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FORM 10-K
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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

For the fiscal year ended December 31, 2001

OR

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

For the transition period from  to

Commission
file number 333-38518

WJ COMMUNICATIONS, INC.

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(Exact name of registrant as specified in its charter)

DELAWARE(State or other jurisdiction of incorporation or organization)

94-1402710(I.R.S. Employer
Identification No.)401 River Oaks Parkway, San Jose, California(Address of principal executive offices)

95134(Zip Code)


(408) 577-6200

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(Registrant's
telephone number, including area code)

Securities
registered pursuant to Section 12(b) of the Act: NONE

Securities
registered pursuant to Section 12(g) of the Act: COMMON STOCK $0.01 PAR VALUE

(Title
of class)

Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months, and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the
Form 10-K. o

As
of March 22, 2002 there were 56,007,045 shares outstanding of the registrant's common stock, $0.01 par value. As of that date, the aggregate market value of voting stock held
by non-affiliates of the registrant was approximately $60,512,650.

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DOCUMENTS
INCORPORATED BY REFERENCE

PART
IIIPortions of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 22, 2002 are incorporated by reference into Part III (Items 10,
11, 12 and 13) to this Form 10-K.

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SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

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

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WJ COMMUNICATIONS, INC.  FORM 10-K ANNUAL REPORT  TABLE OF CONTENTS

|         |  |                                                                                       |  | Page
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|         |  | PART I                                                                                |  |     
|Item 1.  |  | Business                                                                              |  | 4   
|Item 2.  |  | Properties                                                                            |  | 15  
|Item 3.  |  | Legal Proceedings                                                                     |  | 15  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  | 15  
|         |  | PART II                                                                               |  |     
|Item 5.  |  | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 16  
|Item 6.  |  | Selected Consolidated Financial Data                                                  |  | 17  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 20  
|Item 7a. |  | Quantitative and Qualitative Disclosure About Market Risks                            |  | 48  
|Item 8.  |  | Consolidated Financial Statements and Supplemental Data                               |  | 49  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 82  
|         |  | PART III                                                                              |  |     
|Item 10. |  | Directors and Executive Officers of the Registrant                                    |  | 82  
|Item 11. |  | Executive Compensation                                                                |  | 82  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 82  
|Item 13. |  | Certain Relationships and Related Transactions                                        |  | 82  
|         |  | PART IV                                                                               |  |     
|Item 14. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 83  

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PART I

Item 1. BUSINESS

Overview

WJ Communications, Inc. (formerly Watkins-Johnson Company) was founded in 1957 in Palo Alto, California. We were originally incorporated in California and
reincorporated in Delaware in August 2000. For more than 30 years, we developed and manufactured microwave devices for government electronics and space communications systems used for
intelligence gathering and communication.

In
1996, we began to develop commercial applications for our military technologies. Today, we design, develop and manufacture innovative, high quality radio frequency (RF) communications
products for wireless and wireline communications networks. Our products are comprised of advanced RF semiconductors, integrated assemblies, and highly functional components. The RF equipment in a
communications network is used to convert, process, and amplify the high frequency signals that transmit voice, data and images over the network. Our products are installed in wireless and cellular
network base stations, and in broadband high speed wireline networks, particularly fiber optic networks. Our products address the radio frequency (RF) challenges faced by these networks and our core
expertise in RF design and integration, including RF semiconductor design, coupled with our manufacturing capabilities allows us to compete effectively in our markets.

We
previously operated through other segments and have treated our former Government Electronics, Semiconductor Equipment and Telecommunication segments as discontinued operations. All
segments classified as discontinued operations had been divested by March 31, 2000.

We
completed our initial public offering ("IPO") on August 18, 2000. In the IPO we sold an aggregate of 6,210,000 shares of common stock, par value of $0.01 per share. The sale of
the shares of common stock generated net proceeds of approximately $88.4 million after deducting discounts and fees. Our common stock is traded on the Nasdaq National Market under the symbol
"WJCI".

Industry Background

Over the last decade, there have been significant developments in the communications industry, including the emergence of the Internet, broad deployment of
wireless communications and the deployment of broadband communications networks.

Since
the middle of the 1990's, growing demand for voice, video and data services, as well as high speed Internet access, increased the need for communications networks capable of
handling large volumes of traffic. Simultaneously, the deregulation of the communications industry and the licensing of additional radio spectrum for wireless communications increased competition
among service providers and forced these service providers to seek to differentiate themselves in an effort to attract and retain subscribers. These service providers began upgrading their systems, as
well as deploying next-generation wireless and wireline communications technologies including new generations of cellular, fiber optic, broadband cable, and fixed wireless technologies.
This in turn fueled rapid growth in demand for RF semiconductors, components and integrated assemblies such as those we sell.

As
wireless service providers expand and upgrade their networks, they are driving an important transition from wireless networks that use analog signal modulation techniques to wireless
networks that use digital signal modulation techniques. As compared to analog technologies, digital technologies generally provide better signal quality and increase the speed and capacity of the
voice and data network by allowing transmission of more information in a smaller amount of radio frequency space. Digital technologies place a premium on linear power amplification and management of
multiple transmission channels. These are technical challenges which are typically met using increasingly higher performance RF semiconductors and assemblies.

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Over
the last several years infrastructure improvements to wireline networks have most prominently included a dramatic increase in the deployment of fiber optic technology to replace
conventional copper wire. Optical fiber offers substantially greater capacity and is easier to administer than copper wire. The most advanced fiber optic transport technology commercially available is
capable of carrying data at OC-192 transmission rates. OC-192 systems transmit data at 10 gigabits-per-second, which is 150,000 times the capacity of a
standard dial-up twisted-pair copper line. As the transmission speeds of fiber optic networks increases, RF components are increasingly used to reduce transmission frequency so
that signal processing equipment operating at lower frequencies can extract information from the
signal. Today, this is particularly true of the high capacity long haul OC-192 networks that connect major metropolitan areas to one
another.

