Financial Statements.***

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS 157”), which provides guidance for using fairvalue to measure assets and liabilities. The pronouncements clarifies (1) theextent to which companies measure assets and liabilities at fair value; (2) theinformation used to measure fair value; and (3) the effect that fair valuemeasurements have on earnings. SFAS 157 will apply whenever another standardrequires (or permits) assets or liabilities to be measured at fair value. SFAS 157is effective for the Company as of January 1, 2008. The Company iscurrently evaluating the impact this statement will have on our consolidatedfinancial statements.

In September 2006, the SEC issued SAB No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB No. 108”). SAB108 provides guidance on the consideration of the effects of prior yearmisstatements in quantifying current year misstatements for the purpose of amateriality assessment. SAB 108 establishes an approach that requiresquantification of financial statement errors based on the effects of each ofthe Company’s balance sheet, statement of operations and the related financialstatements disclosures. Early adoption of the guidance in SAB 108 is encouragedin the interim periods of fiscal year ending after November 15, 2006. TheCompany adopted SAB 108 as of the year ended December 31, 2006. Theadoption did not have a material impact on its consolidated results ofoperations and financial condition.

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159).SFAS No. 159 permits companies to choose to measure certain financialinstruments and certain other items at fair value. The standard requires thatunrealized gains and losses on items for which the fair value option has beenelected be reported in earnings. SFAS No. 159 is effective for the Companybeginning in the first quarter of fiscal year 2008, although earlier adoptionis permitted. The Company is currently evaluating the impact that SFAS No. 159will have on its consolidated financial statements

***Environmental Matters***—Of our former production facilities, two have known environmentalliabilities of significance, the Scotts Valley site and the Palo Alto site.Prior to the recapitalization merger, we entered into and funded fixed priceremediation contracts, as well as cost overrun and unknown pollution conditionsliability coverage, with respect to both these sites. For a more detaileddescription, see “Business—Environmental Matters.”

***Litigation***—From time to time we are involved in litigation,regulatory proceedings and claims that are incidental to the conduct of our business in the ordinarycourse. While we currently believe that any adverse outcome of such matters wouldnot materially affect our business or financial condition, there can be noassurance that this will ultimately be the case.

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**Item 7a.**                 QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The following discussion about our market riskdisclosures involves forward-looking statements. Actual results could differmaterially from those projected in the forward-looking statements. We areexposed to market risk related to changes in interest rates. We do not usederivative financial instruments for speculative or trading purposes.

*Cash,Cash Equivalents and Investments—**Cash*and cashequivalents consist of municipal bond funds and commercial paper acquired withremaining maturity periods of 90 days or less and are stated at cost plusaccrued interest which approximates market value. Short-term investmentsconsist primarily of high-grade debt securities (A rating or better) with maturitygreater than 90 days from the date of acquisition and are classified asavailable-for-sale. Short-term investments classified as available-for-sale arereported at fair market value with unrealized gains or losses excluded fromearnings and reported as a separate component of stockholders’ equity, net oftax, until realized. These available-for-sale securities are subject tointerest rate risk and will rise or fall in value if market interest rateschange. They are also subject to short-term market risk. We have the ability tohold our fixed income investments until maturity, and therefore we would notexpect our operating results or cash flows to be affected to any significantdegree by the effect of a sudden change in market interest rates on our investmentportfolio.

Thefollowing table provides information about our investment portfolio andconstitutes a “forward-looking statement.”  For investment securities, thetable presents principal cash flows and related weighted average interest ratesby expected maturity dates.

| ** **                            | ** ** | ** **                 | ** ** | **Weighted**              | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                            | ** ** | **Expected Maturity** | ** ** | **Average Interest** | ** ** |
| **Expected Maturity Dates** | ** ** | ** **                 | ** ** | **Amounts**               | ** ** | **Rate** | ** ** |
| ** **                            | ** ** | **(in thousands)**    | ** ** | ** **                | ** ** |
| Cash equivalents:                     |       |                       |       |                      |       |   |   |   |   |
| 2007                                  |       |                       | $          | 16,046                    |       |   |   | 4.98 | % |   |
| Short-term investments:               |       |                       |       |                      |       |   |   |   |   |
| 2007                                  |       |                       | 8,399      |                      |       |   | 5.28 | % |   |
| Fair value at  December 31, 2006 |       |                       | $          | 24,445                    |       |   |   |   |   |   |
|                                       |            |                            |            |                           |            |  |  |  |  |  |  |  |

 

55

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**Item 8.CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

**INDEX TO CONSOLIDATEDFINANCIAL STATEMENTS**
|                                                          | ** ** | **Page** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm |       |     | 57         |   |   |
| Consolidated  Balance Sheets                             |       |     | 58         |   |   |
| Consolidated Statements of Operations                    |       |     | 59         |   |   |
| Consolidated Statements of Comprehensive Loss            |       |     | 60         |   |   |
| Consolidated Statements of Stockholders’ Equity     |       |     | 61         |   |   |
| Consolidated Statements of Cash Flows                    |       |     | 63         |   |   |
| Notes to Consolidated Financial Statements               |       |     | 64         |   |   |

 

56

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To theBoard of Directors and Stockholders ofWJ Communications, Inc.**

We have audited the accompanying consolidated balancesheets of WJ Communications, Inc. and subsidiaries (the “Company”) as of December 31,2006 and 2005, and the related consolidated statements of operations,comprehensive loss, stockholders’ equity, and cash flows for each of the threeyears in the period ended December 31, 2006. Our audits also included thefinancial statement schedule listed in the Index at Item 15. Thesefinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thefinancial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. For the year ended December 31, 2006, the Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrols over financial reporting. Our audits included consideration of internalcontrols over financial reporting as a basis for designing audit proceduresthat are appropriate in the circumstances, but not for the purpose ofexpressing an opinion on the effectiveness of the Company’s internal controlsover financial reporting as of December 31, 2006. Accordingly, we expressno such opinion. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of WJCommunications, Inc. and subsidiaries at December 31, 2006 and 2005,and the results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2006, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, such financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly, inall material respects, the information set forth therein.

Asdescribed in Note 2 to the consolidated financial statements, the Companyadopted Statement of Financial Accounting Standards No. 123 (revised2004), “*Share-Based Payment*”,effective January 1, 2006.
| /S/ DELOITTE & TOUCHE LLP |   |
|------------------------------------|--------|
| San Jose, California               |   |
| March 28, 2007                |   |

 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(In thousands, exceptshare and per share amounts)

| ** **                                                                                                                                                 | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                 | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                 | ** ** |
| CURRENT ASSETS:                                                                                                                                            |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                  |       | $                     | 17,024     |   | $ | 14,169 |   |
| Short-term investments                                                                                                                                     |       | 8,399                 |       | 16,052 |   |
| Receivables (net of allowances of $417 and $122,  respectively)                                                                                            |       | 5,759                 |       | 7,135 |   |
| Inventories                                                                                                                                                |       | 5,281                 |       | 4,826 |   |
| Prepaid expenses and other                                                                                                                                 |       | 1,563                 |       | 2,632 |   |
| Total current assets                                                                                                                                       |       | 38,026                |       | 44,814 |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                                         |       | 7,232                 |       | 7,919 |   |
| Goodwill (Note 5)                                                                                                                                          |       | 6,834                 |       | 6,806 |   |
| Intangible  assets, net (Note 5)                                                                                                                           |       | 960                   |       | 1,884 |   |
| Other assets                                                                                                                                               |       | 181                   |       | 221 |   |
|                                                                                                                                                       |       | $                     | 53,233     |   | $ | 61,644 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                              | ** ** |
| CURRENT LIABILITIES:                                                                                                                                       |       |                  |       |   |   |
| Accounts payable                                                                                                                                           |       | $                     | 4,522      |   | $ | 4,220 |   |
| Accrued compensation and benefits                                                                                                                          |       | 1,966                 |       | 2,024 |   |
| Other accrued liabilities                                                                                                                                  |       | 2,114                 |       | 1,787 |   |
| Income tax contingency liability                                                                                                                           |       | 419                   |       | 1,818 |   |
| Deferred margin on distributor inventory                                                                                                                   |       | 2,824                 |       | 3,217 |   |
| Restructuring accrual (Note 12)                                                                                                                            |       | 3,212                 |       | 3,386 |   |
| Total current liabilities                                                                                                                                  |       | 15,057                |       | 16,452 |   |
| OTHER LONG-TERM  OBLIGATIONS (Notes 7 and 12)                                                                                                              |       | 11,254                |       | 14,075 |   |
| COMMITMENTS AND  CONTINGENCIES (Note10)                                                                                                                    |       |                  |       |   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                |       |                  |       |   |   |
| Preferred stock, $0.01 par value—10,000,000 shares  authorized, no shares issued and outstanding                                                      |       | —                |       | — |   |
| Common stock, $0.01 par value—100,000,000 shares  authorized, 69,354,888 and 67,455,845 shares issued and outstanding in 2006  and 2005, respectively |       | 693                   |       | 675 |   |
| Treasury stock—2,039,743 shares in 2006 and  1,922,063 shares in 2005                                                                                 |       | (20                   | )          | (19 | ) |
| Additional paid-in capital                                                                                                                                 |       | 208,840               |       | 205,320 |   |
| Accumulated deficit                                                                                                                                        |       | (182,591              | )          | (174,187 | ) |
| Other comprehensive loss                                                                                                                                   |       | —                |       | (9 | ) |
| Deferred stock compensation                                                                                                                                |       | —                |       | (663 | ) |
| Total stockholders’ equity                                                                                                                            |       | 26,922                |       | 31,117 |   |
|                                                                                                                                                       |       | $                     | 53,233     |   | $ | 61,644 |   |

 

**See notes to consolidated financial statements.**

58

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**(Inthousands, except per share amounts)

| ** **                                          | ** ** | **Year Ended**   | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                          | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sales, net                                          |       |                  | $          | 48,779 |   |   |   | $ | 31,597 |   |   |   | $ | 32,336 |   |   |
| Cost of goods  sold                                 |       |                  | 23,704     |   |   |   | 16,906 |   |   |   | 15,278 |   |   |
| Gross profit                                        |       |                  | 25,075     |   |   |   | 14,691 |   |   |   | 17,058 |   |   |
| Operating expenses:                                 |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Research and development                            |       |                  | 18,329     |   |   |   | 18,070 |   |   |   | 17,238 |   |   |
| Selling and administrative                          |       |                  | 17,869     |   |   |   | 15,295 |   |   |   | 12,503 |   |   |
| Acquired in-process research & development |       |                  | —     |   |   |   | 3,400 |   |   |   | 8,500 |   |   |
| Restructuring reversals (Note 12)                   |       |                  | (286       | ) |   |   | — |   |   |   | (3,845 | ) |   |
| Total operating expenses                            |       |                  | 35,912     |   |   |   | 36,765 |   |   |   | 34,396 |   |   |
| Loss from  operations                               |       |                  | (10,837    | ) |   |   | (22,074 | ) |   |   | (17,338 | ) |   |
| Interest income                                     |       |                  | 1,241      |   |   |   | 1,048 |   |   |   | 682 |   |   |
| Interest expense                                    |       |                  | (83        | ) |   |   | (96 | ) |   |   | (104 | ) |   |
| Other  expense/income—net                      |       |                  | (91        | ) |   |   | 14 |   |   |   | 5 |   |   |
| Loss before  income taxes                           |       |                  | (9,770     | ) |   |   | (21,108 | ) |   |   | (16,755 | ) |   |
| Income tax  benefit                                 |       |                  | (1,366     | ) |   |   | (120 | ) |   |   | (7,674 | ) |   |
| Net loss                                            |       |                  | $          | (8,404 | ) |   |   | $ | (20,988 | ) |   |   | $ | (9,081 | ) |   |
| Basic and diluted  net loss per share               |       |                  | $          | (0.13 | ) |   |   | $ | (0.33 | ) |   |   | $ | (0.15 | ) |   |
| Basic and diluted  average shares                   |       |                  | 66,408     |   |   |   | 64,162 |   |   |   | 60,397 |   |   |

 

**See notes to consolidated financial statements.**

59

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS**(Inthousands)

| ** **                                                                                                           | ** ** | **Year Ended**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                           | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss                                                                                                             |       |                  | $          | (8,404 | ) |   |   | $ | (20,988 | ) |   |   | $ | (9,081 | ) |   |
| Other comprehensive gains  (losses):                                                                                 |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains (losses) on securities  arising during period net of reclassification adjustments and taxes |       |                  | 9          |   |   |   | 3 |   |   |   | (4 | ) |   |
| Comprehensive loss                                                                                                   |       |                  | $          | (8,395 | ) |   |   | $ | (20,985 | ) |   |   | $ | (9,085 | ) |   |

 

**See notes to consolidated financial statements.**

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**WJCOMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**(Inthousands, except share amounts)
|                                                                                            | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** **  | ** ** | **Additional** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-------------|------------|-------------|------------|----------------|------------|
| ** **                                                                                 | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid-in** | ** ** |
| ** **                                                                                 | ** ** | **Shares**            | ** ** | **Dollars**             | ** ** | **Shares**  | ** ** | **Dollars** | ** ** | **Capital**    | ** ** |
| Balance,  December 31, 2003                                                           |       | 59,047,216            |       |                    | $          | 590         |       |        | (1,340,719 | )              |       | $ | (13 | ) |   | $ | 180,163 |   |
| Net loss                                                                                   |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Common stock issued                                                                        |       | 2,955,437             |       |                    | 30         |        |       | —      |       |           | —     |   |   | 12,942 |   |
| Exercise of stock options                                                                  |       | 934,107               |       |                    | 9          |        |       | —      |       |           | —     |   |   | 1,180 |   |
| Deferred stock compensation                                                                |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | 298 |   |
| Repurchases of common stock                                                                |       | —                |       |                    | —     |        |       | (429,053    | )          |           | (5         | ) |   | (915 | ) |
| Amortization of deferred stock compensation                                                |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Compensation charge due to option date extension        |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | 594 |   |
| Unrealized holding gains on securities                                                     |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Balance,  December 31, 2004                                                           |       | 62,936,760            |       |                    | 629        |        |       | (1,769,772  | )          |           | (18        | ) |   | 194,262 |   |
| Net loss                                                                                   |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Common stock issued                                                                        |       | 3,141,143             |       |                    | 32         |        |       | —      |       |           | —     |   |   | 9,953 |   |
| Exercise of stock options                                                                  |       | 1,377,942             |       |                    | 14         |        |       | —      |       |           | —     |   |   | 1,441 |   |
| Shares repurchased for tax withholding on employee  stock transactions                     |       | —                |       |                    | —     |        |       | (152,291    | )          |           | (1         | ) |   | (249 | ) |
| Amortization of deferred stock compensation                                                |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Elimination of deferred compensation related to  stock options forfeited                   |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | (87 | ) |
| Unrealized holding gains on securities                                                     |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Balance,  December 31, 2005                                                           |       | 67,455,845            |       |                    | 675        |        |       | (1,922,063  | )          |           | (19        | ) |   | 205,320 |   |
| Net loss                                                                                   |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Common stock issued                                                                        |       | 676,648               |       |                    | 6          |        |       | —      |       |           | —     |   |   | 462 |   |
| Exercise of stock options                                                                  |       | 1,222,395             |       |                    | 12         |        |       | —      |       |           | —     |   |   | 1,643 |   |
| Shares repurchased for tax withholding on employee  stock transactions                     |       | —                |       |                    | —     |        |       | (117,680    | )          |           | (1         | ) |   | (251 | ) |
| Stock-based compensation                                                                   |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | 2,329 |   |
| Reclassification of deferred stock  compensation upon adoption of SFAS 123R      |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | (663 | ) |
| Unrealized holding gains on securities                                                     |       | —                |       |                    | —     |        |       | —      |       |           | —     |   |   | — |   |
| Balance,  December 31, 2006                                                           |       | 69,354,888            |       |                    | $          | 693         |       |        | (2,039,743 | )              |       | $ | (20 | ) |   | $ | 208,840 |   |

 

**See notes to consolidated financial statements.**

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)**

(In thousands, except share amounts)

| ** **                                                                       | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Loss** | ** ** | **Deferred  Stock  Compensation** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| Balance, December 31,  2003                                                 |       |                     | $          | (144,118                       | )          |                              |       | $                                     | (8         | ) |   |   | $ | (375 | ) |   |   | $ | 36,239 |   |   |
| Net loss                                                                         |       |                     | (9,081     | )                              |       |                              | —     |                                  |       |   | — |   |   |   | (9,081 | ) |   |
| Common stock issued                                                              |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 12,972 |   |   |
| Exercise of stock options                                                        |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 1,189 |   |   |
| Deferred stock compensation                                                      |       |                     | —     |                           |       |                              | —     |                                  |       |   | (298 | ) |   |   | — |   |   |
| Repurchases of common stock                                                      |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | (920 | ) |   |
| Amortization of deferred stock compensation                                      |       |                     | —     |                           |       |                              | —     |                                  |       |   | 308 |   |   |   | 308 |   |   |
| Compensation charge due to option date extension                                 |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 594 |   |   |
| Unrealized holding gains on securities                                           |       |                     | —     |                           |       |                              | (4         | )                                     |       |   | — |   |   |   | (4 | ) |   |
| Balance,  December 31, 2004                                                 |       |                     | (153,199   | )                              |       |                              | (12        | )                                     |       |   | (365 | ) |   |   | 41,297 |   |   |
| Net loss                                                                         |       |                     | (20,988    | )                              |       |                              | —     |                                  |       |   | — |   |   |   | (20,988 | ) |   |
| Common stock issued                                                              |       |                     | —     |                           |       |                              | —     |                                  |       |   | (1,302 | ) |   |   | 8,683 |   |   |
| Exercise of stock options                                                        |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 1,455 |   |   |
| Shares repurchased for tax withholding on employee  stock transactions           |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | (250 | ) |   |
| Amortization of deferred stock compensation                                      |       |                     | —     |                           |       |                              | —     |                                  |       |   | 917 |   |   |   | 917 |   |   |
| Elimination of deferred compensation related to  stock options forfeited         |       |                     | —     |                           |       |                              | —     |                                  |       |   | 87 |   |   |   | — |   |   |
| Unrealized holding gains on securities                                           |       |                     | —     |                           |       |                              | 3          |                                  |       |   | — |   |   |   | 3 |   |   |
| Balance,  December 31, 2005                                                 |       |                     | (174,187   | )                              |       |                              | (9         | )                                     |       |   | (663 | ) |   |   | 31,117 |   |   |
| Net loss                                                                         |       |                     | (8,404     | )                              |       |                              | —     |                                  |       |   | — |   |   |   | (8,404 | ) |   |
| Common stock issued                                                              |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 468 |   |   |
| Exercise of stock options                                                        |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 1,655 |   |   |
| Shares repurchased for tax withholding on employee  stock transactions           |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | (252 | ) |   |
| Stock-based compensation                                                         |       |                     | —     |                           |       |                              | —     |                                  |       |   | — |   |   |   | 2,329 |   |   |
| Reclassification of deferred stock compensation upon  adoption of SFAS 123R |       |                     | —     |                           |       |                              | —     |                                  |       |   | 663 |   |   |   | — |   |   |
| Unrealized holding gains on securities                                           |       |                     | —     |                           |       |                              | 9          |                                  |       |   | — |   |   |   | 9 |   |   |
| Balance,  December 31, 2006                                                 |       |                     | $          | (182,591                       | )          |                              |       | $                                     | —     |   |   |   | $ | — |   |   |   | $ | 26,922 |   |   |