Throughout
the second half of the 1990's and into calendar 2000 these trends have driven significant increases in demand for wireless and wireline communications products including RF
products. However, since the beginning of calendar 2001 we and our industry have experienced a notable downturn. This downturn has been driven by a reduction in capital expenditures and network
deployments by the telecommunications carriers and service providers that ultimately consume our products. This decrease in demand from carriers and service providers has been caused by several
factors including network overcapacity, generally soft economic conditions world wide, and capital market constraints currently faced by carriers and service providers. The reduction in network
deployments and capital expenditures has had a particularly large effect on the long haul fiber markets and broadband fixed wireless markets that we compete in, and our financial results suffered
accordingly. During the years from 1997 to 2000, our revenues increased from $31.2 million to $115.8 million. However, in 2001 our revenues dropped to $62.2 million.

While
recent reductions in demand across our industry have been pronounced, we believe that our industry and our markets will ultimately rebound. We believe there are several reasons for
their expected future growth.

Increasing Demand for Wireless Communications Equipment Will be Driven by the Increase in the Number of Wireless Service
Subscribers.The global wireless communications industry has grown considerably, and the number of cellular subscribers has continued to grow, albeit at reduced
rates, even in 2001. This growth is driven by the demand for new mobile telephone services, the increase in coverage of mobile networks, and the increase in sales of mobile handsets. Mobile
subscribers are increasingly demanding data services in addition to enhanced voice services. Next-generation mobile networks are presently being built to provide enhanced voice and data
services.

Demand for High-Speed Internet Access and Other Data Services Will Continue to
Grow.Consumers are using the Internet for a variety of applications including e-mail, audio, streaming video and other multimedia services. Businesses
are also using the Internet for e-commerce, global marketing, customer support, order fulfillment and supply management. Furthermore, the growth in the use of corporate data networks and
the rising number of telecommuters has resulted in the need to transmit large quantities of data to almost any location at high speed across both wireline and wireless networks.

These
trends continue to increase the demands placed on communications networks. As a result, communication service providers will continue to focus on implementing system improvements
that provide greater capacity and speed.

Greater Demand for Broadband Access Has Led Service Providers to Develop Next Generation Transport Technologies for both Wireless and
Wireline Networks.Wireless network operators and service providers have begun to announce their plans for deployment of next generation wireless services and
networks, referred
to in the industry as 2.5G and 3G networks. These networks will offer subscribers increased speeds, additional application capabilities, and broader compatible coverage across geographies. Generally
speaking these next generation wireless services require upgrades, additions, or replacement of existing

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wireless infrastructure equipment and therefore as these new services are deployed demand for RF products should be impacted favorably. In wireline networks, the traditional copper wire
communications infrastructure was originally built for voice traffic. This infrastructure has not been sufficient to meet consumer and business demand for broadband access, which has led to the
implementation and deployment of next generation communications networks with greater transmission capacity and speed, in particular fiber optic networks. These networks are typically comprised of
long haul segments, metro-access segments and local access segments. While the fastest segments of these networks currently operate at OC-192 speeds, the capacity and speed of network
access experienced by the end-user is governed by the slowest segment of the network. As the number of users and the amount of network traffic increases over time, eventually service
providers must increase the speed of all parts of the network to keep pace.

The RF Challenge

While the transport medium is very different for wireless and wireline communications networks, including fiber optic networks, the core technology of RF
electronics is common to each. In these networks, signals are transported at radio frequencies or higher and the RF components in the network are used to convert, process, and amplify these signals.

The
design and performance parameters at radio frequencies are generally more challenging and more complex than those at lower frequencies. As a result, the new generation of broadband
wireless and wireline communications networks has led to increased demand for advanced RF products. For example, wireless systems generally require components that transmit signals with minimal
interference or distortion, which is commonly referred to as high linearity. High speed fiber optic systems place a premium on stable and reliable oscillators for precise timing. In addition, in new
generation wireless and wireline networks, the ability to integrate RF components into higher level, more complex assemblies and to interface these RF assemblies and subsystems with other network
elements requires a highly specialized engineering expertise.

RF
semiconductor technology presents different engineering challenges than standard semiconductor design. In general, digital semiconductors are created from standard semiconductor
circuit designs that have predictable performance. This permits an automated design process. Each RF component, however, has distinctly different characteristics that influence overall system
performance in complex ways. Instead of having stable inputs and outputs, the RF circuit characteristics can drift based on process variations, temperature, power supply and other variables. As a
result, performance characteristics are unique for each device, and the RF engineer must evaluate and develop new designs on a continuous basis for each system performance level and air interface
standard. In addition to being skilled in semiconductor circuit design, the RF circuit designer must have a thorough understanding of signal processing principles, must understand the totality of the
system for which the
device is intended and must be able to create designs that function within the unique parameters of different wireless system architectures.

The
knowledge and skills required to design and to manufacture RF semiconductors, components and integrated assemblies are unique and can take many years to develop. Communications
equipment manufacturers seek companies with the technical skills and engineering resources to design, manufacture and integrate RF semiconductors and the other advanced products required by current
and future generations of wireless and wireline infrastructure equipment.

The WJ Communications Solution

With the ability to design and manufacture RF semiconductors, components, and higher level RF assemblies, and interface these assemblies with other network
elements, we enable advanced wireless and wireline communications networks that satisfy the demand for the rapid transmission of large amounts of data, voice and video. Our core technology lies within
our advanced RF semiconductor designs, including gallium arsenide semiconductors, as well as thin-film substrate and oscillator capabilities. By satisfying the

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critical need for linearity in wireless networks and for precise, stable and reliable data timing in fiber optic networks our solutions improve both network capacity and speed.

Our
RF expertise covers a broad range of frequencies, from a few megahertz to 30 gigahertz or more, used in advanced communications networks today. Our solution is comprised of the
following key elements:

RF Design Expertise.We have been designing RF and microwave products for more than 30 years and have developed
significant RF design expertise. Our team of over 80 highly qualified and talented engineering and technical employees is capable of applying this expertise to a variety of wireless and wireline
communications products. This broad range of RF design expertise allows us to create products from the RF semiconductor level, through the component level to the more complex assembly level. These
products are optimized to achieve high performance with minimum cost in wireless and wireline networks. Increasingly, our RF expertise is being applied to the design and delivery of the RF
semiconductors and components that our customers require and we expect that over the coming years this will be an increasing area of focus for the company.

Advanced Device Technology.We design products using the following core technologies:



Manufacturability.Our ability to rapidly convert new technologies and designs into completed RF semiconductors, integrated
assemblies, and highly functional components products results from our flexible manufacturing operations and our manufacturing engineering expertise. Our manufacturing operations are comprised of a
number of individual manufacturing cells. Cells can be added or reconfigured to respond to changes in product demand. This cell-based architecture provides us with the flexibility to use a
cell to manufacture one product in the morning and a different product in the afternoon. Using these processes, we believe we can rapidly transition from prototype to volume manufacturing with
exceptional product quality and performance.

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Business Strategy

Our objective is to be the leading supplier of innovative, proprietary RF solutions to communications equipment companies and service providers. To meet this
goal, we intend to:

Leverage Our Technology Leadership and Our Design and Integration Expertise to Grow with Growing Markets.We intend to
participate in the rapid growth of the global wireless and wireline
communications. We believe that as data throughput requirements expand in wireless networks and as data transmission speeds increase in fiber optic networks the ability to solve the RF challenges
becomes increasingly important and the market for RF products will grow accordingly. We intend to apply our RF design expertise to develop additional leading-edge products in each of the
rapidly growing areas of the communications markets. In the future we expect to focus increasingly on the markets for RF semiconductors and components. Where appropriate we also intend to use our
integration expertise to design cost-effective, high performance integrated assemblies for our customers. Due to the commonality of the RF challenge in fiber optic, broadband cable and
wireless communications networks, we have the flexibility to allocate our design and engineering resources to any or all of these markets and intend to use this flexibility to take advantage of market
opportunities as they arise.

Maintain and Develop Strong Collaborative Customer Relationships with Industry Leaders.We believe our reputation for product
quality, technical performance, customer responsiveness, on-time delivery and cost competitiveness will help us to continue to maintain and develop a loyal customer base. We collaborate
with many of our customers to design and develop new products for them as they develop new products. We plan to maintain our current, and develop new, customer relationships with industry leaders
within wireless and wireline communications markets.

Enhance our Manufacturing Capabilities.We are an ISO 9001 certified manufacturer. We intend to enhance our manufacturing
capabilities to meet our customers' demand through a combination of outsourcing and in-house manufacturing. We also intend to continue to develop robust assembly and test processes that
produce repeatable and reliable product performance. We do not expect to make significant investments in new manufacturing capacity until overall demand for network communications equipment increases.

Acquire and Develop New Technologies.We intend to continue to augment our existing technology base and design capabilities
by acquiring complementary technologies, design capabilities, manufacturing processes and product offerings for broadband communications applications. In addition, we intend to continue to focus our
research and development efforts on emerging communications and RF technologies.

Products and Technology

We are committed to being a technology leader and product development innovator within the growing broadband communications markets. By applying our sophisticated
integration expertise to high level assembly design, we are able to develop cost-effective, high performance products suitable for volume manufacturing. Many of our design engineers,
because of the breadth of their experience and expertise, are capable of working effectively at both the semiconductor level and the integrated assembly level. As a result, we are able to focus our
expertise and resources to quickly address specific market opportunities as they arise. Our product offerings fall into the following three categories:



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Semiconductor Products

Our semiconductor products include a broad array of high performance gallium arsenide semiconductors and thin-film substrates that we manufacture for
our own use as well as for sale to others. The primary markets for our gallium arsenide semiconductor and thin-film substrate products are the wireless, fiber optic and broadband cable
infrastructure markets. In the future we intend to increase our resources focused on developing and marketing our semiconductor products.

Gallium Arsenide Semiconductor Products.Our gallium arsenide semiconductor products are comprised primarily of amplifiers,
mixers and transistors. Amplifiers and transistors increase the level of signals while mixers translate a signal from one frequency to another. The strength of our gallium arsenide semiconductor
technology lies in our ability to design and manufacture highly linear products. High linearity is one of the most critical performance parameters for broadband cable and wireless networks. While our
gallium arsenide semiconductor products form a solid technological foundation for our own integrated product offerings, we sell approximately 90% of these products to customers. The table below
illustrates the wide range of applications for which our gallium arsenide semiconductor products are used:

Amplifiers

Mixers

TransistorsSecond and third generation wireless base stations

X

X

XFiber optic

X

N/A

XBroadband cable

X

X

X


In
the future our products will be manufactured using multiple processes. Some of these processes will be used in our own manufacturing operations and in other cases we will have our
products manufactured for us by an outside foundry. The processes we are currently designing for or evaluating include heterojunction bipolar transistor (HBT), GaAs metal semiconductor field effect
transistor (MESFET), silicon germanium (SiGe) BiCMOS, silicon bipolar transistor, silicon CMOS, silicon BiCMOS.

Thin-Film Substrate Products.Our semiconductor products also include thin-film substrates designed
and manufactured using several advanced processes. Our thin-film substrates incorporate technology that improves the electrical performance of the circuits while enabling increased circuit
density. In addition, we use laser machining technology which allows us to cut our products into virtually any shape. We use our thin-film products in the design and production of our
fiber optic and wireless communications products and sell them to customers.

Fiber Optic Communications Products

Our fiber optic communications products include both high data-rate fiber optic and broadband cable network products. Our fiber optic products are
targeted for use in the long haul, metro-access and first and last mile access segments of networks. Our broadband cable products are used to provide high bandwidth first and last mile access to
consumers and small businesses.

Fiber Optic Products.Fiber optic systems are being upgraded by communications service providers to provide higher data
transmission rates as a means of increasing network capacity. The highest transmission rate systems that are currently commercially available are the OC-192 systems, which operate at a 10
gigabit-per-second rate. At these high rates, the time between consecutive pieces of data is extremely short, making system timing critical. Our highly stable oscillator
assemblies provide the timing function, or clock, that delivers the precision and reliability needed to keep the overall system synchronized. We currently produce oscillator assemblies for
OC-192 systems and are working with our customers to develop similar products for next-generation OC-768 systems, which will operate at 40
gigabits-per-second. In addition to our oscillator products, we produce modulator driver amplifiers and narrow band clock amplifiers for OC-192 systems. We are also
expanding our product base to include transmit and receive functions for high-speed fiber optic systems as we integrate the RF electronics with other elements of these networks.