 

**See notes to consolidated financial statements.**

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**(Inthousands)

| ** **                                                                   | ** ** | **Year Ended**         | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
| **OPERATING ACTIVITIES:**                                                    | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net loss                                                                     |       |                        | $          | (8,404 | ) |   |   | $ | (20,988 | ) |   |   | $ | (9,081 | ) |   |
| Adjustments to reconcile  net loss to net cash used by operating activities: |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Non-cash  restructuring charges (reversals)                                  |       |                        | (286       | ) |   |   | 54 |   |   |   | (3,804 | ) |   |
| Intangible assets  impairment                                                |       |                        | 637        |   |   |   | — |   |   |   | — |   |   |
| Depreciation and  amortization                                               |       |                        | 3,599      |   |   |   | 3,117 |   |   |   | 2,825 |   |   |
| Acquired  in-process research and development                                |       |                        | —     |   |   |   | 3,400 |   |   |   | 8,500 |   |   |
| Amortization of  premiums on short-term investments                          |       |                        | (31        | ) |   |   | 161 |   |   |   | 485 |   |   |
| Net (gain) loss on  disposal of property, plant & equipment         |       |                        | (169       | ) |   |   | 25 |   |   |   | (4 | ) |   |
| Stock based  compensation                                                    |       |                        | 2,329      |   |   |   | 920 |   |   |   | 902 |   |   |
| Amortization of  deferred financing costs                                    |       |                        | 33         |   |   |   | 39 |   |   |   | 41 |   |   |
| Allowance for  doubtful accounts                                             |       |                        | 54         |   |   |   | 20 |   |   |   | 58 |   |   |
| Asset retirement obligations                                                 |       |                        | (109       | ) |   |   | — |   |   |   | — |   |   |
| Net changes in:                                                              |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Receivables                                                                  |       |                        | 1,294      |   |   |   | 26 |   |   |   | (2,340 | ) |   |
| Inventories                                                                  |       |                        | (455       | ) |   |   | 516 |   |   |   | (689 | ) |   |
| Other assets                                                                 |       |                        | 1,068      |   |   |   | 354 |   |   |   | (1,021 | ) |   |
| Accruals and  accounts payable                                               |       |                        | 75         |   |   |   | 1,586 |   |   |   | (311 | ) |   |
| Income tax  contingency liability                                            |       |                        | (1,400     | ) |   |   | (128 | ) |   |   | (8,544 | ) |   |
| Deferred margin on  distributor inventory                                    |       |                        | (393       | ) |   |   | 3,216 |   |   |   | — |   |   |
| Restructuring  liabilities                                                   |       |                        | (2,605     | ) |   |   | (2,697 | ) |   |   | (2,404 | ) |   |
| Net cash (used) by  operating activities                                     |       |                        | (4,763     | ) |   |   | (10,379 | ) |   |   | (15,387 | ) |   |
| **INVESTING ACTIVITIES:**                                                    | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Purchases of  property, plant and equipment                                  |       |                        | (2,135     | ) |   |   | (1,476 | ) |   |   | (878 | ) |   |
| Purchase of  short-term investments                                          |       |                        | (21,852    | ) |   |   | (34,854 | ) |   |   | (59,327 | ) |   |
| Proceeds from sale  and maturities of short-term investments                 |       |                        | 29,550     |   |   |   | 37,591 |   |   |   | 89,170 |   |   |
| Proceeds on  product line sales and assets retirements                       |       |                        | 244        |   |   |   | 500 |   |   |   | 9 |   |   |
| Acquisition of  Telenexus and related costs                                  |       |                        | —     |   |   |   | (3,218 | ) |   |   | — |   |   |
| Acquisition of EiC  and related costs                                        |       |                        | —     |   |   |   | (37 | ) |   |   | (10,747 | ) |   |
| Net cash provided  (used) by investing activities                            |       |                        | 5,807      |   |   |   | (1,494 | ) |   |   | 18,227 |   |   |
| **FINANCING ACTIVITIES:**                                                    | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Principal payments  on capital lease                                         |       |                        | (29        | ) |   |   | — |   |   |   | — |   |   |
| Payments on  long-term borrowings                                            |       |                        | (31        | ) |   |   | (47 | ) |   |   | (104 | ) |   |
| Net proceeds from  issuances of common stock                                 |       |                        | 2,123      |   |   |   | 1,947 |   |   |   | 11,676 |   |   |
| Repurchase of  common stock                                                  |       |                        | (252       | ) |   |   | (250 | ) |   |   | (920 | ) |   |
| Net cash provided  by financing activities                                   |       |                        | 1,811      |   |   |   | 1,650 |   |   |   | 10,652 |   |   |
| Net increase (decrease)  in cash and equivalents                             |       |                        | 2,855      |   |   |   | (10,223 | ) |   |   | 13,492 |   |   |
| Cash and cash equivalents  at beginning of year                              |       |                        | 14,169     |   |   |   | 24,392 |   |   |   | 10,900 |   |   |
| Cash and cash equivalents  at end of year                                    |       |                        | $          | 17,024 |   |   |   | $ | 14,169 |   |   |   | $ | 24,392 |   |   |
| Other cash flow information:                                                 |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Income taxes paid,  net                                                      |       |                        | $          | 51 |   |   |   | $ | 10 |   |   |   | $ | 867 |   |   |
| Interest paid                                                                |       |                        | 48         |   |   |   | 57 |   |   |   | 63 |   |   |
| Non-cash investing and financing activities:                                 |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Increase in  accounts payable related to property, plant and equipment       |       |                        | 374        |   |   |   | — |   |   |   | — |   |   |
| Issuance of common  stock for Telenexus acquisition                          |       |                        | —     |   |   |   | 8,190 |   |   |   | — |   |   |
| Issuance of common  stock for EiC acquisition                                |       |                        | —     |   |   |   | — |   |   |   | 2,484 |   |   |

 

**See notes to consolidated financial statements.**

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.ORGANIZATION AND OPERATIONS OF THE COMPANY**

WJ Communications, Inc. (formerly Watkins JohnsonCompany, “we”, “us”, “our” or the “Company”) was formed after arecapitalization merger with Fox Paine on January 31, 2000. We wereoriginally incorporated in California and reincorporated in Delaware in August 2000.

We are a radio frequency (“RF”)semiconductor company providing RF product solutions worldwide tocommunications equipment companies. We design, develop and manufactureinnovative, high performance products for both current and next generationwireless and cable networks, and RF identification (“RFID”) systems. Our RFproduct solutions are comprised of advanced, highly functional RFsemiconductors, components and integrated assemblies which address the radiofrequency challenges of these various systems. We currently generate themajority of our revenue from our products utilized in wireless networks.Revenue from our products used in RF identification systems represents a lesssignificant portion of our current revenue however we believe they representone of our future growth opportunities. The RF challenge is to create productdesigns that function within the unique parameters of different wireless systemarchitectures. Our solution is comprised of design expertise, advanced devicetechnology and manufacturability. Our communications products are used bytelecommunication equipment manufacturers supporting and facilitating mobilecommunications, enhanced voice services, data and image transport. Ourobjective is to be the leading supplier of innovative RF semiconductorsproducts.

**2. SIGNIFICANT ACCOUNTINGPOLICIES**

PRINCIPLES OF CONSOLIDATION—The consolidated financialstatements include the accounts of the Company and its subsidiaries afterelimination of all intercompany balances and transactions.

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS—Cashand cash equivalents consist of money market funds and commercial paperacquired with remaining maturities of 90 days or less and are stated at cost plusaccrued interest which approximates market value. Short-term investmentsconsist primarily of high-grade debt securities (A rating or better) withmaturities greater than 90 days from the date of acquisition and are classifiedas available-for-sale. Short-term investments classified as available-for-saleare reported at fair market value with unrealized gains or losses excluded fromearnings and reported as other comprehensive income (loss), a separatecomponent of stockholders’ equity, net of tax, until realized. Realized gainsand losses are included in the accompanying consolidated statements ofoperations as other income—net.

FAIR VALUE OF FINANCIAL INSTRUMENTS—The carrying valueof cash and equivalents, receivables and accounts payable are a reasonableapproximation of their fair market value due to the short-term maturities ofthose instruments. Short-term investments are classified as available-for-saleand reported at fair market value with unrealized gains or losses excluded fromearnings and reported as a separate component of stockholders’ equity, net oftax, until realized.

INVENTORIES—Inventories are stated at the lower ofcost, using average-cost basis, or market. Cost of inventory items is based onpurchase and production cost including labor and overhead. Write-downs, whenrequired, are made to reduce excess inventories to their estimated netrealizable values. Such estimates are based on assumptions regarding futuredemand and market conditions. These write-downs amounted to approximately $1.6million in the year ended December 31, 2006, $1.0 million and $670,000 forthe years ended December 31, 2005 and 2004, respectively. If actualconditions become less favorable 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2. SIGNIFICANT ACCOUNTING POLICIES(Continued)**

than the assumptions used, an additional inventorywrite-down may be required. Inventories, at December 31, 2006 and 2005consisted of the following (in thousands):

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Finished goods           |       | $                     | 1,661      |   | $ | 1,683 |   |
| Work in progress         |       | 1,808                 |       | 1,697 |   |
| Raw materials and  parts |       | 1,812                 |       | 1,446 |   |
|                     |       | $                     | 5,281      |   | $ | 4,826 |   |

 

PROPERTY, PLANT AND EQUIPMENT—Property, plant andequipment are stated at cost. Provision for depreciation and amortization isprimarily based on the straight-line method over the assets’ estimated usefullives ranging from four to ten years. Leasehold improvements are amortized overthe shorter of the remaining lease term or the asset’s useful life. Costsincurred to maintain property, plant and equipment that do not increase theuseful life of the underlying asset are expensed as incurred. Asset retirementobligations are amortized over the useful life of the related asset.

At December 31,2006 and 2005 property, plant and equipment consisted of the following (inthousands):

| ** **                                 | ** ** | ** **                          | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **Estimated Useful Life** | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Buildings and  leasehold improvements      |       |                                | 4-10 years |                  |       | $ | 5,109 |   | $ | 5,063 |   |
| Machinery and  equipment                   |       |                                | 5-7 yrs    |                  |       | 25,289 |   | 24,696 |   |
|                                       |       |                                |       |                  |       | 30,398 |   | 29,759 |   |
| Accumulated  depreciation and amortization |       |                                |       |                  |       | (23,166 | ) | (21,840 | ) |
| Property, plant and  equipment—net    |       |                                |       |                  |       | $ | 7,232 |   | $ | 7,919 |   |

 

IMPAIRMENT OF LONG-LIVED ASSETS—In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, the Company reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying amount of such assets may not be recoverable.Factors the Company considers that could trigger an impairment review includethe following:  significant underperformance relative to expectedhistorical or projected, future operating results; significant changes in themanner of use of the acquired assets or the strategy for the overall business;significant negative industry or economic trends; or significant technologicalchanges, which would render equipment and manufacturing processes obsolete.Recoverability of assets to be held and used is measured by a comparison of thecarrying amount of these assets to future undiscounted cash flows expected tobe generated by these assets. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets The Companyrecognized an impairment loss of $637,000 in 2006 relating to certain acquiredintangible assets that the Company discontinued using in 2006 (see Note 5). Noimpairment losses were incurred in 2005 and 2004. The Company revised itsdepreciation estimates for certain equipment in the wafer fabrication facilityresulting in increased depreciation of $337,000 in the fourth quarter over whatthe depreciation amount would have been. See note 12 to the condensedconsolidated financial statements for 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.SIGNIFICANT ACCOUNTING POLICIES (Continued)**

further information on theCompany’s restructuring plan to close and exit the Milpitas fabricationfacility in the first quarter of 2007.

REVENUE RECOGNITION—The Company recognizes revenue inaccordance with SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition.”SAB 104 requires that four basic criteria must be met before revenue can berecognized:  (1) persuasive evidence of an arrangement exists; (2) deliveryhas 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 thefee charged for products delivered and the collectibility of those fees.Effective the second quarter ended July 3, 2005, the Company changed theapplication of its revenue recognition policy regarding its distributors. TheCompany had previously recognized revenue upon shipment to its distributorsless estimated reserves for distributor right of return, authorized price reductionsfor specific end-customer sales opportunities and price protection based onknown events and historical trends. Effective for the second quarter ended July 3,2005, the Company recognizes revenue from its distribution channels when itsdistributors have sold the product to the end customer. Historically, theCompany has received stock rotation requests from the Company’s distributorsthat were within the amounts estimated and contractually allowed with only oneexception of an insignificant amount. However, the request for stock rotationduring our second quarter ended July 3, 2005 was higher than the amountcontractually allowed. The Company’s management, with the concurrence of theCompany’s Audit Committee, believes the increasing percentage of new productsintroduced by the Company makes it likely that stock rotation reserves willcontinue to be difficult to estimate based on historical patterns andcontractual provisions. Based on this change in facts and circumstances and ourmanagement’s future expectations, the Company believes that the Company can nolonger reasonably estimate the amount of future returns from our distributorsas of July 3, 2005. Accordingly, recognition of revenue and associatedcost of sales on shipments to distributors is deferred until the resale to theend customer. This change in application resulted in a $4.1 million revenuedeferral in the Company’s second quarter of 2005, which is reflected in theaccompanying consolidated statements of operations for 2005. Although revenueis deferred until resale, title of products sold to distributors transfers uponshipment. Accordingly, shipments to distributors are reflected in theconsolidated balance sheets as accounts receivable and a reduction ofinventories at the time of shipment. Deferred revenue and the correspondingcost of sales on shipments to distributors are reflected in the consolidatedbalance sheet on a net basis as “Deferred margin on distributor inventory.”

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

*AuthorizedPrice Reductions for Specific End-Customer Sales Opportunities (“Ship &Debit Allowance”):*   Beginning in September 2003,the Company entered into a program where the distributor would receive a creditif it sold specific product at a reduced price to specific end-customerspre-authorized by the Company. Through the quarter ended April 3, 2005,the Ship & Debit Allowance was recognized as an offset to revenue inthe period such pre-authorization occurred. Since the Company began recognizingrevenue from its distributor channels only when the Company’s distributors soldthe product to the end customers, the Ship & Debit Allowance willoffset revenue only when the products with pre-authorized price reductions havebeen shipped to the end-customer otherwise it will offset “Deferred margin on 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.SIGNIFICANT ACCOUNTING POLICIES (Continued)**

distributor inventory”. Asof December 31, 2006, 2005 and 2004, the Company’s Ship & DebitAllowance was $249,000, $34,000 and $5,000, respectively.

*DistributorRight of Return:**  *Inaccordance with Financial Accounting Standards Board (“FASB”) Statement No. 48“Revenue Recognition When Right of Return Exists”, the Company accrued areserve based on its reasonable estimate of future returns based on historicaltrends and contractual limitations. Per contractual agreement, the distributormay return product three times per year under certain conditions. Due to theCompany’s change in application of its revenue recognition policy regarding itsdistributors, the Company no longer accrues a distributor stock rotationreserve. As of December 31, 2004, the Company’s distributor stock rotationreserve was $338,000.

*DistributorPrice Protection:*   If the Company reduces theprices of its products as negotiated with the distributor, the distributor mayreceive a credit for the difference between the price paid by the distributorand the reduced price on applicable unsold products remaining in the distributor’sinventory on the effective date of the price reduction assuming that inventoryis less than 24 months old as determined by the original invoice date. When theCompany recognized revenue upon shipment to its distributors, the Companyreserved for distributor price protection per issue 4 of EITF 01-9 basedon specific identification of its initiated price reductions and the associatedreported distributor inventory. There were no such price reductions in 2006,2005 or 2004.