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Wireless Communications Products

Our wireless communications products are primarily used in wireless infrastructure equipment, such as cellular base stations, which provide a combination of voice
and data services to mobile users.

Mobile Wireless Infrastructure Equipment.We have an extensive array of integrated products for the mobile wireless
infrastructure market. These products include base station RF front ends, diagnostic and support equipment and repeaters. Base station RF front ends consist of filters and frequency converters, and
are used in virtually every communications system to translate signals from one frequency to another.



Customers

We sell our semiconductor, fiber optic and wireless communications components and subassemblies principally to original equipment manufacturers, including their
manufacturing subcontractors, that, in turn, integrate our products into network infrastructure equipment solutions. We believe that we have strong relationships with market leaders in the wireless
and wireline markets, including the fiber optic market. A sample of our revenue-producing customers include:

Agilent Technologies
Ameritech
Ciena Corporation
Cisco Systems, Inc.
Ericsson
Fujitsu Quantum Devices Ltd.

Harris Corporation
JDS Uniphase Corporation
Lucent Technologies, Inc.
M/A-COM
Marconi Communications GMBH
Nokia Networks

Nortel Networks
NU Horizons Electronics
QUALCOMM, Inc.
Richardson Electronics Ltd.
Samsung Electronics Co. Ltd.
Sprint PCS


During the year ended December 31, 2001, we had four customers which each accounted for more than 10% of our sales and in aggregate
accounted for 71% of our sales. Those customers were Lucent Technologies, Marconi Communications, Nortel Networks and Richardson Electronics including sales to their respective manufacturing
subcontractors. During the year ended December 31, 2000, we had two customers which each accounted for more than 10% of our sales and in aggregate accounted for approximately 72% of our sales.
Those customers were Lucent Technologies and Nortel Networks including sales to their respective manufacturing subcontractors. While our sales have historically been concentrated with several key
communications equipment manufacturers, we have expanded our product offering from wireless mobile infrastructure products to include fiber optic, broadband cable and fixed wireless products and we
believe this will allow us to diversify our customer base.

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Sales and Marketing

We sell and market our products primarily through the following three sales channels:

Direct SalesWe have a dedicated team of direct sales people who are responsible for maintaining relationships with our key
customers and generating new business with both existing and potential customers. We cultivate strong direct relationships with our key customers through major account teams that are led by our sales
professionals and are comprised of engineers and product managers. These teams are designed to address the specific product needs of our key customers.

Manufacturer Sales RepresentativesManufacturer sales representatives are responsible for calling on potential customers as
well as maintaining relationships with non-major accounts. We use manufacturer sales representatives to augment our own direct sales force.

DistributorsWe sell our RF semiconductor products to component distributors that resell them through catalog,
e-commerce and direct channels.

International SalesOur sales outside the United States were 42%, 53% and 29% of our total sales, in 2001, 2000 and 1999,
respectively. For more detailed disclosure on our foreign sales, see Note 12 to the audited consolidated financial statements included elsewhere in this annual report.

Manufacturing

We have two leased manufacturing sites: a building in Milpitas, California with over 35,000 square feet and two buildings in San Jose, California totaling over
124,000 square feet. The San Jose facility consists of two buildings: a larger building of approximately 82,000 square feet and a smaller building of approximately 42,000 square foot. In
September 2001, we decided to abandon the smaller building at our San Jose facility based on revised anticipated demand for our products and current market conditions and incurred a charge of
$9.8 million, see Note 11 to the audited consolidated financial statements included elsewhere in this annual report.

Our
Milpitas facility produces gallium arsenide semiconductor and thin-film. Considerable manufacturing capacity exists for gallium arsenide semiconductor. Our gallium
arsenide products are packaged in the Philippines, Hong Kong and China at vendor facilities. The thin-film manufacturing lines are capable of processing three-inch,
four-inch and six-inch substrate squares.

The
San Jose facility produces our fiber optic and wireless communications products. These products are assembled in either of two ways: surface mount or hybrid modules. Surface mount
technology is generally used for products operating at frequencies below 10 gigahertz. Hybrid modules are necessary for products operating above 10 gigahertz. We contract with external surface mount
manufacturers for high volume manufacturing, using both turnkey and consignment material arrangements with these surface mount contract manufacturers depending on the characteristics of the assembly.
We have used a number of capable surface mount manufacturers. Once the surface mount assembly operations are completed, the products are shipped to our facilities for testing and final configuration.
Hybrid modules are manufactured internally using automated processes for both assembly and testing.

We
depend on single or limited source suppliers for the components and materials used in many of our products, including our thin-film products, substrates, gallium arsenide
wafers, packaging, electronic components and antennas. A significant portion of the raw material used to manufacture our thin-film products is sole sourced from Coors Ceramics, and there
exist very limited alternative sources for this material. Although we rely on limited or sole source suppliers for other components and materials, there are typically alternative sources of supply
available for them. If in the future we face difficulties obtaining these components and materials from any of our limited or sole source suppliers, we may face a delay in the shipment of products
which are manufactured using these components and materials while we identify

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and qualify an alternative source of supply if available. As a result of these delays, we may fail to satisfy customer orders and our sales may decline while we look for a suitable alternative
supplier.

Research and Development

Our future success depends on our ability to develop new designs, technologies and product enhancements. We have assembled a core team of experienced engineers
and technologists to accomplish these objectives. These employees are involved in advancing our core technologies, as well as applying these core technologies to our product development activities in
our target markets. We have made, and will continue to make, a substantial investment in research and development activities. Research and development costs, which are expensed when incurred, were
approximately $17 million, $19 million and $17 million for the years 2001, 2000 and 1999, respectively.

Intellectual Property

We rely on patent, copyright, trademark and trade secret laws, as well as confidentiality procedures and contractual provisions, to protect our proprietary
rights. We believe that one of our competitive strengths is our core competence in engineering, manufacturing and understanding our customers and markets, and we take aggressive steps to protect that
knowledge. We have been active in securing patents and entering into non-disclosure and confidentiality agreements to protect our proprietary technologies and know-how
resulting from our ongoing research and development.

We
seek patent protection for our unique developments in circuit designs, processes and algorithms. We have 26 United States patents and four foreign patents in force. In 2001, we filed
seven and were granted two patents. We currently have several patent applications pending in the United States Patent and Trademark Office. Our existing United States patents will expire between
June 2007 and March 2017. We have chosen to pursue foreign patent protection only in selected foreign countries. Our failure to pursue foreign protection in these countries and the fact
that patent rights may be unavailable or limited in some foreign countries could make it easier for our competitors to utilize our intellectual property. We cannot assure you that any patent will be
issued as a result of our pending applications or any future applications or that, if issued, these patents will be sufficient to protect our technology. In addition, we cannot assure you that any
existing or future United States or foreign patents will not be challenged, invalidated or circumvented, or that any patent granted will provide us with adequate protection or any competitive
advantages.

We
license various technologies from third parties that we have integrated into our products. We have a non-exclusive, non-transferable license to use particular
thin-film technology and transferable, non-exclusive licenses to use particular gallium arsenide technology, and technology used in the field of commercial, or
non-military, RF communications, all of which are perpetual licenses. Our failure to maintain these licenses could harm our business.

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

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

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The
telecommunications industry is characterized by the vigorous protection and pursuit of intellectual property rights. We cannot assure you that actions alleging infringement by us of
third-party intellectual property, misappropriation or misuse by us of third-party trade secrets or the invalidity of the patents held by us will not be asserted or prosecuted against us, or that any
assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of our patents will not harm our competitive position or reputation or result in significant
monetary expenditures.

Employees

One of our most important assets is our base of well-trained and experienced employees. As of December 31, 2001, we had 243 employees, none of
whom were represented by a collective bargaining agreement. As of December 31, 2001, our employees consisted of:



We
have historically experienced relatively low turnover. However, since January 1, 2001 we have reduced our workforce by approximately 48% due to the recent economic downturn and
weakness in demand resulting in approximately $1.5 million of employee severance costs. If demand increases in the future, we expect to correspondingly increase our workforce and there can be
no assurance that we will be able to hire qualified employees. Our employees have an average of over five years tenure with us. Many of our engineering and technical staff have been with us for even
longer. We believe that many of our engineers, as a result of their tenure and their defense electronics background, are among the most experienced high frequency engineers in the United States. We
believe that the relationship with our employees is good.

Backlog

Our backlog is comprised of standard purchase orders and multi-year contracts for the delivery of products. For our multi-year contracts,
our major customers provide us with twelve month rolling sales forecasts on at least a monthly basis. These forecasts, however, are subject to changes, including changes as a result of changes in
market conditions, and could fluctuate significantly from quarter to quarter. Due to industry practice which allows customers to cancel or change orders with limited advance notice prior to shipment,
we believe that backlog is not a reliable indicator of future revenue levels.

Competition

The markets for our products are extremely competitive and are characterized by rapid technological change, new product development, product obsolescence and
evolving industry standards. We compete primarily on the basis of product performance and design, reliability, delivery and price. We face competition from other component manufacturers, as well as
companies with product integration capabilities. In addition, we compete with the captive manufacturing operations of large communications original equipment manufactures such as Lucent Technologies,
Marconi and Nortel Networks who are also our largest customers. Some of our competitors are large public companies that have significantly greater financial, technical, marketing and other resources
than us. As a result, these competitors may be able to devote greater resources to the development, promotion, sale and support of their products. Furthermore, those of our competitors that have large
market capitalization or cash reserves may be better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines.

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Environmental Matters

Our operations are subject to federal, state and local laws and regulations governing the use, storage, disposal of and exposure to hazardous materials, the
release of pollutants into the environment and the remediation of contamination. Our former Scotts Valley and Palo Alto sites have significant environmental liabilities for which we have entered into
and funded fixed price remediation contracts and obtained cost-overrun and unknown pollution conditions insurance coverage.

The
Scotts Valley site is a federal Superfund site. Chlorinated solvent and other contamination was identified at the site in the early 1980s, and by the late 1980s we had installed a
groundwater extraction and treatment system. In 1991, we entered into a consent decree with the United States Environmental Protection Agency providing for remediation of the site. In
July 1999, we signed a remediation agreement with an environmental consulting firm, ARCADIS Geraghty & Miller. Pursuant to this remediation agreement, we paid approximately
$3.0 million in exchange for which ARCADIS agreed to perform the work necessary to assure satisfactory completion of our obligations under the consent decree. The agreement also contains a cost
overrun guaranty from ARCADIS up to a total project cost of $15.0 million. In addition, the agreement included procurement of a ten-year, claims-made insurance policy to
cover overruns of up to $10.0 million from Reliance Insurance Company, along with a ten-year, claims made $10-million policy to cover various unknown pollution
conditions at the site.

The
Palo Alto site is a state Superfund site and is within a larger, regional state Superfund site. As with the Scotts Valley site, contamination was discovered in the 1980s, and
groundwater extraction and treatment systems have been operating for several years at both the site and the regional site. In July 1999, we entered into a remediation agreement with an
environmental consulting firm, SECOR. Pursuant to this remediation agreement, we paid approximately $2.4 million in exchange for which
SECOR agreed to perform the work necessary to assure satisfactory completion of our obligations under the applicable remediation orders. The payment included the premium for a 30-year,
claims-made insurance policy to cover cost overruns up to $10.0 million from AIG, along with a ten-year claims-made $10.0 million insurance policy to
cover various unknown pollution conditions at the site.