*DevelopmentContracts:*   The Company may enter into contractsto perform research and development for others meeting the requirements ofStatement of Financial Accounting Standards No. 68 “Research andDevelopment Arrangements”. Revenue under these development agreements is recognizedwhen applicable contractual non-refundable milestones have been met, includingdeliverables, and in any case, does not exceed the amount that would berecognized using the percentage-of-completion accounting method based on theactual physical completion of work performed and the ratio of costs incurred tototal estimated costs to complete the contract in accordance with AccountingResearch Bulletin 45 “Long-Term Construction Type Contracts” using the relevantguidance in the American Institute of Certified Public Accountants Statement ofPosition (“SOP”) 81-1, Accounting for Performance of Construction-Typeand Certain Production-Type Contracts. For contracts including significantsoftware development efforts, the provisions of SOP 97-2 “Software RevenueRecognition” are also followed. Given the duration and nature of thesedevelopment contracts, the Company believes that recognizing revenue under thepercentage completion method best represents the legal and economic results ofcontract performance on a timely basis. Losses on contracts are recognized whendetermined. Revisions in estimates are reflected in the period in which theconditions become known. These development contracts with customers haveenabled the Company to accelerate its own product development efforts. Suchdevelopment revenues have only partially funded its product developmentactivities, and the Company generally retains ownership of the productsdeveloped under these arrangements. As a result, the Company classifies alldevelopment costs related to these contracts as research and developmentexpenses. The achievement of contractual milestones is evidenced by writtendocumentation provided by the customer in accordance with the applicable termsand conditions of each contract. In any period, progress on the contract isbased on input measures (direct labor dollars, direct material costs and directoutside processing costs) in the ratio of costs incurred to total estimatedcosts. Estimated costs to complete are provided by engineering personneldirectly involved in the development program and are reviewed by management andfinance personnel for reasonableness given the known facts and circumstances. Anumber of internal and external factors can 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.SIGNIFICANT ACCOUNTING POLICIES (Continued)**

affect ourestimates, including labor rates, utilization and efficiency variances andspecification and testing requirement changes. If different conditions were toprevail such that accurate estimates could not be made, then the use of thecompleted contract method would be required and the recognition of all revenueand costs would be deferred until the project was completed. If we bill thecustomer prior to performing services under the development agreement, theamounts are recorded as deferred revenue. The Company recorded revenue of$770,000 and $832,000 under development agreements in 2006 and 2005,respectively. The Company recorded deferred revenue of $424,000 and nil at December 31,2006 and 2005, respectively. No comparable amounts were recorded in 2004.

RECEIVABLESALLOWANCES—Receivables amounts on the balance sheet are shown net of thefollowing allowances (in thousands):

| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Allowance for  doubtful accounts |       | $                     | 49         |   | $ | 15 |   |
| Sales return  allowance          |       | 119                   |       | 73 |   |
| Ship &  debit allowance |       | 249                   |       | 34 |   |
|                             |       | $                     | 417        |   | $ | 122 |   |

 

PRODUCT WARRANTY—The Company generally sells productswith a limited warranty of product quality and a limited indemnification ofcustomers against intellectual property infringement claims related to the Company’sproducts. Such warranty generally ranges from 12 to 24 months. The Companyaccrues for known warranty and indemnification issues if a loss is probable andcan be reasonably estimated, and accrues for estimated incurred butunidentified issues based on historical activity. The Company generally sellsproducts with a limited warranty of product quality and a limitedindemnification of customers against intellectual property infringement claimsrelated to the Company’s products. Such warranty generally ranges from 12 to 24months. The Company accrues for known warranty and indemnification issues if aloss is probable and can be reasonably estimated, and accrues for estimatedincurred but unidentified issues based on historical activity. The Company estimatesthe cost of warranty based on the warranty period for the product, thehistorical field return rates for a given product or family of products and theaverage cost required to repair or replace the product. Allowances forestimated warranty costs are recorded during the period of sale. Thedetermination of such allowances requires us to make estimates of productreturn rates and expected costs to repair or replace the products underwarranty. If actual return rates and/or repair and replacement costs differsignificantly from our estimates, adjustments to recognize additional cost ofsales may be required in future periods. Components of the reserve for warrantycosts during 2006, 2005 and 2004 consisted of the following (in thousands):

| ** **                                              | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning balance                                       |       | $                     | 40         |   | $ | 54 |   | $ | 36 |   |
| Additions related  to current period sales              |       | 21                    |       | 22 |   | 74 |   |
| Warranty costs  incurred in the current period          |       | (35                   | )          | (24 | ) | (58 | ) |
| Adjustments to  accruals related to prior period sales. |       | 4                     |       | (12 | ) | 2 |   |
| Ending balance                                          |       | $                     | 30         |   | $ | 40 |   | $ | 54 |   |

 

 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2. SIGNIFICANT ACCOUNTINGPOLICIES (Continued)**

INCOME TAXES—In accordance with SFAS No. 109,“Accounting for Income Taxes,” the consolidated financial statements includeprovisions for deferred income taxes using the liability method fortransactions that are reported in one period for financial accounting purposesand in another period for income tax purposes. Deferred tax assets arerecognized when management believes realization of future tax benefits oftemporary differences is more likely than not. In estimating future taxconsequences, generally all expected future events are considered (includingavailable carryback claims), other than enactment of changes in the tax law orrates. Valuation allowances are established for those deferred tax assets wheremanagement believes it is not more likely than not such assets will berealized.

PER SHARE INFORMATION—Basic loss per share is computedusing the daily weighted average number of common shares outstanding for theperiod. Diluted loss per share includes the above and reflects the potentialdilution that could occur if stock options whose exercise price are less thanthe average share price for the period were exercised or converted into commonstock and shares related to contributions under the Employee Stock PurchasePlan for pending purchases, however, such adjustments are excluded when theyare anti-dilutive. In determining the dilutive effect of the stock options, thenumber of shares resulting from the assumed exercise of the options is reducedby the number of shares that could have been purchased by the Company with theproceeds from the exercise of such options including excess tax benefits andunamortized deferred stock compensation.

CONCENTRATION OF CREDIT RISK—Financial instrumentsthat potentially subject the Company to concentrations of credit risk consistprincipally of cash, cash equivalents, short-term investments and tradereceivables. The Company maintains cash in bank deposit accounts, which, attimes, may exceed federally insured limits. The Company has not experienced anylosses in such accounts. The Company invests in a variety of financialinstruments such as money market funds, commercial paper and high qualitycorporate bonds, and, by policy, limits the amount of credit exposure with anyone financial institution or commercial issuer. At December 31, 2006, twocustomers represented 23% and 20% of the total accounts receivable balance. AtDecember 31, 2005, three customers represented 32%, 15% and 13% of thetotal accounts receivable balance, respectively. The Company maintains anallowance for doubtful accounts based upon the expected collectibility ofreceivables.

USE OF ESTIMATES—The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amount of revenues andexpenses during the reporting period. Key estimates include allowance fordoubtful accounts, reserves for sales returns, write-down of excess andobsolete inventories, income tax contingency reserves, valuation of deferredtax assets and restructuring accruals. Actual results could differ from thoseestimates.

STOCK-BASED COMPENSATION—Effective January 1,2006, the Company adopted the provisions of, and accounts for stock-basedcompensation in accordance with the Financial Accounting Standards Board’s(“FASB”) Statement of Financial Accounting Standards No. 123 (revised2004), “Share-Based Payment”, (“SFAS 123R”) which replaced Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation”, (“SFAS 123”) and supersedes APB Opinion No. 25 , “Accountingfor Stock Issued to Employees”, (“APB 25”). Under the fair value recognitionprovisions of this statement, stock-based compensation cost is measured at thegrant date based on the fair value of the award and is recognized as expense ona straight-line basis over the requisite service period, which is the 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.SIGNIFICANT ACCOUNTING POLICIES (Continued)**

vesting period. TheCompany elected the modified-prospective method, under which prior periods arenot revised for comparative purposes. The valuation provisions of SFAS 123Rapply to new grants and to grants that were outstanding as of the effectivedate and are subsequently modified. Estimated compensation for grants that wereoutstanding as of the effective date will be recognized over the remaining serviceperiod using the compensation cost estimated for the SFAS 123 pro formadisclosures which included adjustments for estimated forfeitures. See Note 8for further information regarding our stock-based compensation assumptions andexpenses, including pro-forma disclosures for prior periods as if the Companyhad recorded stock-based compensation expense.

Prior to the adoption of SFAS 123R, the Companyrecognized the estimated compensation cost of restricted stock over the vestingterm. The estimated compensation cost is based on the fair value of the Company’scommon stock on the date of grant. We will continue to recognize thecompensation cost, net of estimated forfeitures, over the vesting term.

On November 10, 2005, the Financial AccountingStandards Board (“FASB”) issued FASB Staff Position No. SFAS 123 (R)-3,*Transition Election Related to Accountingfor Tax Effects of Share-Based Payment Awards*. The alternativetransition method includes simplified methods to establish the beginningbalance of the additional paid-in capital pool (“APIC pool”) related to the taxeffects of employee share-based compensation, and to determine the subsequentimpact on the APIC pool and consolidated statements of cash flows of the taxeffects of employee share-based compensation awards that are outstanding uponadoption of SFAS 123R. The Company has adopted this simplified method.

RECENT ACCOUNTING PRONOUNCEMENTS—In July 2006,the FASB issued Financial Interpretation No. 48, Accounting forUncertainty in Income Taxes, (“FIN 48”) as an interpretation of FASB Statement No. 109,Accounting for Income Taxes (“SFAS 109”). The Interpretation prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This Interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN 48 is effective for us beginning January 1,2007. Differences between the amounts recognized in the statements of financialposition prior to the adoption of FIN 48 and the amounts reported afteradoption should be accounted for as a cumulative-effect adjustment recorded tothe beginning balance of retained earnings. The Company is currently evaluatingthe impact of adopting FIN 48 on our Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS 157”), which provides guidance for using fairvalue to measure assets and liabilities. The pronouncements clarifies (1) theextent to which companies measure assets and liabilities at fair value; (2) theinformation used to measure fair value; and (3) the effect that fair valuemeasurements have on earnings. SFAS 157 will apply whenever another standardrequires (or permits) assets or liabilities to be measured at fair value.SFAS 157 is effective for the Company as of January 1, 2008. TheCompany is currently evaluating the impact this statement will have on ourconsolidated financial statements.

In September 2006, the SEC issued SAB No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB No. 108”). SAB108 provides guidance on the consideration of the effects of prior yearmisstatements in quantifying current year misstatements for the purpose of amateriality assessment. SAB 108 establishes an approach that requiresquantification of financial statement errors based on the effects of each ofthe Company’s 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.SIGNIFICANT ACCOUNTING POLICIES (Continued)**

balance sheet, statementof operations and the related financial statements disclosures. Early adoptionof the guidance in SAB 108 is encouraged in the interim periods of fiscal yearending after November 15, 2006. The Company adopted SAB 108 as of the yearended December 31, 2006. The adoption did not have a material impact onits consolidated results of operations and financial condition.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities” (SFAS No. 159). SFAS No. 159 permits companiesto choose to measure certain financial instruments and certain other items atfair value. The standard requires that unrealized gains and losses on items forwhich the fair value option has been elected be reported in earnings. SFAS No. 159is effective for the Company beginning in the first quarter of fiscal year2008, although earlier adoption is permitted. The Company is currentlyevaluating the impact that SFAS No. 159 will have on its consolidatedfinancial statements.

**3. INVESTMENTS**

*Available-for-SaleInvestments*

Investments,which are classified as available-for-sale, are summarized below for December 31,2006 and 2005 (in thousands):

| ** **                    | ** ** | ** **    | ** ** | ** **     | ** ** | ** **     | ** ** | ** **          | ** ** | **Classified on   Balance Sheet as:** | ** ** |
|-------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|-----------------------------------------------------------|------------|
| ** **                    | ** ** | **Purchase/** | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** | **Cash**                                                  | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Aggregate**       | ** ** | **and Cash**                                         | ** ** | **Short-term** | ** ** |
| ** **                    | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** | **Equivalents**                                           | ** ** | **Investments** | ** ** |
| As of  December 31, 2006 |       |          |       |           |       |           |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate debt securities     |       |          | $          | 11,695         |       |           |       | $                   | —     |                                                      |       |   | $ | — |   |   |   | $ | 11,695 |   |   |   | $ | 3,296 |   |   |   | $ | 8,399 |   |   |
| Money market funds            |       |          | 12,750     |           |       |           | —     |                |       |                                                      | —     |   |   |   | 12,750 |   |   |   | 12,750 |   |   |   | — |   |   |
| Total                         |       |          | $          | 24,445         |       |           |       | $                   | —     |                                                      |       |   | $ | — |   |   |   | $ | 24,445 |   |   |   | $ | 16,046 |   |   |   | $ | 8,399 |   |   |
|                          |       |          |       |           |       |           |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| As of  December 31, 2005 |       |          |       |           |       |           |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate debt securities     |       |          | $          | 16,069         |       |           |       | $                   | —     |                                                      |       |   | $ | (9 | ) |   |   | $ | 16,060 |   |   |   | $ | 1,001 |   |   |   | $ | 15,059 |   |   |
| Money market funds            |       |          | 10,773     |           |       |           | —     |                |       |                                                      | —     |   |   |   | 10,773 |   |   |   | 10,773 |   |   |   | — |   |   |
| U. S. government agency       |       |          | 999        |           |       |           | —     |                |       |                                                      | (6         | ) |   |   | 993 |   |   |   | — |   |   |   | 993 |   |   |
| Total                         |       |          | $          | 27,841         |       |           |       | $                   | —     |                                                      |       |   | $ | (15 | ) |   |   | $ | 27,826 |   |   |   | $ | 11,774 |   |   |   | $ | 16,052 |   |   |

As of December 31, 2006 and 2005, $11.7 millionand $17.1 million of fixed income securities had contractual maturities of sixmonths or less, respectively. There were no fixed income securities that had acontractual maturity beyond six months.

*Impairment ofInvestments*

The Company monitors itsinvestment portfolio for impairment on a periodic basis. In the event that thecarrying value of an investment exceeds its fair value and the decline in valueis determined to be other-than-temporary, an impairment charge is recorded anda new cost basis for the investment is established. In order to determinewhether a decline in value is other-than-temporary, the Company evaluates,among other factors: the duration and extent to which the fair value has beenless than the carrying value; the financial condition of and business outlookfor the Company, including key operational and cash flow metrics, current marketconditions and future trends in the Company’s industry; the 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3.INVESTMENTS (Continued)**

Company’srelative competitive position within the industry; and the Company’s intent andability to retain the investment for a period of time sufficient to allow forany anticipated recovery in fair value.

*Risk Management*

The Company generallyplaces its investments with high-credit-quality counterparties and, by policy,all financial instruments and counterparties must maintain the followingminimally acceptable credit ratings:  commercial deposits and corporateobligations A2/A, commercial paper A-1/P-1, municipal notes MIG 1/Sand P-1, municipal bonds AAA and asset back securities AAA. The Company,by policy, also limits the amount of credit exposure with any one financialinstitution or commercial issuer. No significant concentration of credit riskexisted at December 31, 2006.

**4. BUSINESS COMBINATIONS**

***EiC Acquisition***

On June 18, 2004, the Company completed itsacquisition of the wireless infrastructure business and associated assets fromEiC. The aggregate purchase price was $13.3 million. In connection with theacquisition, $1.5 million in cash and 294,118 shares of common stock were heldin escrow as security against certain financial contingencies. On March 30,2005, the Company made a claim against the escrow account for unpaid invoicesissued 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 theescrow agreement and the residual balance of the $1.5 million was released toEiC on May 4, 2005. On March 24, 2006, the Company made a claimagainst 147,059 of the 294,118 shares in the escrow account pending resolutionof claims made by a vendor regarding a pre-acquisition contact and released theuncontested 147,059 shares from the escrow. The Company reached a settlementwith EiC on May 25, 2006 resulting in the remaining 147,059 shares beingreleased from escrow on June 16, 2006.

The EiC acquisition agreement contained contingencyclauses which could have required the Company to pay further consideration ofup to $14 million if specific revenue and gross margin targets were achieved byMarch 31, 2005 and March 31, 2006, of which $7 million of theadditional compensation related to the period ended March 31, 2005. TheCompany has determined that the revenue and gross margin targets were not metfor both the periods ended March 31, 2005 and March 31, 2006, andthis was communicated to EiC. EiC subsequently notified the Company that itdisagrees with the Company’s conclusions. While the Company believes EiC’sassertions are without merit and has notified EiC of such, there can be noassurances as to the eventual outcome of this matter.

The $14.0 million would have been payable 10% in cashand, at the Company’s election, 90% in shares of its common stock. If thetargets were fully attained and the Company elected to pay in shares of commonstock, the number of additional shares issued would have been 2,540,323computed at $2.48 per share which represents the average closing price of theCompany’s stock on the NASDAQ Global Market (“NASDAQ”) during the ten dayperiod prior to the end of the earnout period. If the Company is ultimatelyrequired to pay such consideration, the amounts would be recorded as anincrease to goodwill.

The acquisition wasaccounted for using the purchase method of accounting in accordance with SFAS No. 141,“Business Combinations” (“SFAS No. 141”), and accordingly the Company’sconsolidated financial statements from June 18, 2004 include the impact ofthe acquisition. The following table 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4.BUSINESS COMBINATIONS (Continued)**

summarizes the allocation of the total purchase priceof 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 wasaccounted for as a purchase transaction, and accordingly, the assets of EiCwere recorded at their estimated fair values at the date of the acquisition.With the exception of the goodwill and acquired in-process research anddevelopment (“IPRD”), the identified intangible assets will be amortized on astraight-line basis over their estimated useful lives, with a weighted averagelife of approximately five years.

A portion of the purchase price, $8.7 million, wasallocated to developed and core technology and in-process research anddevelopment (“IPRD”). Developed and core technology and IPRD were identifiedand valued through extensive interviews, analysis of data provided by EiCCorporation concerning developmental products, their stage of development, thetime and resources needed to complete them, their expected income generatingability, target markets and associated risks. The income method was the primarytechnique utilized in valuing the developed and core technology and IPRD. Underthe income method, fair value reflects the present value of the projected cashflows that are expected to be generated by the products incorporating thecurrent technologies.

Developmental projects that reached technologicalfeasibility were classified as developed and core technology, and the $200,000value assigned to developed technology was capitalized to be amortized usingthe straight-line method over a weighted-average period of five years.Developmental projects that had not reached technological feasibility, and hadno future alternative uses were classified as IPRD. The $8.5 million valueallocated to projects that were identified as IPRD was charged to acquiredin-process research and development in 2004. The value assigned to IPRDcomprises the following projects: 12 V heterojunction bipolar transistor (“HBT”)power amplifiers ($1.5 million) and 28 V HBT high power amplifiers ($7.0million).