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

Recapitalization Merger

On October 25, 1999, an affiliate of Fox Paine agreed to enter into a recapitalization merger transaction with us. The recapitalization merger transaction
was the culmination of a strategy implemented by the predecessor Board of Directors in February 1999 to seek to maximize shareholder value by pursuing the sale of the company in its entirety or
as separate business groups. For a number of years prior to that time, difficult market conditions, including decreased Federal defense spending, affected some of our business groups. The predecessor
Board determined that these conditions, as well as the difficulty that the public capital markets had in categorizing our business and identifying comparable companies, given our several disparate
businesses, resulted in our public stock price being undervalued. As a result, the predecessor Board decided to divest the microwave products group in 1997, the semiconductor products group in 1999
and the telecommunications group in early 2000, in some cases along with associated real estate assets. We replaced the majority of our senior management and our entire Board of Directors upon the
closing of the recapitalization merger on January 31, 2000. From January 1, 1998 until January 31, 2000, our stock price ranged from $0.55 to $1.37 per share, adjusted for
subsequent stock splits. The price per share paid in the recapitalization merger was $1.37, which was the price Fox Paine paid for its shares. Since our recapitalization merger, we have been focused
exclusively on providing product solutions that enable and facilitate the development of fiber optic, broadband cable and wireless network infrastructure.

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In April 2000, we changed our name from Watkins-Johnson Company to WJ Communications, Inc. to highlight our focus on the commercial broadband communications markets. We reincorporated
in Delaware and effected a 3-for-2 stock split on August 15, 2000.

In
the recapitalization merger, FP-WJ Acquisition Corp., a newly-formed corporation wholly-owned by Fox Paine, merged into us. All of our pre-recapitalization
shareholders except, with respect to a portion of its shares, a family trust of which Dean A. Watkins is a co-trustee and beneficiary, became entitled to receive cash in exchange for their
shares of the pre-recapitalization common stock. Dr. Watkins is our co-founder and was the Chairman of our Board of Directors at the time of the recapitalization merger.
As a result of the rollover of a portion of the interest in our equity in us held by Dr. Watkins' trust pursuant to an agreement entered into with the trust at the time we entered into the
merger agreement, we were able to account for the merger as a recapitalization for financial accounting purposes. In addition, the rollover provided the trust with a tax benefit, in that the rollover
shares were not retired for cash or otherwise.

Our
statement of operations includes the costs of the recapitalization merger as an expense. In addition, as a result of the continuing significant ownership interest of the
pre-recapitalization stockholders, no adjustments have been made to the historical carrying amounts of our assets and liabilities as a result of the recapitalization merger. Furthermore,
the premium paid in cash to stockholders in excess of that historical cost is shown as a reduction of stockholders' equity.

Seasonality and Cyclicality

It has been our experience that telecommunication equipment spending is typically lower in the first quarter of the calendar year and higher during the fourth
quarter of the calendar year. Our semiconductor business is cyclical and most recently has been effected by an overall downturn in the semiconductor market.

Item 2. PROPERTIES

We have two leased manufacturing sites: a building in Milpitas, California with over 35,000 square feet and two buildings in San Jose, California totaling over
124,000 square feet. The San Jose facility consists of two buildings: a larger building of approximately 82,000 square feet and a smaller building of approximately 42,000 square foot. Both buildings
are leased for ten years. The larger building has a beginning base monthly rent of $158,340 for the first twelve months, which increases by 4% over each succeeding twelve month period. The smaller
building has a beginning base monthly rent of $94,500 for the first twelve months which will also increase by 4% over each succeeding twelve month period.

In
September 2001, we decided to abandon the smaller building at our San Jose facility based on revised anticipated demand for our products and current market conditions (see
Note 11 to the audited consolidated financial statements included elsewhere in this annual report). We have signed one tenant to cover a portion of the excess leased space and are actively
seeking others. This sub-tenant has a two year lease occupying approximately 27% of the building and is paying a beginning base rent of approximately $25,300. Any sub-lease
tenants are subject to our landlord's consent. Based on our current expected level of business, we will be utilizing less than 50% of our total capacity of all of our facilities.

Item 3. LEGAL PROCEEDINGS

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

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

There were no matters submitted to a vote of security holders in the fourth quarter of 2001.

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PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Price Range of Common Stock

Our
common stock is traded on the Nasdaq National Market under the symbol "WJCI". The following table sets forth, for the periods indicated since our IPO on August 18, 2000, the
high and low closing sales prices as reported on the Nasdaq National Market for WJ Communications, Inc. common stock, as adjusted for all stock splits.

High

LowAugust 18, 2000 through September 29, 2000

$
58.938

$
30.938Fourth Quarter (through December 31, 2000)


34.125


9.000First Quarter (through April 1, 2001)


24.750


2.313Second Quarter (through July 1, 2001)


9.750


1.938Third Quarter (through September 30, 2001)


5.380


2.810Fourth Quarter (through December 31, 2001)


4.590


2.350


As
of December 31, 2001, there were approximately 290 stockholders of record of our common stock.

Dividend Policy

We
did not pay any dividends in 2001 and 2000. We do not intend to pay cash dividends on our common stock for the foreseeable future. Instead, we intend to retain all earnings for use in
the operation and expansion of our business. Our board of directors will make any future determination of the payment of dividends based upon various factors then existing, including, but not limited
to, our financial condition, operating results and current and anticipated cash needs. In addition, covenants in our revolving credit facility limit our ability to declare and pay cash dividends on
our common stock, see "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources" and Note 4 to the audited consolidated
financial statements included elsewhere in this annual report.

Report of Public Offering of Securities and Use of Proceeds

We
completed our initial public offering ("IPO") on August 18, 2000, pursuant to a Registration Statement Form S-1 (File No. 333-38518),
which was declared effective by the Securities and Exchange Commission on August 17, 2000. In the IPO we sold an aggregate of 6,210,000 shares of common stock, par value of $0.01 per share. The
sale of the shares of common stock generated aggregate proceeds of $99.4 million. The aggregate net proceeds were approximately $88.4 million after deducting underwriters discounts and
commissions of approximately $7.0 million and directly paid expenses of the offering of $4.0 million. Chase H&Q, CIBC World Markets and Thomas Weisel Partners LLC were the lead
underwriters for the IPO.

Since
the completion of our IPO through December 31, 2001 we reasonably estimate that we have used the net proceeds from the initial public offering as follows: approximately
$40.0 million to repay outstanding debt amounts, approximately $23.4 million to purchase and install equipment and construct various leasehold improvements, and approximately
$6.4 million for working capital and general corporate purposes (including compensation to employees, officers and directors in accordance with their standard agreements). We expect to use the
remaining net proceeds for general corporate purposes, including

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funding our operations, our working capital needs and capital expenditures. Pending further use of the net proceeds, we have invested them in short-term, interest-bearing,
investment-grade securities. Except as indicated above, all of the payments described above were direct or indirect payments to entities or persons other than directors, officers or greater than 10%
owners of our equity securities.

Recent Sales of Unregistered Securities

In
2001, we did not sell any of our securities that were not registered under the Securities Act.

Item 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial data included elsewhere in this report. The
statements of operations data for the years ended December 31, 2001, 2000, and 1999 and the selected balance sheet data as of December 31, 2001 and 2000 are derived from our audited
financial statements which are included elsewhere in this report. The statements of operations data for the years ended December 31, 1998 and the selected consolidated balance sheet data as of
December 31, 1999 and 1998 are derived from our audited consolidated financial statements which are not included in this annual report. The statements of operations data for the year ended
December 31, 1997 and the selected consolidated balance sheet data as of December 31, 1997 is derived from our unaudited consolidated financial statements which are not included in this
annual report. The selected consolidated statements of operations data represent our results from continuing operations only and the selected consolidated balance sheet data exclude net assets from
discontinued operations. For a discussion of our discontinued operations, see "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital
Resources" and Note 12 to the audited consolidated financial statements included elsewhere in this annual report. The selected consolidated statements of operations data excludes our
extraordinary item resulting from the write-off of unamortized deferred financing costs associated with our early extinguishment of debt and includes our preferred stock
dividendassumed beneficial conversion. For a discussion of our preferred stock dividendassumed beneficial conversion,

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see Note 6 to the audited consolidated financial statements included elsewhere in this annual report. The historical results are not necessarily indicative of results to be expected for any
future period.

|                                            |                                                                                     | Year Ended December 31,                     |                         
|------------------------------------------- | ----------------------------------------------------------------------------------- | ------------------------------------------- | ------------------------
|
|
|Consolidated Statements of Operations Data: |                                                                                     |                                             |                         
|                                            | Sales                                                                               |                                             | $                       
|                                            | Cost of goods sold                                                                  |                                             |                         
|                                            |                                                                                     |                                             |                         
|                                            | Gross profit                                                                        |                                             |                         
|                                            | Operating expenses:                                                                 |                                             |                         
|                                            |                                                                                     | Research and development                    |                         
|                                            |                                                                                     | Selling and administrative                  |                         
|                                            |                                                                                     | Amortization of deferred stock compensation |                         
|                                            |                                                                                     | Recapitalization merger and other           |                         
|                                            |                                                                                     | Restructuring charge                        |                         
|                                            |                                                                                     |                                             |                         
|                                            |                                                                                     |                                             | Total operating expenses
|                                            |                                                                                     |                                             |                         
|                                            | Income (loss) from operations                                                       |                                             |                         
|                                            | Interest income                                                                     |                                             |                         
|                                            | Interest expense                                                                    |                                             |                         
|                                            | Other income (expense)net                                                          |                                             |                         
|                                            | Gain on dispositions of real property                                               |                                             |                         
|                                            |                                                                                     |                                             |                         
|                                            | Income (loss) from continuing operations before income taxes                        |                                             |                         
|                                            | Income tax (provision) benefit                                                      |                                             |                         
|                                            |                                                                                     |                                             |                         
|                                            | Income (loss) from continuing operations                                            |                                             | $                       
|                                            |                                                                                     |                                             |                         
|                                            | Income (loss) from continuing operations per sharebasic                            |                                             | $                       
|                                            |                                                                                     |                                             |                         
|                                            | Income (loss) from continuing operations per sharediluted                          |                                             | $                       
|                                            |                                                                                     |                                             |                         
|                                            | Shares used to calculate income (loss) from continuing operations per sharebasic   |                                             |                         
|                                            | Shares used to calculate income (loss) from continuing operations per sharediluted |                                             |                         
|                                            | Dividends per common share                                                          |                                             | $                       

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|                                          |                                                   | December 31,
|----------------------------------------- | ------------------------------------------------- | ------------
|
|
|Selected Consolidated Balance Sheet Data: |                                                   |             
|                                          | Cash, cash equivalents and short-term investments |             
|                                          | Working capital (2)                               |             
|                                          | Total assets (3)                                  |             
|                                          | Total debt                                        |             
|                                          | Capital leases, net of current portion            |             
|                                          | Total stockholders' equity                        |             

---

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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS

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

The following discussion should be read in conjunction with our consolidated financial statements and related disclosures included elsewhere in this annual
report. Except for historic actual results reported, the following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties.
See "Special Notice Regarding Forward-looking Statements" above and "Risk Factors That May Affect Future Results" below for a discussion of certain factors that could cause future actual results to
differ from those described in the following discussion.

Overview

We design, develop and manufacture innovative, high quality broadband communications products that enable voice, data and image transport over fiber optic,
broadband cable and wireless communications networks around the world. Our products are comprised of advanced, highly functional components and integrated assemblies which address the RF challenges of
both current and next generation broadband communications networks. These products are used in the network infrastructure supporting and facilitating mobile communications, broadband
high-speed data transmission and enhanced voice services. Our core expertise in gallium arsenide semiconductor and thin-film technology, coupled with our exceptional RF design,
integration, and manufacturing capabilities, have enabled us to obtain a competitive advantage in these broadband communications markets.

When
we began our operations in the broadband commercial communications market, we benefited from the significant increases in spending on capital equipment by communications service
providers. However, towards the end of 2000 and in 2001, several of our major customers significantly delayed and reduced their demand for our fiber optic and wireless products. The primary reason for
these delays and reductions in their recent and forecasted demand is an overall slow down in capital spending by communication service providers. We believe that this slow down relates to two primary
items. First, our customers have indicated that there has been a significant build up of their inventory as well as a significant build up of uninstalled equipment at communication service providers.
We believe that numerous service providers have reduced their capital expenditures until they have installed their excess inventory of equipment, which they have already purchased, and begin
generating revenue from this uninstalled equipment. In addition, based on the slow down in capital expenditures, our customers are attempting to reduce their inventory levels. Secondly, we believe
that numerous early stage communication service providers, who have previously been able to access the capital markets, are having difficulties in finding new sources of capital and in certain
instances these companies have filed for bankruptcy. As a result, we believe that these companies have had to greatly reduce their capital expenditures.