The nature of the efforts required to develop theacquired IPRD into commercially viable products principally relate to thecompletion of all planning, designing, prototyping, verification and testingactivities that are necessary to establish that the products can be produced tomeet their design specifications, including functions, features and technicalperformance requirements.

In valuing the IPRD, the Company considered, among otherfactors, the importance of each project to the overall development plan, theprojected incremental cash flows from the projects when completed and anyassociated risks. The projected incremental cash flows were discounted back totheir present value using an after-tax discount rate of 25%. This discount ratewas determined after consideration of the Company’s weighted average cost ofcapital and the weighted average return on assets. Associated risks include theinherent difficulties and uncertainties in completing each project and therebyachieving 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4.BUSINESS COMBINATIONS (Continued)**

technological feasibility,anticipated levels of market acceptance and penetration, market growth ratesand risks related to the impact of potential changes in future target markets.

As part of theacquisition, the Company entered into a sublease with EiC Corporation for28,160 square feet of space at their facility in Fremont, California. Thissublease expired in December 2004 and converted into a month to monthlease thereafter. At the end of January 2005 the Company moved the waferfabrication 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, byand between the Company, WJ Newco, LLC (the “WJ Sub”), Telenexus andRichard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and MarkSutton (collectively the “Shareholders”), Telenexus merged with and into theWJ Sub effective on January 29, 2005. The WJ Sub was the survivor inthe 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 themerger, the Company purchased through the WJ Sub all of the assets necessaryfor the conduct of the RFID business of Telenexus, consisting primarily of, andincluding, but not limited to RFID modules, baseband processing algorithmtechnology, applications software and realizations of several reader productdesigns. The consideration paid by the Company on the closing date inconnection 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, and2,333,333 shares of the Company’s common stock valued at $8.2 million at theclosing date. Including acquisition costs of $230,000, the aggregate purchaseprice for the net assets of Telenexus totaled $11.4 million. Of the closingconsideration, cash in the amount of $500,000 and 333,333 shares of the Company’scommon stock was held in escrow with respect to any indemnification mattersunder the merger agreement.

The outstanding cash balance of the escrow accountless any properly noticed unpaid or contested amounts was to be distributedwithin two days after October 28, 2005. The Company released the fullamount of the cash balance of the escrow account on October 31, 2005. The333,333 shares in the escrow account less any shares for any properly noticedunpaid or contested amounts have been fully distributed. The fair value of theCompany’s common stock was determined based on the average closing price pershare of the Company’s common stock over a 5-day period beginning twotrading days before and ending two trading days after the amended terms of theacquisition were agreed to and announced (January 31, 2005). In additionto the closing consideration, the sellers may be entitled to furthercompensation of up to $2.5 million in cash and up to 833,333 shares of theCompany’s common stock if the Company achieves certain revenue targets by July 28,2006. The Company determined that the revenue targets were not met andcommunicated its conclusion to the selling shareholders. Any change in the fairvalue of the net assets of Telenexus or any additional consideration to theShareholders would change the amount of the purchase price allocable togoodwill. Two of the Shareholders, Richard J. Swanson and Wilfred K. Lau alsoentered into three-year employment agreements with the Company. The acquisitionwas accounted for using the purchase method of accounting in accordance with SFASNo. 141, “Business Combinations” 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4.BUSINESS COMBINATIONS (Continued)**

(“SFASNo. 141”), and accordingly the Company’s consolidated financial statementsfrom January 28, 2005 include the impact of the acquisition.

Inaccordance with SFAS No. 141, the total purchase price was allocated tothe tangible and intangible assets acquired and liabilities assumed based upontheir respective estimated fair values at the acquisition date with the excesspurchase price allocated to goodwill. The Company determined that acquiringTelenexus, Inc. was a more cost effective means of developing the RFIDproducts and technology necessary to continue to enhance its RFID readerofferings to further capitalize on market opportunity than developing theproducts and technology internally. The acquisition also offers the Company theopportunity to shorten the time it takes to bring additional RFID readerproducts and technology to market. The valuation of the identifiable intangibleassets 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 ofthe Telenexus acquisition, as of the date of the acquisition (in thousands):

| Net tangible  assets                 |   | $      | 579    |   |
|--------------------------------------|--------|--------|--------|--------|
| 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                             |   | 5,401  |   |
| Total purchase price                 |   | $      | 11,420 |   |

With the exception of thegoodwill and IPRD, the identified intangible assets consisting of existingtechnology, customer relationships, trademarks and trade names andnon-competition agreements will be amortized on a straight-line basis overtheir estimated useful lives, with a weighted average life of approximatelyeight years. In accordance with SFAS No. 142, Goodwill and OtherIntangible Assets (“SFAS No. 142”), goodwill of $5.5 million will not beamortized and will be tested for impairment at least annually or wheneverevents or changes in circumstances indicate that the carrying value may not berecoverable in accordance with the Company’s policy on impairment analysis.

Prior to the acquisition, the Company and Telenexushad entered into an agreement to jointly design, develop and produce a PersonalComputer Memory Card International Association (“PCMCIA”) Type IIMulti-Protocol RFID reader. The Company has evaluated the effective settlementof this preexisting executory contract and the associated reacquired right tothe use of its technology in accordance with Emerging Issues Task Force (“EITF”)04-1 “Accounting for Preexisting Relationships between the Parties to aBusiness Combination.”  The Company has determined that the effectivesettlement of the executory contract and the associated reacquired right to useits technology was neither favorable nor unfavorable as the agreementrepresented fair value when compared to similar market transactions and therewere no stated settlement provisions in the contract.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4. BUSINESS COMBINATIONS(Continued)**

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

Developmental projects that reached technologicalfeasibility were classified as developed and core technology, and the $40,000value assigned to developed technology was capitalized to be amortized usingthe straight-line method over a weighted-average period of fourteen months.Developmental projects that had not reached technological feasibility, and hadno future alternative uses were classified as IPRD. The $3.4 million valueallocated to projects that were identified as IPRD was charged to acquiredin-process research and development in the accompanying condensed consolidatedstatements of operations for the nine months ended October 2, 2005. Thevalue assigned to IPRD comprises the following projects:  multi-protocolreaders ($1.3 million), Smart readers ($900,000) and Class 3 readers ($1.2million). The value of these projects was determined by estimating thediscounted net cash flows from the sale of the products resulting from thecompletion of the projects, reduced by the portion of the revenue attributableto developed technology and the percentage of completion of the project.

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

**5. GOODWILL AND INTANGIBLEASSETS**

In connection with theacquisition of the wireless infrastructure business and associated assets fromEiC 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 ofthe associated supply agreement with EiC and partially offset by $152,000 ofadditional registration statement related expenses. In connection with theacquisition of Telenexus on January 28, 2005, the Company recorded $5.5million of goodwill. Adjustments to the Telenexus goodwill through December 2006,subsequent to the Telenexus acquisition date, resulted primarily fromcollection of a previously unrecognized pre-acquisition accounts receivable andfinalization of direct acquisition costs. This goodwill was based upon thevalues assigned to the transactions at the time they were announced in 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.GOODWILL AND INTANGIBLE ASSETS (Continued)**

accordance with SFAS No. 142,“Goodwill and Other Intangible Assets” (“SFAS No. 142”). The changes inthe carrying value of goodwill as of December 31, 2006 are as follows (inthousands):

| ** **                            | ** ** | **EiC** | ** ** | **Telenexus** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------|------------|---------------|------------|-----------|------------|
| Balance as of  December 31, 2005 |       | $       | 1,405      |          |       | $         | 5,401      |   |   | $ | 6,806 |   |
| Adjustments to  goodwill              |       | —  |       |          | 28         |      |       | 28 |   |
| Balance as of  December 31, 2006 |       | $       | 1,405      |          |       | $         | 5,429      |   |   | $ | 6,834 |   |

 

The Company periodically evaluates its goodwill in accordancewith SFAS No. 142 for indications of impairment whenever events or changesin circumstances indicate that the carrying value may not be recoverable.Factors the Company considers important that could trigger an impairment reviewinclude significant under-performance relative to historical or projectedfuture operating results, significant changes in the manner of the Company’suse of the acquired assets or the strategy for the Company’s overall business,or significant negative industry or economic trends. If these criteria indicatethat the value of the goodwill may be impaired, an evaluation of therecoverability of the net carrying value is made. Irrespective of theaforementioned circumstances where impairment indicators are present, the Companyis required by SFAS No. 142 to test its goodwill for impairment at leastannually. The Company has chosen the end of its fiscal month of May as thedate of its annual impairment test. The Company has determined its goodwill wasnot impaired as of May 31, 2006.

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 salesand production of multiple products employing common manufacturing and researchand 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 variousproducts would be impractical, arbitrary and currently does not make suchallocations internally. As such, the Company considers itself a singlereporting unit.

Intangible assets are recorded at cost, lessaccumulated amortization. During the quarter ended April 2, 2006, theCompany determined that it would no longer use the Telenexus trademarks andtrade names and would instead market its RFID products under the WJCommunications brand. As such, the remaining unamortized balance of $637,000was expensed as “Selling and administrative” which is reflected in theaccompanying consolidated statements of operations for the year ended December 31,2006.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.GOODWILL AND INTANGIBLE ASSETS (Continued)**

The following tables present details of the Company’spurchased intangible assets (in thousands):

As of December 31,2006:

| **Description**                     | ** ** | ** ** | ** ** | **Useful  Life** | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|-------------------------------------|------------|------------|------------|------------------|------------|-----------|------------|-------------------------------|------------|---------|------------|
| EiC acquisition                     |       |       |       |             |       |      |       |                          |       |    |       |
| Purchased developed technology      |       | 5 years    |       | $                | 200        |      |       | $                             | 100        |    |       | $ | 100 |   |
| Telenexus acquisition               |       |       |       |             |       |      |       |                          |       |    |       |
| Purchased developed technology      |       | 1.2 years  |       | 40               |       |      | 40         |                          |       | —  |       |
| Customer relationships.             |       | 7 years    |       | 900              |       |      | 250        |                          |       | 650     |       |
| Non-competition agreements          |       | 4 years    |       | 400              |       |      | 190        |                          |       | 210     |       |
| Total identified  intangible assets |       |       |       | $                | 1,540      |      |       | $                             | 580        |    |       | $ | 960 |   |

 

As of December 31,2005:

| ** **                          | ** ** | **Useful** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** **       | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|-----------------|------------|------------------|------------|
| **Description**                     | ** ** | ** ** | ** ** | **Life**   | ** ** | **Gross**       | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| EiC acquisition                     |       |       |       |       |       |            |       |             |       |   |   |
| Purchased developed technology      |       | 5 years    |       | $          | 200        |            |       | $                | 60         |   |   | $ | 140 |   |
| Telenexus acquisition               |       |       |       |       |       |            |       |             |       |   |   |
| Purchased developed technology      |       | 1.2 years  |       | 40         |       |            | 32         |             |       | 8 |   |
| Customer relationships.             |       | 7 years    |       | 900        |       |            | 118        |             |       | 782 |   |
| Trademarks and trade names          |       | 12 years   |       | 700        |       |            | 54         |             |       | 646 |   |
| Non-competition agreements          |       | 4 years    |       | 400        |       |            | 92         |             |       | 308 |   |
| Total identified  intangible assets |       |       |       | $          | 2,240      |            |       | $                | 356        |   |   | $ | 1,884 |   |
|                                     |            |            |            |            |            |                 |            |                  |            |  |  |  |  |  |  |  |

 

|   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

For the year ended December 31,2006, 2005 and 2004, amortization of purchased intangible assets included incost of goods sold was approximately $48,000, $72,000 and $20,000,respectively. For the year ended December 31, 2006 and 2005, amortizationof purchased intangible assets included in operating expense was approximately$238,000 and $264,000, respectively. There was no amortization of purchasedintangible assets included in operating expense for 2004. Amortization iscomputed using the straight-line method over the estimated useful life of theintangible asset. The intangible assets related to purchased developedtechnology is amortized to cost of goods sold. The intangible assets related tocustomer relationships, trademarks and trade names and non-competitionagreements with sales/engineering 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.GOODWILL AND INTANGIBLE ASSETS (Continued)**

personnel are amortized to operating expense. TheCompany expects that annual amortization of acquired intangible assets to be asfollows (in thousands):

| ** **         | ** ** | **EiC** | ** ** | **Telenexus** | ** ** | **Total** | ** ** |
|--------------------|------------|---------|------------|---------------|------------|-----------|------------|
| Fiscal year:       |       |    |       |          |       |      |       |   |   |
| 2007               |       | $       | 40         |          |       | $         | 229        |   |   | $ | 269 |   |
| 2008               |       | 40      |       |          | 229        |      |       | 269 |   |
| 2009               |       | 20      |       |          | 139        |      |       | 159 |   |
| 2010               |       | —  |       |          | 129        |      |       | 129 |   |
| 2012 and beyond    |       | —  |       |          | 134        |      |       | 134 |   |
| Total amortization |       | $       | 100        |          |       | $         | 860        |   |   | $ | 960 |   |

 

**6. BORROWING ARRANGEMENTS**

On January 23, 2007,WJ Communications, Inc. entered into a fifth amendment which extends thematurity date from January 21, 2007 to June 30, 2008 of its Amendedand Restated Loan and Security Agreement (the “Credit Facility”) betweenComerica Bank and the Company dated September 23, 2003 and as amended June 13,2005, July 12, 2005, September 28, 2005, and December 27, 2005.Comerica also provided the Company with a letter agreement that, starting on January 22,2007, the Company had a 30-day grace period until the credit facilityautomatically expired during which period the credit facility remained in fullforce without lapse or termination. Interest rates on outstanding borrowingsare periodically adjusted based on certain financial ratios and are initiallyset, at the Company’s option, at LIBOR plus 2.0% or Prime less 0.25%. TheRevolving Facility requires the Company to maintain certain financial ratios,(such as a minimum unrestricted cash balance and a minimum tangible net worth),and contains limitations on, among other things, its ability to incurindebtedness, pay dividends and make acquisitions without the bank’spermission. The Revolving Facility is secured by substantially all of theCompany’s assets. The Company was in compliance with the covenants as of December 31,2006. As of December 31, 2006 and December 31, 2005, there were nooutstanding borrowings under the Revolving Facility. The Company has letters ofcredit of $3.2 million available as of December 31, 2006 that are beingused as collateral on its leased facilities.

**7. OTHER LONG-TERMOBLIGATIONS**

Long-termobligations, excluding amounts due within one year, consist of the following(in thousands):

| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Environmental  remediation (Note 10) |       | $                     | 56         |   | $ | 60 |   |
| Restructuring  accrual (Note 12)     |       | 10,673                |       | 13,390 |   |
| Deferred rent and  deposits               |       | 496                   |       | 596 |   |
| Long-term  advances and deposits          |       | 29                    |       | 29 |   |
| Total                                     |       | $                     | 11,254     |   | $ | 14,075 |   |

 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8. STOCKHOLDERS’ EQUITY**

On January 28, 2004, the Company completed a secondaryunderwritten public offering of 2,000,000 shares of common stock at $5.75 pershare, 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’scommon stock. In October 2003, the Board approved an additional $2.0million to expand this existing share repurchase program increasing the totalamount authorized to $4.0 million. Purchases under this stock repurchaseprogram were made in the open market, through block trades or otherwise.Depending on market conditions and other factors, these purchases werecommenced 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 topurchase 1,340,719 shares of the Company’s common stock at a weighted averagepurchase price of $2.08 per share. All of the purchases were made on the NASDAQGlobal 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 Directorsauthorized a new repurchase program of up to $2.0 million of the Company’scommon stock. This new program was effective July 27, 2004 and replacedall previous repurchase programs. Under this new program, $920,000 was utilizedto purchase 429,053 shares of the Company’s common stock at a weighted averagepurchase price of $2.12 per share. This program expired on July 26, 2005.The repurchases reduced the Company’s cash and interest income during theperiod and correspondingly reduced the number of the Company’s outstandingshares of common stock.

During the year ended December 31, 2004, theCompany modified two option agreements (to extend the option exercise period)resulting in $594,000 of severance expense which was recorded as selling andadministrative expense in the accompanying consolidated statements ofoperations for the year ended December 31, 2004 and an increase toadditional paid-in capital in the accompanying consolidated balance sheet at December 31,2004.

STOCK OPTION PLANS—During 2000, the Company’s “2000Stock Incentive Plan” and “2000 Non-Employee Director Stock Compensation Plan”(collectively the “Plans”) were adopted and approved by the Board and theCompany’s stockholders. Under the Plans, the Company may grant incentive awardsin 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 consultantsto the Company and its affiliates. On May 22, 2002, the Board approved theadoption of an amendment to the Company’s “2000 Stock Incentive Plan” toincrease the number of shares of common stock authorized for issuance from16,500,000 to 19,000,000 shares.

This plan amendment did not affect any other terms ofthe “2000 Stock Incentive Plan.” On May 29, 2003, the Board approved theadoption of an amendment to the Company’s “2000 Non-Employee DirectorCompensation Plan” to increase the number of shares of common stock authorizedfor issuance from 570,000 to 800,000, which was approved by the Company’sstockholders on July 15, 2003 at the Company’s Annual Meeting ofStockholders. Also on May 29, 2003, the Board approved the adoption of asecond amendment to the Company’s “2000 Stock Incentive Plan” so that optionsgranted to employees under the “2000 Stock Incentive Plan” will qualify asperformance-based compensation under Internal Revenue Code Section 162(m) andthereby not be subject to a deduction limitation. Particularly, the amendmentto the “2000 Stock Incentive Plan” provides that no employee or prospectiveemployee shall be granted one or more options within any fiscal year which inthe aggregate are for the purchase of more than 3,000,000 shares. On June 1,2006, the Company’s Board of Directors approved the adoption of an amendment to

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**8.STOCKHOLDERS’ EQUITY (Continued)**

the Company’s “Amended andRestated 2000 Non-Employee Director Compensation Plan” to increase the numberof shares of common stock authorized for issuance from 800,000 to 1,000,000,which was approved by the Company’s stockholders on July 20, 2006 at theCompany’s Annual Meeting of Stockholders. The total number of shares of commonstock authorized for issuance pursuant to the Plans is 22,000,000 shares.

On May 23, 2001, the Company’s 2001 EmployeeStock Incentive Plan was adopted and approved by the Board and the Company’s stockholders.Under the “2001 Employee Stock Incentive Plan”, the Company may grant incentiveawards 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 andits affiliates and consultants to the Company and its affiliates. The totalnumber of shares of common stock reserved and available for grant under the “2001Employee Stock Incentive Plan” is 2,000,000 shares. Shares subject to awardunder the “2001 Employee Stock Incentive Plan” may be authorized and unissuedshares or may be treasury shares. Stock options may include incentive stockoptions, nonqualified stock options or both, in each case, with or withoutstock appreciation rights.

In fiscal 2006, the Compensation Committee of theBoard of Directors awarded 1,977,990 Performance Restricted Stock Units toemployees. 1,403,640 of the Performance Accelerated Restricted Stock Units wereissued under the “Amended and Restated 2000 Stock Incentive Plan” and 574,350of the Performance Accelerated Restricted Stock Units were issued under the “2001Employee Stock Incentive Plan”. The Performance Accelerated Restricted StockUnits vest upon the achievement of performance targets that are determined bythe Compensation Committee of the Board of Directors. Any PerformanceAccelerated Restricted Stock Units that do not vest upon the achievement ofperformance targets cliff vest at the end of four years.

The Company’s stock option plans provide that optionsgranted under the stock option plans will have a term of no more than 10 years.Options granted under the stock option plans have vesting periods ranging fromtwo to four years. The provisions of the stock option plans provide that undercertain circumstances, such as a change in control, the achievement of certainperformance objectives, or certain liquidity events, the outstanding option maybe subject to accelerated vesting. As of December 31, 2006 the number ofshares available for future grants under the above plans was 4,520,424. Stockoptions may include incentive stock options, nonqualified stock options orboth, in each case, with or without stock appreciation rights.

**STOCK-BASED COMPENSATION**

The Company currently uses the Black-Scholes optionpricing model to determine the fair value of stock options and employee stockpurchase plan shares. The determination of the fair value of stock-basedpayment awards on the date of grant using an option-pricing model is affectedby the Company’s stock price as well as assumptions regarding a number ofcomplex and subjective variables. These variables include the Company’sexpected stock price volatility over the expected term of the awards, actual andprojected employee stock option exercise behaviors, risk-free interest rate andexpected dividends.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8. STOCKHOLDERS’ EQUITY(Continued)**

The Company estimates the expected term of optionsgranted by reviewing annual historical employee exercise behavior of optiongrants with similar vesting periods and the expected life assumptions ofsemiconductor peer companies. The Company’s estimate of pre-vesting optionforfeitures is based on historical pre-vest termination rates and those ofsemiconductor peer companies and it records stock-based compensation expenseonly for those awards that are expected to vest. The Company considered (alongwith its own actual experience) the forfeiture rates of semiconductor peercompanies due to its lack of extensive history. The Company’s volatilityassumption is forecasted based on its historical volatility over the expected term.The Company bases the risk-free interest rate that it uses in the optionpricing model on U.S. Treasury zero-coupon issues with remaining terms similarto the expected term on the options. The Company does not anticipate paying anycash dividends in the foreseeable future and therefore uses an expecteddividend yield of zero in the option pricing model. The Company is required toestimate forfeitures at the time of grant and revise those estimates insubsequent periods if actual forfeitures differ from those estimates. All sharebased payment awards are amortized on a straight-line basis over the requisiteservice periods of the awards, which are generally the vesting periods.

Theweighted average fair value of stock-based awards granted in fiscal years 2006,2005 and 2004 reported below have been estimated at the date of grant using theBlack-Scholes option pricing model with the following assumptions:

| ** **                                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Employee Stock Option Plans:**                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value                                                 |       | $          | 1.33       |       | $          | 0.88       |       | $ | 2.19 |   |
| Dividend yield                                             |       | 0.0        | %          | 0.0        | %          | 0.0        | %          |
| Volatility                                                 |       | 84.9       | %          | 82.1       | %          | 87.1       | %          |
| Risk free  interest rate at the time of grant              |       | 4.6        | %          | 4.1        | %          | 3.0        | %          |
| Expected term to  exercise (in months from the grant date) |       | 51         |       | 48         |       | 48         |       |
| **Employee  Stock Purchase Plan:**                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value                                                 |       | $          | 0.56       |       | $          | 0.70       |       | $ | 1.32 |   |
| Dividend yield                                             |       | 0.0        | %          | 0.0        | %          | 0.0        | %          |
| Volatility                                                 |       | 64.4       | %          | 75.4       | %          | 69.0       | %          |
| Risk free  interest rate at the time of grant              |       | 4.7        | %          | 2.7        | %          | 1.2        | %          |
| Expected term to  exercise (in months from the grant date) |       | 6          |       | 6          |       | 6          |       |

 

The following tablepresents details of stock-based compensation expense by functional line item(in thousands):

| ** **                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cost of goods  sold         |       | $        | 520        |     | $          | 62       |       | $ | 65 |   |
| Research and  development   |       | 485      |       | 161      |       | 194      |       |
| Selling and  administrative |       | 1,324    |       | 697      |       | 49       |       |
|                        |       | $        | 2,329      |     | $          | 920      |       | $ | 308 |   |

 

The amounts included in the year ended December 31,2006 reflect the adoption of SFAS 123R. In accordance with the modifiedprospective transition method, the Company’s consolidated statements of 

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**8.STOCKHOLDERS’ EQUITY (Continued)**

operations for priorperiods have not been restated to reflect, and do not include, the impact ofSFAS 123R. The impact on basic and diluted net loss per share for the yearended December 31, 2006 from the adoption of SFAS 123R was $0.04.

Thefollowing table illustrates the effect for periods prior to the adoption ofSFAS 123 on net loss had compensation cost for all of the Company’s stockoption plans been determined based upon the fair value at the grant date forawards under these plans, and amortized to expense over the vesting period ofthe awards consistent with the methodology prescribed under SFAS 123, “Accountingfor Stock-Based Compensation” (in thousands except per share amounts):

| ** **                                                                                             | ** ** | **Year Ending December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Reported net loss                                                                                      |       |                                        | $          | (20,988 | ) |   |   | $ | (9,081 | ) |   |
| Add: Total  stock-based employee compensation expense included in reported net loss                    |       |                                        | 920        |   |   |   | 308 |   |   |
| Deduct: Total  stock-based employee compensation expense under fair value based method for  all awards |       |                                        | (1,116     | ) |   |   | (5,474 | ) |   |
| Pro forma loss                                                                                         |       |                                        | $          | (21,184 | ) |   |   | $ | (14,247 | ) |   |
| Reported net loss  per basic and diluted share                                                         |       |                                        | $          | (0.33 | ) |   |   | $ | (0.15 | ) |   |
| Pro forma net loss per  basic and diluted share                                                        |       |                                        | $          | (0.33 | ) |   |   | $ | (0.24 | ) |   |

 

Activityunder the stock option plans during 2006, 2005 and 2004 are set forth below:

| ** **                                                 | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
|------------------------------------------------------------|------------|------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **Shares** | ** ** | **Exercise Price**   | ** ** |
| **2004**                                                   | ** ** | ** ** | ** ** |                      | ** ** | ** ** |   |
| Granted (weighted  average fair value of $2.19 per option) |       | 3,046,500  |       |                      | $          | 3.27 | ** ** |   |
| Exercised                                                  |       | (934,107   | )          |                      | $          | 1.27 | ** ** |   |
| Cancelled                                                  |       | (813,031   | )          |                      | $          | 0.98 | ** ** |   |
| At December 31:                                       |       |       |       |                      |       | ** ** |   |
| Outstanding                                                |       | 13,727,396 |       |                      | $          | 2.26 | ** ** |   |
| Exercisable                                                |       | 6,389,431  |       |                      | $          | 2.03 | ** ** |   |

 

 

| ** **                                                 | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
|------------------------------------------------------------|------------|------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **Shares** | ** ** | **Exercise Price**   | ** ** |
| **2005**                                                   | ** ** | ** ** | ** ** |                      | ** ** | ** ** |   |
| Granted (weighted  average fair value of $0.87 per option) |       | 1,728,000  |       |                      | $          | 1.43 | ** ** |   |
| Exercised                                                  |       | (1,377,960 | )          |                      | $          | 1.06 | ** ** |   |
| Cancelled                                                  |       | (4,710,677 | )          |                      | $          | 3.08 | ** ** |   |
| At December 31:                                       |       |       |       |                      |       | ** ** |   |
| Outstanding                                                |       | 9,366,759  |       |                      | $          | 1.87 | ** ** |   |
| Exercisable                                                |       | 5,225,843  |       |                      | $          | 2.02 | ** ** |   |

** **

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8.STOCKHOLDERS’ EQUITY (Continued)**

 

| ** **                                                 | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
|------------------------------------------------------------|------------|------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **Shares** | ** ** | **Exercise Price**   | ** ** |
| **2006**                                                   | ** ** | ** ** | ** ** |                      | ** ** | ** ** |   |
| Granted (weighted  average fair value of $1.33 per option) |       | 4,109,990  |       |                      | $          | 1.08 | ** ** |   |
| Exercised                                                  |       | (1,222,395 | )          |                      | $          | 1.35 | ** ** |   |
| Cancelled                                                  |       | (3,366,074 | )          |                      | $          | 2.34 | ** ** |   |
| At  December 31:                                      |       |       |       |                      |       | ** ** |   |
| Outstanding                                                |       | 8,888,280  |       |                      | $          | 1.40 | ** ** |   |
| Exercisable                                                |       | 2,919,621  |       |                      | $          | 1.71 | ** ** |   |
| Vested and expected  to vest                               |       | 7,611,325  |       |                      | $          | 1.56 | ** ** |   |

 

The total intrinsic value of options exercised during2006, 2005 and 2004 was $682,000, $777,000 and $2.0 million respectively.

The aggregate intrinsic value of options outstanding,options exercisable and options vested and expected to vest as of December 31,2006 was $4.0 million, $549,000 and $1.1 million, respectively. The intrinsicvalue is calculated as the difference between the market value as of December 31,2006 and the exercise price of shares that were in the money at December 31,2006. The market value of as December 29, 2006 was $1.57 as reported byNASDAQ.

As of December 31, 2006, the weighted averageremaining contractual life of stock options outstanding, exercisable and vestedand expected to vest was 7.0 years, 4.4 years and 6.4 years respectively.

The following tablesummarizes information concerning currently outstanding and exercisable optionsat December 31, 2006:

| ** **                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | ** **                   | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | **Average Years**       | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                 | ** ** | **Number**                   | ** ** | **of Remaining**        | ** ** | **Average** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Price** | ** ** | ** **                   | ** ** | **Outstanding**              | ** ** | **Contractual Life** | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $0.00 to $0.01                             |       |                         | 1,845,095  |                         |       |   | 9.1 |   |   |   | $ | 0.00 |   |   | — |   |   | $ | — |   |   |
| $0.02 to $1.00                             |       |                         | 762,250    |                         |       |   | 8.7 |   |   |   | $ | 0.93 |   |   | 189,708 |   |   | $ | 0.93 |   |   |
| $1.01 to $1.50                             |       |                         | 3,549,785  |                         |       |   | 4.3 |   |   |   | $ | 1.39 |   |   | 2,209,445 |   |   | $ | 1.38 |   |   |
| $1.51 to $2.00                             |       |                         | 918,500    |                         |       |   | 9.0 |   |   |   | $ | 1.65 |   |   | 33,125 |   |   | $ | 1.76 |   |   |
| $2.01 to $3.00                             |       |                         | 1,334,900  |                         |       |   | 8.7 |   |   |   | $ | 2.52 |   |   | 158,463 |   |   | $ | 2.36 |   |   |
| $3.01 to $5.00                             |       |                         | 443,000    |                         |       |   | 7.3 |   |   |   | $ | 3.42 |   |   | 301,750 |   |   | $ | 3.44 |   |   |
| $5.01 to $10.00                            |       |                         | 21,950     |                         |       |   | 5.1 |   |   |   | $ | 7.75 |   |   | 19,950 |   |   | $ | 7.94 |   |   |
| $10.01 to $26.75                           |       |                         | 12,800     |                         |       |   | 3.8 |   |   |   | $ | 21.35 |   |   | 7,180 |   |   | $ | 21.94 |   |   |
|                                       |       |                         | 8,888,280  |                         |       |   | 7.0 |   |   |   | $ | 1.40 |   |   | 2,919,621 |   |   | $ | 1.71 |   |   |
|                                            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2006, there was $3.7 millionof unrecognized compensation cost, adjusted for estimated forfeitures, relatedto non-vested stock-based awards granted to employees and non-employee membersof the Board of Directors. The unrecognized compensation cost is expectedto be recognized over a weighted average period of 3.11 years. If there are anymodifications or cancellations of the underlying unvested securities, theCompany may be required to accelerate, increase or cancel any 

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**8.STOCKHOLDERS’ EQUITY (Continued)**

remaining unearnedstock-based compensation expense. Future stock-based compensation expense andunearned stock-based compensation will increase to the extent that the Companygrants additional equity awards to employees or assumes unvested equity awardsin connection with acquisitions.

Restricted(i.e., non-vested) stock activity under the Company’s stock incentive plansduring the year ended December 31, 2006 is set forth below, (in thousandsexcept per share amounts):

| ** **                          | ** ** | ** ** | ** ** | **Weighted**                  | ** ** |
|-------------------------------------|------------|------------|------------|-------------------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**                   | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Grant Date Fair** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Value per Share** | ** ** |
| Unvested at  December 31, 2005 |       |       | 430,560    |                          |       |   | $ | 1.49 |   |   |
| Grants                              |       |       | 670,000    |                          |       |   | $ | 1.71 |   |   |
| Vested                              |       |       | (316,656   | )                             |       |   | $ | 1.57 |   |   |
| Unvested at  December 31, 2006 |       |       | 783,904    |                          |       |   | $ | 1.65 |   |   |

 

The total intrinsic value of restricted stock vestedduring the year ended December 31, 2006 was $681,000 based on the vestdate intrinsic value.

As of December 31, 2006, there was $515,000 ofunrecognized compensation cost related to unvested restricted stock awardswhich is expected to be recognized over a weighted average period of 1.43 years.In addition, additional compensation cost may be recognized on performancebased restricted stock awards if the performance targets become probable ofachievement.

EMPLOYEE STOCK PURCHASE PLAN (“ESPP”)—In May 2001,the Company’s stockholders approved the adoption of the Company’s 2001 EmployeeStock Purchase Plan (the “Purchase Plan”). Up to 1,500,000 shares of CommonStock may be issued under the Purchase Plan. Under the plan, all eligibleemployees may purchase shares of the Company’s common stock at six-monthintervals at 85% of fair market value (calculated in the manner provided underthe plan). Employees purchase such stock using payroll deductions, which maynot exceed 15% of their total cash compensation. The plan imposes certainlimitations upon an employee’s right to acquire common stock, such as noemployee may be granted rights to purchase more than $25,000 worth of commonstock for each calendar year in which such rights are at any time outstanding. OnJune 1, 2006, the Company’s Board of Directors approved the adoption of anamendment to the Company’s Purchase Plan to increase the number of shares ofcommon stock authorized for issuance from 1,500,000 to 2,250,000, which wasapproved by the Company’s stockholders on July 20, 2006 at the Company’sAnnual Meeting of Stockholders.

In fiscal 2006, 222,762 and 137,230 shares were issuedunder this Purchase Plan at an average price of $1.13 and $1.56 for thePurchase Plan intervals ended April 2006 and October 2006,respectively. In fiscal 2005, 142,453 shares and 267,417 shares were issuedunder this Purchase Plan at an average price of $1.99 and $1.11 for thePurchase Plan intervals ended April 2005 and October 2005,respectively. At December 31, 2006, 936,582 shares were available forfuture issuance under the Purchase Plan.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9. INCOME TAXES**

Thebenefit from federal and state income taxes is as follows. Foreign income(loss) before income taxes was insignificant for all years.

| ** **     | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **(in thousands)** | ** ** |
| Current:       |       |                    |       |     |       |     |       |
| Federal        |       | $                       | (1,373     | )        | $          | (123     | )          | $ | (7,674 | ) |
| State          |       | 7                       |       | 3        |       | —   |       |
| Total current  |       | (1,366                  | )          | (120     | )          | (7,674   | )          |
| Deferred:      |       |                    |       |     |       |     |       |
| Federal        |       | —                  |       | —   |       | —   |       |
| State          |       | —                  |       | —   |       | —   |       |
| Total deferred |       | —                  |       | —   |       | —   |       |
| Total          |       | $                       | (1,366     | )        | $          | (120     | )          | $ | (7,674 | ) |

 

In 2006, the Company recorded a net tax benefit of$1.4 million as the statute of limitations had expired on certain estimatedstate tax exposures. The tax benefit for 2005 of $120,000 resulted from theexpiration of the statute of limitations on certain estimated federal taxexposures. In 2004, the Company recorded a tax benefit of $7.7 millionresulting from a revision of the Company’s estimated income tax contingencyliability due to the receipt of the final assessment from the Internal RevenueService related to the audit of the Company’s 1996 through 2000 tax returns.

Thedifferences between the effective income tax rate as applied to loss fromoperations and the statutory federal income tax rate are as follows:

| ** **                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory federal  tax rate              |       | (35.0    | )%         | (35.0    | )%         | (35.0    | )%         |
| Research and  development credit         |       | (6.7     | )          | (3.0     | )          | (3.1     | )          |
| State taxes, net  of federal tax benefit |       | (5.7     | )          | (5.7     | )          | (5.7     | )          |
| In-process  research and development     |       | —   |       | 6.6      |       | —   |       |
| Expired foreign  tax credit              |       | —   |       | 2.1      |       | —   |       |
| Other                                    |       | 0.7      |       | 1.6      |       | 0.3      |       |
| Tax reserve no  longer required          |       | (14.1    | )          | (0.6     | )          | (45.8    | )          |
| Change in  valuation allowance           |       | 46.8     |       | 33.4     |       | 43.5     |       |
| Effective tax rate                       |       | (14.0    | )%         | (0.6     | )%         | (45.8    | )%         |

 

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9. INCOMETAXES (Continued)**

Deferred tax assets arerecognized when management believes realization of future tax benefits oftemporary differences is more likely than not. In estimating future taxconsequences, all expected future events are considered (including availablecarryback claims), other than enactment of changes in the tax law or rates.Valuation allowances are established for those deferred tax assets wheremanagement believes it is not more likely than not such assets will berealized. Deferred tax amounts are comprised of the following at December 31(in thousands):

| ** **                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Net operating  loss                |       | $        | 24,609     |     | $          | 19,304 |   |
| Restructuring  accrual             |       | 5,658    |       | 6,835    |       |
| Depreciation and  amortization     |       | 11,706   |       | 12,998   |       |
| Accounts  receivable valuation     |       | 189      |       | 38       |       |
| Inventory  valuation               |       | 2,411    |       | 2,394    |       |
| Stock related                      |       | 679      |       | —   |       |
| Tax credits                        |       | 8,815    |       | 8,158    |       |
| Employee benefit  related accruals |       | 360      |       | 477      |       |
| Other                              |       | 536      |       | 398      |       |
| Total deferred  tax assets         |       | 54,963   |       | 50,602   |       |
| Valuation allowance                |       | (54,963  | )          | (50,602  | )          |
| Total deferred  tax assets         |       | $        | —     |     | $          | — |   |
| Income tax contingency  liability  |       | $        | 419        |     | $          | 1,818 |   |

 

As of December 31, 2006, the Company had$1,709,000 in federal minimum tax credit carryforwards which are availableindefinitely. The Company also had federal R&D tax credit carryforwards of$5,263,000, which begin to expire in 2012. Additionally, the Company had statetax credit carryforwards of $2,835,000 of which $583,000 begin to expire in2009 and $2,252,000 are available indefinitely.

At December 31, 2006 the Company had $59,742,000of federal net operating loss carryforwards which will expire beginning in2023. The Company also had state net operating loss carryforwards of$70,061,000, which begin to expire in 2013.

Current federal and statetax laws include substantial restrictions on the utilization of net operatinglosses and tax credits in the event of an “ownership change” of a corporation.Accordingly, the Company’s ability to utilize net operating loss and tax creditcarryforwards may be limited as a result of such an ownership change. Such alimitation could result in the expiration of carry forwards before they areutilized.

**10. COMMITMENTS ANDCONTINGENCIES**

***Commitments***

The Company leases its corporate headquarters andmanufacturing facilities under various non-cancelable operating leases expiringthrough January 2011. See Note 12 for a discussion of restructuringcharges recorded related to these leases.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10.COMMITMENTS AND CONTINGENCIES (Continued)**

Minimum lease commitmentsas of December 31, 2006 under non-cancelable leases are as follows (inthousands):

| ** **      | ** ** | **Operating  Leases** | ** ** |
|-----------------|------------|-----------------------|------------|
| Lease payments: |       |                  |       |   |   |
| 2007            |       |                  | $          | 4,324 |   |   |
| 2008            |       |                  | 4,416      |   |   |
| 2009            |       |                  | 4,442      |   |   |
| 2010            |       |                  | 3,117      |   |   |
| 2011            |       |                  | 142        |   |   |
| Remaining years |       |                  | —     |   |   |
| Total           |       |                  | $          | 16,441 |   |   |

 

Rent expense in 2006, 2005 and 2004 was $3.3 million,$3.1 million and $3.2 million, respectively.

The Company subleases to third parties approximately31,800 square feet of its abandoned leased space under non-cancelable operatingleases expiring through January 2008. This sublease income is incorporatedin the restructuring charges related to our lease loss accruals.

Minimumsublease income commitments as of December 31, 2006 under non-cancelableleases are as follows (in thousands):

| ** **              | ** ** | **Operating  Leases** | ** ** |
|-------------------------|------------|-----------------------|------------|
| Sublease rental income: |       |                  |       |   |   |
| 2007                    |       |                  | $          | 462 |   |   |
| 2008                    |       |                  | 14         |   |   |
| 2009                    |       |                  | —     |   |   |
| 2010                    |       |                  | —     |   |   |
| 2011                    |       |                  | —     |   |   |
| Remaining years         |       |                  | —     |   |   |
| Total                   |       |                  | $          | 476 |   |   |

 

Sublease rental incomeearned in 2006, 2005 and 2004 was $533,000, $424,000 and $759,000,respectively.

***Environmental Remediation***

Our current operations are subject to federal, stateand local laws and regulations governing the use, storage, disposal of andexposure to hazardous materials, the release of pollutants into the environmentand the remediation of contamination. The Company has an accrued liability of$61,000 as of December 31, 2006 to offset estimated program oversight,remediation actions and record retention costs. In 2005 the accruedliability was reduced by $100,000 when it was determined that the probabilityof an assessment for a prior violation was remote. Expenditures charged againstthe provision totaled $5,000, $9,000 and $14,000 in 2006, 2005 and 2004,respectively.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10. COMMITMENTSAND CONTINGENCIES (Continued)**

The Company continues to be in compliance with theremedial action plans being monitored by various regulatory agencies at itsformer Palo Alto and Scotts Valley sites. The Company has entered into fundedfixed price remediation contracts and obtained cost-overrun and unknownpollution conditions insurance coverage. The Company believes that it is remotethat it would incur any significant liability beyond which it has recorded. TheCompany does ultimately retain responsibility for these environmentalliabilities and in the unlikely event that the environmental firm and theinsurance company do not meet their obligations.

With respect to ourremaining current or former production facilities, to date either nocontamination of significance has been identified or reported to us or theregulatory agency involved has granted closure with respect to the identifiedcontamination. Nevertheless, we may face environmental liabilities related tothese sites in the future.

***Indemnification***

As part of the Company’s normal ongoing businessoperations and consistent with industry practice, the Company enters intonumerous agreements with other parties, which apportion future risks among theparties to the transaction or relationship governed by the agreements. Onemethod of apportioning risk is the inclusion of provisions requiring one partyto indemnify the other against losses that might otherwise be incurred by theother party in the future. Many of the Company’s agreements contain an indemnityor indemnities that require us to perform certain acts, such as remediation, asa result of the occurrence of a triggering event or condition. The Company is aparty to a variety of agreements pursuant to which it may be obligated toindemnify the other party with respect to certain matters. Typically, theseobligations arise in the context of contracts entered into by the Company,under which the Company customarily agrees to hold the other party harmlessagainst losses arising from a breach of representations and covenants relatedto such matters as title to assets sold, certain IP rights, specifiedenvironmental matters, and certain income taxes. In each of thesecircumstances, payment by the Company is conditioned on the other party makinga claim pursuant to the procedures specified in the particular contract, whichprocedures typically allow the Company to challenge the other party’s claims.Further, the Company’s obligations under these agreements may be limited interms of time and/or amount, and in some instances, the Company may haverecourse against third parties for certain payments made by the Company.

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

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10. COMMITMENTS ANDCONTINGENCIES (Continued)**

As permitted underDelaware law, the Company has agreements whereby we indemnify our officers anddirectors for certain events or occurrences while the officer or director is,or was serving, at our request in such capacity. The indemnification periodcovers all pertinent events and occurrences during the officer’s or director’slifetime. The maximum potential amount of future payments the Company could berequired to make under these indemnification agreements is unlimited; however,the Company has director and officer insurance coverage that reduces itsexposure and enables it to recover a portion of any future amounts paid. TheCompany believes the estimated fair value of these indemnification agreementsin excess of applicable insurance coverage is minimal.

***Other Contingencies***

From time to time, theCompany is involved in various legal actions which arise in the ordinary courseof its business activities. Management does not currently believe that any adverseoutcome from these matters would ultimately have a material impact on theCompany’s results of operations or financial position. However, there can be noassurance that this will ultimately be the case.

**11. EMPLOYEE BENEFIT PLANS**

The Company has anEmployees’ Investment 401(k) Plan that covers substantially all employeesand provides that the Company match employees’ salary deferrals up to 3% ofeligible employee compensation. The amounts charged to operations were$403,000, $414,000 and $391,000 in 2006, 2005 and 2004, respectively.

**12. RESTRUCTURING CHARGES**

**Fourth Quarter 2006Restructuring Plan**

On October 30, 2006, the Company committed to arestructuring plan to close and exit the Company’s Milpitas fabricationfacility (“fab”) during the first quarter of 2007. The Milpitas fab produces asubstantial portion of the Company’s gallium arsenide semiconductor productsand has substantial excess capacity. The Company’s lease of the fab expired on November 14,2006 and in accordance with the terms of the lease the Company is continuingthe lease on a month-to-month basis until the closure is complete.

The Company formed a strategic foundry relationshipwith Global Communication Semiconductors, Inc. (“GCS”) to second-sourcethe manufacturing of its GaAs and InGaP HBT wafers and GCS will become the solesource for these products after closing of the Milpitas fab. The Company plansto produce additional wafer inventory from its Milpitas fab to be used as abuffer in the event of delayed qualifications from customers or ramp-up issueswith GCS.

During the fourth quarterof 2006, a restructuring charge of $174,000 was recognized related to employeeseverance under the plan, which was offset by reversals of restructuringaccruals of approximately $460,000.

**Fourth Quarter 2002Restructuring Plan**

Over the course of 2002, the Company began to designand manufacture semiconductors utilizing additional manufacturing technologiesat external wafer fabrication foundries. The Company believed that thisapproach was required in order to continue to offer competitive products andexpected that a greater number of its future products would be developed inthis fashion. The Company at that time believed that 

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**12.RESTRUCTURING CHARGES (Continued)**

thisbusiness strategy offered considerable other advantages such as allowing it tofocus its resources on product development and marketing, minimizing capitalexpenditures, reducing operating expenses, allowing it to continue to offercompetitive pricing, reducing time to market, reducing technology and productrisks and facilitating the migration of the Company’s products to new processtechnologies, which reduce costs and optimize performance. On December 17,2002, the Company’s Board of Directors approved a plan to completely outsourcethe Company’s internal wafer fabrication within one year and close its ownwafer fabrication facility (the “fab closure”), which was subsequently modifiedin 2003 and 2004 as described below.

*Lease Loss—**The*fab closure wouldhave resulted in additional excess space of approximately 35,000 square feetfor which the Company would have had a remaining two year commitment after theanticipated fab closure. The original decision resulted in a lease loss of $4.3million, comprised of future lease payments net of broker commissions and otherfacility costs. In determining this estimate, the Company made certainassumptions with regards to its ability to sublease the space in line with theCompany’s best estimate of current market conditions.

During the fourth quarterof 2003 the Company decided that additional time would be needed to affect thecomplete outsourcing of its internal wafer fabrication due to an unplannedincrease in near-term product demand and additional qualification proceduresassociated with outsourced wafer fabrication. The Company planned to continueto operate its fab through April 2004. As such, the additional four monthsof rent and facility costs would be incurred as an operating expense resultingin an approximate $364,000 reduction in the lease loss accrual.

During the second quarterof 2004, the Company delayed the closure of its internal wafer fabricationfacility (“fab”) for a minimum of three additional months to assess the integrationof the EiC acquisition (see Note 4) into its existing operations which resultedin a $430,000 reduction in its lease loss accrual. During the third quarter of2004, the Company decided not to close its fab as the Company believed thatintegrating the newly acquired fab from EiC with its pre-existing fab wouldoffer the Company certain benefits over outsourcing the pre-existing fab. Assuch, the Company reversed the remainder of this lease loss accrual of $3.6million in the second quarter of 2004.

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

**Third Quarter 2002 Restructuring Plan**

*LeaseLoss—**In*the third quarter of 2002, theCompany decided to abandon a portion of its leased facility based on revisedanticipated demand for its products and current market conditions. This excessspace, for which the Company had a remaining eight year commitment, is locatedon the first floor of the Company’s current corporate headquarters andoriginally housed a portion of the Company’s optics and integrated assembliesmanufacturing operations. This decision resulted in a lease loss of $10.6million, 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. Indetermining this estimate, the Company made certain assumptions with regards toits ability to sublease the space and reflected offsetting assumed subleaseincome in line with the Company’s best estimate of current market conditions.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12.RESTRUCTURING CHARGES (Continued)**

During the fourth quarterof 2002, based on a continuing deterioration in the real estate market anddifficulties subleasing its available space, the Company revised itsassumptions regarding sublease occupancy rates and market rates downwardresulting in an additional lease loss of $674,000.

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

During the third quarterof 2004, after reviewing current information regarding reduced facilityoperating costs (predominantly building maintenance costs), the Company revisedits lease loss assumptions resulting in a reversal of $377,000 of the leaseloss.

During the fourth quarterof 2006, after reviewing current information regarding reduced facilityoperating costs, the Company revised its lease loss assumptions resulting in areversal of $487,000 of the lease loss.

As of December 31,2006, the maximum potential amount of the lease loss for this property is $5.3million.

**Third Quarter 2001 Restructuring Plan**

*Lease Loss and LeaseholdImpairment—**In*September 2001, the Companydecided to abandon a leased facility based on revised anticipated demand forits products and current market conditions. This excess facility, for which theCompany had a ten year commitment, is located adjacent to the Company’s currentcorporate headquarters and was originally developed to house additionaladministrative and corporate offices to accommodate planned expansion. Thisdecision resulted in a lease loss of $7.2 million, comprised of future leasepayments net of anticipated sublease income, broker commissions and otherfacility costs, and an asset impairment charge of $2.6 million on tenantimprovements deemed no longer realizable. In determining this estimate, theCompany made certain assumptions with regards to its ability to sublease thespace and reflected offsetting assumed sublease income in line with the Company’sbest estimate of current market conditions.

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

During the fourth quarterof 2003, after reviewing current information regarding continuing deteriorationin the real estate market, difficulties subleasing its available space andfacility costs, the Company revised its lease loss assumptions. $203,000 ofadditional lease loss was accrued as reductions in estimated sublease occupancyand market rates were partially offset by reduced facility costs (mainlyproperty taxes and utilities).

During the third quarterof 2004, after reviewing current information regarding continuing deteriorationin the real estate market, difficulties subleasing its available space andincreasing facility operating costs, the Company revised its lease lossassumptions resulting in $538,000 of additional lease loss.

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12. RESTRUCTURING CHARGES(Continued)**

As of December 31, 2006, the maximum potentialamount of the lease loss for this property is $9.1 million which ispartially offset by $481,000 of minimum sublease income commitments undernon-cancelable sublease rental agreements and $152,000 of estimated netsublease income.

The following tablesummarizes restructuring accrual activity recorded during the years 2004 thoughDecember 31, 2006 (in thousands):
|                                    | ** ** | **Q3 2001**  | ** ** | ** **                                    | ** ** | ** **                                    | ** ** | ** **     | ** ** | ** **    | ** ** | ** ** | ** ** | ** **     | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|----------------|------------|---------------|------------|------------|------------|----------------|------------|-------------------|------------|------------|------------|
| ** **                         | ** ** | **Restructuring** | ** ** | ** **                                    | ** ** | ** **                                    | ** ** | ** **     | ** ** | ** **    | ** ** | ** ** | ** ** | ** **     | ** ** | **Q4**            | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Plan**          | ** ** | **Q3 2002 Restructuring Plan** | ** ** | **Q4 2002 Restructuring Plan** | ** ** | **2006**       | ** ** | ** **    | ** ** |
| ** **                         | ** ** | **Lease**         | ** ** | **Workforce**                                 | ** ** | **Lease**                                     | ** ** | **Asset**      | ** ** | **Workforce** | ** ** | **Lease**  | ** ** | **Asset**      | ** ** | **Restructuring** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Loss**          | ** ** | **Reduction**                                 | ** ** | **Loss**                                      | ** ** | **Impairment** | ** ** | **Reduction** | ** ** | **Loss**   | ** ** | **Impairment** | ** ** | **Plan**          | ** ** | **Total**  | ** ** |
| Balance at  January 1, 2004   |       |              | $          | 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         |                                          |       |                                          | —     |           |       | 8             |       |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | — |   |   | 54 |   |
| Cash payments                      |       |              | (1,420     | )                                             |       |                                          | —     |           |       | (1,277        | )          |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | — |   |   | (2,697 | ) |
| Balance at  December 31, 2005 |       |              | 9,684      |                                          |       |                                          | —     |           |       | 7,092         |       |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | — |   |   | 16,776 |   |
| 2006 additional charge  (credit)   |       |              | —     |                                          |       |                                          | —     |           |       | —        |       |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | — |   |   | — |   |
| Non-cash charges  (reversals)      |       |              | 27         |                                          |       |                                          | —     |           |       | (487          | )          |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | 174 |   |   | (286 | ) |
| Cash payments                      |       |              | (1,291     | )                                             |       |                                          | —     |           |       | (1,314        | )          |       | —     |           |       |              | —     |       |       | — |   |   | — |   |   |   | — |   |   | (2,605 | ) |
| Balance at  December 31, 2006 |       |              | $          | 8,420                                         |       |                                          |       | $              | —     |          |       | $          | 5,291      |           |       | $                 | —     |       |       |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |   | $ | 174 |   |   | $ | 13,885 |   |

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

(2)          Non-cash charges relatedto the Q3 2002 Restructuring Plan lease loss represents $3.2 million of tenantimprovements deemed no longer realizable net of a $310,000 write-off of accrueddeferred rent.

Of the accruedrestructuring charge at December 31, 2006, the Company expects $3.2million 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 $10.7 millionto be paid out over the remaining life of the lease of approximately four yearsis recorded as a long-term liability.

**13. BUSINESS SEGMENTREPORTING**

In 1997, the Company adopted SFAS 131, “Disclosuresabout Segments of an Enterprise and Related Information.” As an integratedproducts provider, the Company currently has one reportable segment. TheCompany’s Chief Operating Decision Maker (“CODM”) is the CEO. While the Company’sCODM monitors the sales of various products, operations are managed andfinancial performance evaluated based upon the sales and production of multipleproducts employing common manufacturing and research and 

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**13. BUSINESSSEGMENT REPORTING (Continued)**

development resources;sales and administrative support; and facilities. This allows the Company toleverage its costs in an effort to maximize return. Management believes thatany allocation of such shared expenses to various products would beimpractical, and currently does not make such allocations internally.

Salesto individual customers representing greater than 10% of Company consolidatedsales during at least one of the past three years are as follows (in thousands):

| ** **                       | ** ** | **Year Ended**   | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Richardson  Electronics, Ltd (1) |       |                  | $          | 21,278 |   |   |   | $ | 14,194 |   |   |   | $ | 16,681 |   |   |
| Celestica                        |       |                  | 8,224      |   |   |   | 4,060 |   |   |   | 3,768 |   |   |

----

(1)          Richardson Electronics,Ltd is the worldwide distributor of the Company’s line of RF semiconductorproducts

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

| ** **                        | ** ** | **Year Ended**   | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                        | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States                     |       |                  | $          | 23,500 |   |   |   | $ | 17,800 |   |   |   | $ | 20,904 |   |   |
| Export Sales from United  States: |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Europe                            |       |                  | 5,048      |   |   |   | 1,632 |   |   |   | 2,435 |   |   |
| Thailand                          |       |                  | 4,984      |   |   |   | 1,667 |   |   |   | 844 |   |   |
| Republic of Korea                 |       |                  | 2,203      |   |   |   | 1,775 |   |   |   | 599 |   |   |
| China                             |       |                  | 9,877      |   |   |   | 6,777 |   |   |   | 4,492 |   |   |
| Other                             |       |                  | 3,167      |   |   |   | 1,946 |   |   |   | 3,062 |   |   |
| Total                             |       |                  | $          | 48,779 |   |   |   | $ | 31,597 |   |   |   | $ | 32,336 |   |   |

 

Long-lived assets locatedoutside of the United States are insignificant.

**14. LOSS PER SHARECALCULATION**

Pershare amounts are computed based on the weighted average number of basic anddiluted (dilutive stock options) common and common equivalent sharesoutstanding during the respective periods. The net loss per share calculationis as follows (in thousands, except per share amounts):

| ** **                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  (numerator)                                  |       | $                                          | (8,404     | ) | $ | (20,988 | ) | $ | (9,081 | ) |
| Denominator for basic  and diluted net loss per share: |       |                                       |       |   |   |   |   |
| Weighted average shares outstanding                    |       | 66,408                                     |       | 64,162 |   | 60,397 |   |
| Basic and diluted net  loss per share from operations  |       | $                                          | (0.13      | ) | $ | (0.33 | ) | $ | (0.15 | ) |

 

For the years ended December 31,2006, 2005 and 2004, the incremental shares from the assumed exercise of8,888,280, 9,366,759 and 13,727,396 stock options, respectively, and 64,648,65,936 and 158,601 

94

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**14. LOSSPER SHARE CALCULATION (Continued)**

sharesfor the years ended December 31, 2006, 2005 and 2004, respectively,related to contributions under the Employee Stock Purchase Plan for pendingpurchases were not included in computing the dilutive per share amounts becauseoperations resulted in a loss and the effect of such assumed exercise would beanti-dilutive.

**15. RELATED PARTYTRANSACTIONS**

On January 31, 2000,the Company entered into a management agreement with Fox Paine &Company, LLC (“Fox Paine”). Fox Paine was the majority stockholder in theCompany at that time. Under that agreement, the Company would pay Fox Paine amanagement fee in the amount of 1% of the prior year’s income before interestexpense, interest income, income taxes, depreciation and amortization andequity in earnings (losses) of minority investments, calculated without regardto the fee. Due to the Company’s loss incurred in 2005, 2004 and 2003, nomanagement fee was paid to Fox Paine for the years ended December 31,2006, 2005 and 2004, respectively. In exchange for its management fee, Fox Paineassists the Company with its strategic planning, budgets and financialprojections and helps the Company identify possible strategic acquisitions andto recruit qualified management personnel. Fox Paine also helps develop andenhance customer and supplier relationships on behalf of the Company andconsults with management on various matters including tax planning and publicrelations strategies, economic and industry trends and executive compensation.In connection with this agreement, the Company has agreed to indemnify FoxPaine against various liabilities that may arise as a result of the managementservices it will perform. The Company has also agreed to reimburse Fox Painefor its expenses incurred in providing these services. The Company paid Fox Paine$29,000, $29,000 and $108,000 for the reimbursement of expenses incurred by FoxPaine in 2006, 2005 and 2004, respectively. The Company also paid Fox Paine$700,000 in July of 2004 for investment banking services rendered inconnection with the EiC Acquisition that was completed on June 18, 2004(see Note 4).

**16. QUARTERLY FINANCIALDATA—UNAUDITED**

The following table setsforth, for the periods presented, selected data from our consolidatedstatements of operations on a quarterly basis. The consolidated statements ofoperations data have been derived from our unaudited consolidated financialstatements. In the opinion of management, these 

95

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**16.QUARTERLY FINANCIAL DATA—UNAUDITED (Continued)**

statements have been prepared on substantially thesame basis as the audited consolidated financial statements and include alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the financial information for the periods presented. Thisinformation should be read in conjunction with the consolidated financialstatements and notes to those financial statements included elsewhere in thisfiling.

| ** **                                   | ** ** | **Three Months Ended**                                   | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **April 2,**                                                  | ** ** | **July 2,** | ** ** | **October 1,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                   | ** ** | **2006**                                                           | ** ** | **2006** | ** ** | **2006** | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands, except per share data)** | ** ** |
| Consolidated Statements  of Operations Data: |       |                                                               |       |   |   |   |   |   |   |   |   |
| Sales                                        |       | $                                                                  | 12,341     |   | $ | 12,412 |   |   | $ | 12,741 |   |   | $ | 11,285 |   |
| Cost of goods sold                           |       | 6,140                                                              |       | 5,713 |   |   | 5,648 |   |   | 6,203 | (4) |
| Gross profit                                 |       | 6,201                                                              |       | 6,699 |   |   | 7,093 |   |   | 5,082 |   |
| Operating  expenses:                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Research and development                     |       | 5,147                                                              |       | 4,642 |   |   | 4,235 |   |   | 4,305 | (4) |
| Selling and administrative                   |       | 5,365                                                              |       | 3,892 |   |   | 4,423 |   |   | 4,189 | (4) |
| Restructuring reversals                      |       | —                                                             |       | — |   |   | — |   |   | (286 | ) |
| Total operating expenses                     |       | 10,512                                                             |       | 8,534 |   |   | 8,658 |   |   | 8,208 |   |
| Loss from  operations                        |       | (4,311                                                             | )          | (1,835 | ) |   | (1,565 | ) |   | (3,126 | ) |
| Interest income                              |       | 292                                                                |       | 295 |   |   | 327 |   |   | 327 |   |
| Interest expense                             |       | (30                                                                | )          | (16 | ) |   | (14 | ) |   | (23 | ) |
| Other  income/expense—net               |       | 3                                                                  |       | 1 |   |   | 2 |   |   | (97 | ) |
| Loss from  operations before income taxes    |       | (4,046                                                             | )          | (1,555 | ) |   | (1,250 | ) |   | (2,919 | ) |
| Income tax  benefit                          |       | (1,289                                                             | )          | — |   |   | (77 | ) |   | — |   |
| Net loss                                     |       | $                                                                  | (2,757     | ) | $ | (1,555 | ) |   | $ | (1,173 | ) |   | $ | (2,919 | ) |
| Basic and diluted  net loss per share        |       | $                                                                  | (0.04      | ) | $ | (0.02 | ) |   | $ | (0.02 | ) |   | $ | (0.04 | ) |
| Basic and diluted  average shares            |       | 65,707                                                             |       | 66,017 |   |   | 66,687 |   |   | 67,229 |   |

** **

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**WJ COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**16.QUARTERLY FINANCIAL DATA—UNAUDITED (Continued)**

 

| ** **                                                       | ** ** | **Three Months Ended**                                   | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **April 3,**                                                  | ** ** | **July 3,** | ** ** | **Oct. 2,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                                       | ** ** | **2005**                                                           | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Consolidated Statements  of Operations Data:                     |       |                                                               |       |   |   |   |   |   |   |
| Sales                                                            |       | $                                                                  | 7,774      |   | $ | 4,023 | (1) | $ | 8,094 |   | $ | 11,706 |   |
| Cost of goods sold                                               |       | 4,348                                                              |       | 2,870 |   | 3,774 |   | 5,914 |   |
| Gross profit                                                     |       | 3,426                                                              |       | 1,153 |   | 4,320 |   | 5,792 |   |
| Operating  expenses:                                             |       |                                                               |       |   |   |   |   |   |   |
| Acquired in-process research and development(2)                  |       | 3,400                                                              |       | — |   | — |   | — |   |
| Research and development                                         |       | 4,743                                                              |       | 4,397 |   | 4,451 |   | 4,480 |   |
| Selling and administrative                                       |       | 3,189                                                              |       | 4,824 | (3) | 3,632 |   | 3,650 |   |
| Total operating expenses                                         |       | 11,332                                                             |       | 9,221 |   | 8,083 |   | 8,130 |   |
| Loss from  operations                                            |       | (7,906                                                             | )          | (8,068 | ) | (3,763 | ) | (2,338 | ) |
| Interest income                                                  |       | 240                                                                |       | 261 |   | 272 |   | 275 |   |
| Interest expense.                                                |       | (23                                                                | )          | (24 | ) | (29 | ) | (20 | ) |
| Other income—net                                            |       | 5                                                                  |       | 3 |   | 3 |   | 3 |   |
| Loss from  operations before income taxes                        |       | (7,684                                                             | )          | (7,828 | ) | (3,517 | ) | (2,080 | ) |
| Income tax  (benefit)/provision                                  |       | —                                                             |       | — |   | (123 | ) | 3 |   |
| Net loss                                                         |       | $                                                                  | (7,684     | ) | $ | (7,828 | ) | $ | (3,394 | ) | $ | (2,083 | ) |
| Basic and diluted  net loss per share                            |       | $                                                                  | (0.12      | ) | $ | (0.12 | ) | $ | (0.05 | ) | $ | (0.03 | ) |
| Basic and diluted shares  used to calculate net loss   per share |       | 63,027                                                             |       | 64,055 |   | 64,516 |   | 65,084 |   |

----

1)               Effective for theCompany’s second quarter ended July 3, 2005, the Company changed theapplication of its revenue recognition policy regarding its distributors (seeNote 2 to the consolidated financial statements). This change in applicationresulted in a $4.1 million revenue deferral in the Company’s second quarter of2005.

2)               During the firstquarter of 2005, $3.4 million of the purchase price for the acquisition ofTelenexus, Inc. was allocated to acquired in-process research anddevelopment expense  (see Note 4 to the consolidated financialstatements).

3)               The second quarterof 2005 includes a $1.2 million charge for separation expenses related to theCompany’s former CEO.

4)               Duringthe fourth quarter of 2006, the Company identified and corrected an error inits methodology used during the first three quarters of 2006 for accounting forforfeitures under SFAS 123R, which accounting was adopted effective January 1,2006. The correction of the error resulted in a cumulative stock-basedcompensation charge of approximately $126,000, which was recorded in the fourthquarter of 2006. Management has determined that the impact of correcting theerror in the fourth quarter is not material.

97

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**Item 9.**                        CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**Item 9a.**                 CONTROLSAND PROCEDURES

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures.**

We carried out an evaluation, under the supervisionand with the participation of our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered by this reportpursuant to Exchange Act Rule 13a-15. Based on this evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were not effective as of December 31,2006, to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external reportingpurposes in accordance with generally accepted accounting principles due to thematerial weaknesses described below (the results of management’s assessmentwere reviewed with the Audit Committee). Not withstanding these materialweaknesses, we believe that the consolidated financial statements included inthis report fairly present, in all material respects, our consolidatedfinancial position as of, and the consolidated results of operations for theyear ended, December 31, 2006.

During the preparation of our financial statements forthe quarterly period ended October 1, 2006, we determined that we had notproperly accrued cash bonuses earned under employment agreements, includingexecutive officers. As a result, management concluded, after discussions withthe Audit Committee of the Company’s Board of Directors, that we should restateour previously filed financial statements for the quarterly periods ended April 2,2006 and July 2, 2006 in order to correct these errors. As a result of ourdetermination that the errors should be corrected and that previously filedfinancial statements should be restated, management concluded that there was amaterial weakness in our internal control over financial reporting. Although wehave already taken some actions to remediate the material weakness describedabove, including the retention of a skilled outside resource to advise us onsuch matters and processes, we believe that further action is required tocomplete its remediation, including the need to develop and implement enhancedprocesses. The effectiveness of the steps we have taken to date and the stepswe are still in the process of completing is subject to continued managementreview, as well as Audit Committee oversight, and we may make additionalchanges to our internal control over financial reporting other than thosedescribed above.

In connection with the preparation of our financialstatements for the year ended December 31, 2006, we have identified amaterial weakness in the Company’s internal control over financial reporting asof December 31, 2006. We did not maintain a sufficient number of qualifiedresources with the required proficiency to apply our accounting policies inaccordance with generally accepted accounting principles of the United Statesof America. This control deficiency resulted in adjustments, including auditadjustments, recorded in the financial statements, affecting revenue,restructuring accruals, operating expenses and SFAS 123R expenses. This controldeficiency could result in misstatements of our financial statements anddisclosures that could result in a material misstatement to the annual orinterim consolidated financial statements that would not be prevented ordetected.  We are currently evaluatingfurther actions required to remediate this material weakness.

Although we believe wewill be able to adequately address the above material weaknesses, we cannotguarantee that the measures we take will remediate the material weaknesses thatwe have identified, or that any additional material weaknesses will not arisein the future.

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**Changes in Internal Control Over Financial Reporting.**

Other than the materialweaknesses described above, there has been no change in our internal controlover financial reporting during the fourth quarter of 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

**Inherent Limitations on Effectiveness of Controls**

The Company’s management,including the Chief Executive Officer and Chief Financial Officer, does notexpect that its disclosure controls and procedures or its internal control overfinancial reporting will prevent or detect all error and all fraud. A controlsystem, no matter how well designed and operated, can provide only reasonable,not absolute, assurance that the control system’s objectives will be met. Thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Further, because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that misstatements due toerror or fraud will not occur or that all control issues and instances offraud, if any, within the Company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controls effectiveness to futureperiods are subject to risks. Over time, controls may become inadequate becauseof changes in conditions or deterioration in the degree of compliance withpolicies or procedures.

**Item9b.**                 OTHER INFORMATION

None.

**PART III**

**Item10.**                 DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information requiredby this item will be set forth in the registrant’s Form 10-K/A andis incorporated herein by reference.

**Item11.**                 EXECUTIVECOMPENSATION

The information requiredby this item will be set forth in the registrant’s Form 10-K/A andis incorporated herein by reference.

**Item12.**                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby this item will be set forth in the registrant’s Form 10-K/A andis incorporated herein by reference.

**Item13.**                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information requiredby this item will be set forth in the registrant’s Form 10-K/A andis incorporated herein by reference.

**Item14.**                 PRINCIPALACCOUNTANT FEES AND SERVICES

The information requiredby this item will be set forth in the registrant’s Form 10-K/A andis incorporated herein by reference.

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**PART IV**

**Item 15.  EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

1. Financial Statements

The consolidated financial statements, and relatednotes thereto, of the Company, and the Report of Independent Registered PublicAccounting Firm listed in the accompanying Index to Consolidated FinancialStatements on page 3 are filed as part of this Form 10-K.

2. Financial Statement Schedules

The following financialstatement schedule of the Company is filed as part of this Form 10-K.All other schedules have been omitted because they are not applicable, notrequired, or the information is included in the consolidated financialstatements or notes thereto.

Schedule II—Valuation and Qualifying Accounts

3. Exhibits

The exhibits listed on thefollowing index to exhibits are filed as part of, or hereby incorporated byreference into, this Form 10-K.

|             | ** ** | ** **                                                                                                                                                                                         | ** ** | **Incorporated by Reference** | ** ** | ** **       | ** ** |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|------------------|------------|
| **Exhibit** | ** ** | ** **                                                                                                                                                                                         | ** ** | ** **                              | ** ** | ** **       | ** ** | ** ** | ** ** | **Filing** | ** ** | **Filed** | ** ** |
| **Number**  | ** ** | **Exhibit Description**                                                                                                                                                                       | ** ** | **Form**                                | ** ** | **File No** | ** ** | **Exhibit** | ** ** | **Date** | ** ** | **Herewith** | ** ** |
| 2.1         |       | Agreement  and Plan of Merger, dated October 25, 1999, by and between FP-WJ  Acquisition Corp. and the Registrant                                                                             |       | 8-K                                     |       | 1-5631           |       | 2.1 |   | 10/28/99 |   |   |   |   |   |
| 3.1         |       | Certificate  of Incorporation of the Registrant                                                                                                                                                    |       | S-1/A                                   |       | 333-38518        |       | 3.1 |   | 7/12/00 |   |   |   |   |   |
| 3.2         |       | By-Laws  of the Registrant                                                                                                                                                                         |       | S-1/A                                   |       | 333-38518        |       | 3.2 |   | 7/12/00 |   |   |   |   |   |
| 4.1         |       | Specimen  of Common Stock Certificate                                                                                                                                                              |       | 8-A                                     |       | 000-31337        |       | 4.1 |   | 8/14/00 |   |   |   |   |   |
| 4.2*        |       | Shareholders’  Agreement, dated as of January 31, 2000, by and among the Registrant,  the Parties listed on the signature pages thereto and certain  stockholders of the Registrant |       | S-1/A                                   |       | 333-38518        |       | 4.2 |   | 7/26/00 |   |   |   |   |   |
| 10.1*       |       | Employment  Agreement, dated as of January 31, 2000, by and between the Registrant  and Thomas R. Kritzer                                                                                     |       | S-1/A                                   |       | 333-38518        |       | 10.4 |   | 7/12/00 |   |   |   |   |   |
| 10.2*       |       | Employment  Agreement, dated as of January 31, 2000, by and between the Registrant  and Rainer N. Growitz                                                                                     |       | S-1/A                                   |       | 333-38518        |       | 10.6 |   | 7/12/00 |   |   |   |   |   |
| 10.3*       |       | WJ  Communications, Inc. 2000 Stock Incentive Plan                                                                                                                                            |       | S-1/A                                   |       | 333-38518        |       | 10.8 |   | 7/12/00 |   |   |   |   |   |
| 10.4        |       | Lease  (Phase I) dated March 24, 2000, by and between the Registrant and 401  River Oaks, LLC                                                                                                 |       | S-1/A                                   |       | 333-38518        |       | 10.9 |   | 7/12/00 |   |   |   |   |   |
| 10.5        |       | Lease  (Phase II) dated March 24, 2000, by and between the Registrant and 401  River Oaks, LLC                                                                                                |       | S-1/A                                   |       | 333-38518        |       | 10.10 |   | 7/12/00 |   |   |   |   |   |

100

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| 10.6              |   | Management  Agreement, dated as of January 31, 2000, by and between Registrant and  Fox Paine & Company, LLC                                                                                                              |   | S-1/A |   | 333-38518 |   | 10.17                                       |   | 7/12/00  |   |   |   |   |   |
|-------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------|--------|-----------|--------|---------------------------------------------|--------|----------|--------|--------|--------|--------|--------|
| 10.7              |   | WJ  Communications, Inc. 2000 Non-Employee Director Stock Compensation Plan                                                                                                                                                        |   | S-8   |   | 333-52408 |   | 99.2                                        |   | 12/21/00 |   |   |   |   |   |
| 10.8*             |   | Employment  Agreement, by and between the Registrant and Michael R. Farese, Ph.D.                                                                                                                                                       |   | 8-K   |   | 000-31337 |   | 10.1                                        |   | 11/15/04 |   |   |   |   |   |
| 10.9              |   | Amended  and Restated WJ Communications, Inc. 2002 Non-Employee Director Stock  Compensation Plan                                                                                                                                  |   | 10-Q  |   | 000-31337 |   | 10.1 and 10.2                     |   | 8/12/03  |   |   |   |   |   |
| 10.10*            |   | Second  Amendment to WJ Communications, Inc. 2000 Stock Incentive Plan                                                                                                                                                             |   | 10-Q  |   | 000-31337 |   | 10.1 and 10.2                     |   | 8/12/03  |   |   |   |   |   |
| 10.11             |   | Amended  and Restated Loan and Security Agreement, dated September 29, 2003, by  and among the Registrant and Comerica Bank                                                                                                        |   | 10-Q  |   | 000-31337 |   | 10.1 and 10.2                     |   | 10/30/03 |   |   |   |   |   |
| 10.12             |   | Intellectual  Property Security Agreement, dated September 29, 2003, by and among the  Registrant and Comerica Bank                                                                                                                |   | 10-Q  |   | 000-31337 |   | 10.1 and 10.2                     |   | 10/30/03 |   |   |   |   |   |
| 10.13             |   | Acquisition  related agreements by and between WJ Communications, Inc., EiC  Corporation and EiC Enterprises Limited dated June 18, 2004                                                                                      |   | 8-K   |   | 000-31337 |   | 2.1, 2.2, 4.1,  4.2 and 10.1 |   | 7/2/04   |   |   |   |   |   |
| 10.14             |   | Acquisition  related agreements by and among WJ Communications, Inc., WJ Newco, LLC,  Telenexus, Inc. and Richard J. Swanson, Wilfred K. Lau, David  Fried, Kurt Christensen and Mark Sutton dated January 28, 2005 |   | 8-K   |   | 000-31337 |   | 2.1 and 4.1                       |   | 2/3/05   |   |   |   |   |   |
| 10.15†† |   | Employment  Agreement by and between WJ Communications, Inc. and Richard J. Swanson  dated January 28, 2005                                                                                                                   |   | 8-K   |   | 000-31337 |   | 10.1                                        |   | 2/3/05   |   |   |   |   |   |
| 10.16†† |   | Employment  Agreement by and between WJ Communications, Inc. and Wilfred K. Lau  dated January 28, 2005                                                                                                                       |   | 8-K   |   | 000-31337 |   | 10.2                                        |   | 2/3/05   |   |   |   |   |   |
| 10.17             |   | Employment  agreement between the Registrant and Javed S. Patel                                                                                                                                                                         |   | 10-Q  |   | 000-31337 |   | 10.1                                        |   | 5/18/05  |   |   |   |   |   |
| 10.18*            |   | Employment  agreement between the Registrant and Neil Morris, Ph.D.                                                                                                                                                                     |   | 10-Q  |   | 000-31337 |   | 10.2                                        |   | 5/18/05  |   |   |   |   |   |
| 10.19*            |   | Employment  agreement between the Registrant and Robert J. Bayruns                                                                                                                                                                      |   | 10-Q  |   | 000-31337 |   | 10.3                                        |   | 5/18/05  |   |   |   |   |   |

101

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| 10.20        |   | Acquisition  related agreements by and among WJ Communications, Inc., WJ Newco, LLC,  Telenexus, Inc. and Richard J. Swanson, Wilfred K. Lau, David  Fried, Kurt Christensen and Mark Sutton dated January 28, 2005 to refile  Exhibit 2.1 to include certain information that was previously redacted  pursuant to a confidential treatment request. The Exhibit 2.1 attached  hereto supersedes in its entirety the exhibit previously filed on Form 8-K  on February 3, 2005. |   | 8-K/A |   | 000-31337 |   | 2.1   |   | 6/24/05  |   |   |   |   |   |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------|--------|-----------|--------|-------|--------|----------|--------|--------|--------|--------|--------|
| 10.21        |   | Employment  Agreement, dated as of June 28, 2005, by and between the Registrant and  Bruce W. Diamond                                                                                                                                                                                                                                                                                                                                                                                                               |   | 8-K   |   | 000-31337 |   | 10.2  |   | 7/1/05   |   |   |   |   |   |
| 10.22        |   | Employment  agreement, dated October 19, 2005, by and between the Company and Haresh  P. Patel                                                                                                                                                                                                                                                                                                                                                                                                                      |   | 8-K   |   | 000-31337 |   | 10.1  |   | 10/28/05 |   |   |   |   |   |
| 10.23        |   | Amendment  No. 4 to Loan and Security Agreement by and between the Company and  Comerica Bank dated December 27, 2005                                                                                                                                                                                                                                                                                                                                                                                          |   | 8-K   |   | 000-31337 |   | 10.1  |   | 1/3/06   |   |   |   |   |   |
| 10.24*† |   | Employment  Agreement, dated as of December 21, 2005, by and between the Registrant  and Mark S. Knoch                                                                                                                                                                                                                                                                                                                                                                                                         |   | 10-K  |   | 000-31337 |   | 10.27 |   | 3/31/06  |   |   |   |   |   |
| 10.25*       |   | Employment  Agreement, dated as of January 13, 2006, by and between the Registrant  and Morteza Saidi                                                                                                                                                                                                                                                                                                                                                                                                               |   | 10-K  |   | 000-31337 |   | 10.28 |   | 3/31/06  |   |   |   |   |   |
| 10.26*† |   | Employment  Agreement dated as of March 1, 2006, by and between the Registrant and  R. Gregory Miller.                                                                                                                                                                                                                                                                                                                                                                                                              |   | 10-Q  |   | 000-31337 |   | 10.1  |   | 5/17/06  |   |   |   |   |   |
| 10.27*       |   | First  Amendment to the Amended and Restated WJ Communications, Inc. 2000  Non-Employee Director Stock Compensation Plan.                                                                                                                                                                                                                                                                                                                                                                                           |   | 10-Q  |   | 000-31337 |   | 10.1  |   | 8/10/06  |   |   |   |   |   |
| 10.28*       |   | Second  Amendment to the WJ Communications, Inc. 2001 Employee Stock Purchase  Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                |   | 10-Q  |   | 000-31337 |   | 10.2  |   | 8/10/06  |   |   |   |   |   |
| 10.29†  |   | Wafer  Manufacturing and Supply Agreement between Registrant and Global  Communication Semiconductors, Inc.                                                                                                                                                                                                                                                                                                                                                                                                         |   | 10-Q  |   | 000-31337 |   | 10.1  |   | 11/17/06 |   |   |   |   |   |
| 10.30        |   | Amended  and Restated 2000 Stock Incentive Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   | 10-Q  |   | 000-31337 |   | 10.1  |   | 8/6/06   |   |   |   |   |   |
| 10.31        |   | Performance  Accelerated Restricted Stock Unit Agreement (CIC)                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   | 10-Q  |   | 000-31337 |   | 10.2  |   | 8/6/06   |   |   |   |   |   |
| 10.32        |   | Performance  Accelerated Restricted Stock Unit Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | 10-Q  |   | 000-31337 |   | 10.3  |   | 8/6/06   |   |   |   |   |   |

102

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| 10.33 |   | Letter  Agreement between the Company and Comerica Bank regarding the extension of  the Credit Facility                                                                    |   | 8-K    |   | 000-31337 |   | 10.1   |   | 1/4/07  |   |   |   |   |   |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|-----------|--------|--------|--------|---------|--------|--------|--------|--------|--------|
| 10.34 |   | Fifth  Amendment to Amended and Restated Loan and Security Agreement                                                                                                       |   | 8-K    |   | 000-31337 |   | 10.1   |   | 1/29/07 |   |   |   |   |   |
| 10.35 |   | Letter  Agreement with Comerica Bank                                                                                                                                       |   | 8-K    |   | 000-31337 |   | 10.2   |   | 1/29/07 |   |   |   |   |   |
| 21.1  |   | Subsidiaries  of the registrant                                                                                                                                            |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 23.1  |   | Consent  of Deloitte & Touche LLP, Independent Registered Public Accounting  Firm                                                                                 |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 24.1  |   | Power  of Attorney (see signature page)                                                                                                                                    |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 31.1  |   | Certification  of Bruce W. Diamond, Chief Executive Officer (principal executive officer),  pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.           |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 31.2  |   | Certification  of R. Gregory Miller, Interim Chief Financial Officer (principal financial  officer), pursuant to Rule 13a-14 of the Securities Exchange Act  of 1934. |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 32.1  |   | Certification  of Bruce W. Diamond, principal executive officer, Pursuant To 18 U.S.C.  Section 1350.                                                                 |   |   |   |      |   |   |   |    |   |   | X      |   |   |
| 32.2  |   | Certification of R.  Gregory Miller, principal financial officer, Pursuant To 18 U.S.C.  Section 1350.                                                                |   |   |   |      |   |   |   |    |   |   | X      |   |   |

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*                    Indicates acontract, compensatory plan or arrangement in which directors or executiveofficers are eligible to participate.

†                    Confidentialtreatment has been requested with respect to the redacted portions of thereferenced exhibit.

††             Confidential treatmenthas previously been granted by the SEC for certain portions of the referencedexhibit pursuant to Rule 406 under the Securities Act.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this Report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City of San Jose,State of California, on the 28th day of March 2007.

|                                |   |   |   | WJ  COMMUNICATIONS, INC.               |
|--------------------------------|--------|--------|--------|----------------------------------------|
|                           |   |   |   | (Registrant)                           |
| Date  March 28, 2007 |   | By:    |   | /s/  BRUCE W. DIAMOND                  |
|                           |   |   |   | Bruce W. Diamond                       |
|                           |   |   |   | President and  Chief Executive Officer |

 

**POWEROF ATTORNEY**

We, the undersigned officers and directors of WJCommunications, Inc., do hereby constitute and appoint Bruce W. Diamond,and R. Gregory Miller, and each of them, our true and lawful attorneys-in-factand agents, each with full power of substitution and resubstitution, for himand in his name, place and stead, in any and all capacities, to sign any andall amendments to this Report, and to file the same, with exhibits thereto, andother documents in connection therewith, with the Securities and ExchangeCommission, granting unto said attorneys-in-fact and agents, and each of them,full power and authority to do and perform each and every act and thingrequisite or necessary to be done in and about the premises, as fully to allintents and purposes as he might or could do in person, hereby, ratifying andconfirming all that each of said attorneys-in-fact and agents, or hissubstitute or substitutes, may lawfully do or cause to be done by virtuehereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons in the capacities and on the datesindicated:

| **Signature**                  | ** ** | **Title**                                | ** ** | **Date**  |
|--------------------------------|------------|------------------------------------------|------------|-----------|
| /s/  BRUCE W. DIAMOND          |       | President, Chief  Executive Officer      |       | 3/28/2007 |
| Bruce W. Diamond               |       | (principal executive officer) , Director |       |      |
| /s/  R. GREGORY MILLER         |       | Chief Financial Officer                  |       | 3/28/2007 |
| R. Gregory Miller              |       | (principal financial officer)            |       |      |
| /s/  W. DEXTER PAINE, III |       | Chairman of the Board                    |       | 3/28/2007 |
| W. Dexter  Paine, III     |       |                                     |       |      |
| /s/  MICHAEL E. HOLMSTROM      |       | Director                                 |       | 3/28/2007 |
| Michael E.  Holmstrom          |       |                                     |       |      |
| /s/  LIANE J. PELLETIER        |       | Director                                 |       | 3/28/2007 |
| Liane J.  Pelletier            |       |                                     |       |      |
| /s/ JACK G. LEVIN              |       | Director                                 |       | 3/28/2007 |
| Jack G. Levin                  |       |                                     |       |      |
| /s/  PATRICE M. DANIELS        |       | Director                                 |       | 3/28/2007 |
| Patrice M. Daniels             |       |                                     |       |      |
| /s/  CATHERINE P. LEGO         |       | Director                                 |       | 3/28/2007 |
| Catherine P. Lego              |       |                                     |       |      |
| /s/  ROBERT WHELTON            |       | Director                                 |       | 3/28/2007 |
| Robert Whelton                 |       |                                     |       |      |

 

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**SCHEDULE II**

**WJ COMMUNICATIONS, INC. AND SUBSIDIARIESVALUATION AND QUALIFYING ACCOUNTS AND RESERVESFOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004**(inthousands)

| ** **                         | ** ** | **Balance at**   | ** ** | **Charged (Credits)** | ** ** | **Balance at** | ** ** | ** **      | ** ** |
|------------------------------------|------------|-----------------------|------------|----------------------------|------------|---------------------|------------|-----------------|------------|
| ** **                         | ** ** | **Beginning of** | ** ** | **to Costs and** | ** ** | **Recoveries/**     | ** ** | **End of** | ** ** |
| **Description**                    | ** ** | **Period**            | ** ** | **Expenses**               | ** ** | **(Write-offs)**    | ** ** | **Period**      | ** ** |
| Year ended  December 31, 2006 |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Deducted from  asset accounts:     |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts    |       |                  | $          | 15                         |       |                |       | $               | 54         |   |   |   | $ | (20 | ) |   |   | $ | 49 |   |   |
| Sales return allowance             |       |                  | 73         |                       |       |                | 528        |            |       |   | (482 | ) |   |   | 119 |   |   |
| Ship & debit allowance    |       |                  | 34         |                       |       |                | 504        |            |       |   | (289 | ) |   |   | 249 |   |   |
| Warranty reserve                   |       |                  | 40         |                       |       |                | 21         |            |       |   | (31 | ) |   |   | 30 |   |   |
| Total                              |       |                  | $          | 162                        |       |                |       | $               | 1,107      |   |   |   | $ | (822 | ) |   |   | $ | 447 |   |   |
| Year ended  December 31, 2005 |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Deducted from  asset accounts:     |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts    |       |                  | $          | 79                         |       |                |       | $               | 32         |   |   |   | $ | (96 | ) |   |   | $ | 15 |   |   |
| Sales return allowance             |       |                  | 74         |                       |       |                | 511        |            |       |   | (512 | ) |   |   | 73 |   |   |
| Distributor stock rotation reserve |       |                  | 338        |                       |       |                | 26         |            |       |   | (364 | ) |   |   | — |   |   |
| Ship & debit allowance    |       |                  | 5          |                       |       |                | 89         |            |       |   | (60 | ) |   |   | 34 |   |   |
| Warranty reserve                   |       |                  | 54         |                       |       |                | 22         |            |       |   | (36 | ) |   |   | 40 |   |   |
| Total                              |       |                  | $          | 550                        |       |                |       | $               | 680        |   |   |   | $ | (1,068 | ) |   |   | $ | 162 |   |   |
| Year ended  December 31, 2004 |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Deducted from  asset accounts:     |       |                  |       |                       |       |                |       |            |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts    |       |                  | $          | 21                         |       |                |       | $               | 51         |   |   |   | $ | 7 |   |   |   | $ | 79 |   |   |
| Sales return allowance             |       |                  | 75         |                       |       |                | 760        |            |       |   | (761 | ) |   |   | 74 |   |   |
| Distributor stock rotation reserve |       |                  | 196        |                       |       |                | 847        |            |       |   | (705 | ) |   |   | 338 |   |   |
| Ship & debit allowance    |       |                  | 29         |                       |       |                | 35         |            |       |   | (59 | ) |   |   | 5 |   |   |
| Warranty reserve                   |       |                  | 36         |                       |       |                | 76         |            |       |   | (58 | ) |   |   | 54 |   |   |
| Total                              |       |                  | $          | 357                        |       |                |       | $               | 1,769      |   |   |   | $ | (1,576 | ) |   |   | $ | 550 |   |   |

 

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