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On
a long-term basis, we believe that the demand for broadband communications equipment and our products will rebound. Throughout 2001, we have introduced several new
products in each of our three product categories. These new products will further position us to benefit from the roll-out of the following broadband communications technologies: 2.5G and
3G wireless, and OC-192 and OC-768 for both the metro and long haul fiber optics markets. During 2001, we introduced over twenty new semiconductor products primarily targeted
at wireless infrastructure applications. During 2001, we also had many new socket wins at major OEMs. Additionally, during the first half of 2001, we expanded our thin film capabilities by
introducing a new polished aluminum nitride process. During 2001, we also introduced over ten new fiber products including OC-192 modulator drivers, clock amplifiers and filter products.
During the fourth quarter of 2001, we announced an alliance with Fujitsu Quantum Devices Ltd. for joint development of 40 Gb/s Optical products for OC-768 applications. While
customer interest, new product introductions, additional design wins, strategic alliances and new orders are encouraging, there is no assurance that they will have a positive impact on our overall
sales.

Our
manufacturing operations are highly automated which has required us to make significant investments in equipment and fixed overhead. As a result, the volume of product we produce and
sell has a significant impact on our gross profit margin. Until demand increases, the slow down in spending on broadband communications equipment will negatively impact our gross margin. In addition,
we typically generate lower gross margin on new product introductions. Over time, we typically become more efficient relative to new products through learning and increased volumes as well as through
introducing lower cost elements to the product designs. We expect our new product introductions to continue to be a higher percentage of our sales mix, which will continue to have a temporary negative
impact on our gross margin. As we broaden our product lines we must purchase a wider variety of components to utilize in our manufacturing processes. In addition, new product lines contain a greater
degree of uncertainty due to a lack of visibility and predictability of customer demand and potential competition. Both of these factors will contribute a higher level of inventory risk in our near
future.

Over
the course of 2001, we have taken aggressive steps designed to more closely align our production costs with our customers' current forecasted demand for our products. As part of
this effort, we have reduced our workforce by approximately 48%, incurring approximately $1.5 million in severance related costs. We have also saved an additional $2.0 million during the
second half of 2001 by reducing non-employee costs including sales and marketing, general and administrative, and overhead expenses. Our cost reduction initiatives also include temporary
shutdowns of our manufacturing facilities and significant reductions in capital spending. In addition to our cost reduction efforts, we have abandoned our excess San Jose facility and recorded a
pre-tax restructuring charge of $9.8 million (see Note 11 to the audited consolidated financial statements included elsewhere in this annual report). This abandonment reduced
our selling and administrative expenses by approximately $380,000 in the second half of 2001 and is expected to reduce our selling and administrative expense by approximately $250,000 per quarter
going forward. While our continuing efforts are expected to further reduce our expense levels, we still have a significant amount of fixed manufacturing cost that these efforts will not impact and our
expense reduction initiatives alone will not return us to profitability. We expect that reduced end-customer demand, underutilization of our manufacturing capacity and other factors will
continue to adversely affect our operating results in the near term and we anticipate incurring additional losses in 2002. In order to return to profitability, we must achieve substantial revenue
growth and we currently face an environment of uncertain demand in the markets our products address. We cannot assure you as to whether or when we will return to profitability or whether we will be
able to sustain such profitability, if achieved.

Sales

We sell our products predominantly to large equipment manufacturers and service providers in the fiber optic, broadband cable and wireless network infrastructure
markets. Our major customers provide forecasted demand on at least a monthly basis, which assists us in allocating our manufacturing capacity.

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These forecasts, however, are subject to changes, including changes as a result of market conditions, and could fluctuate from quarter to quarter.

We
depend on a small number of customers for a majority of our sales. During the year ended December 31, 2001, we had four customers which each accounted for more than 10% of our
sales and in aggregate accounted for 71% of our sales. Those customers were Lucent Technologies, Marconi Communications, Nortel Networks and Richardson Electronics including sales to their respective
manufacturing subcontractors. During the year ended December 31, 2000, we had two customers which each accounted for more than 10% of our sales and in aggregate accounted for approximately 72%
of our sales. Those customers were Lucent Technologies and Nortel Networks including sales to their respective manufacturing subcontractors. We have diversified our customer base over the last few
years and intend to further diversify our customer base and product offering in the future. However, we anticipate that we will continue to sell a majority of our products to a relatively small group
of customers. In addition, most of our sales result from purchase orders or contracts that can be cancelled on short-term notice. Delays in manufacturing or supply procurement or other
factors, including general market slow downs, have caused and could potentially continue to cause cancellation, reduction or delay in orders by or in shipments to a significant customer. Based on
specific terms of the customer contract and purchase order, we may negotiate a final delivery and settlement in connection with order
cancellations. Due to the uncertain and often lengthy nature of these negotiations, a substantial portion, if not all, of the inventory subject to the cancellation may be provided for as part of our
excess and obsolete inventory provision. In the fourth quarter of 2001, we reached final agreement with one customer, Marconi Communications, and recognized revenue of $3.5 million related to
the delivery of specific fixed wireless products that have previously been reserved for. We anticipate that similar arrangements will be made with other customers for final deliveries of less than
$5 million over the first half of 2002 in addition to our core business. Since the fourth quarter of 2000 we have experienced a sequential reduction in demand for our wireless base station and
OC-192 fiber optic products which continued throughout 2001. Also, during 2001, we have experienced a reduction in and push out of demand for our GaAs semiconductors. In addition, since
the fourth quarter of 2000 and throughout 2001, three of our largest customers, Lucent, Nortel and Marconi, issued press releases discussing the slow down in telecom spending which has resulted in
reduced demand for their products and major reductions in their work forces. In March 2002, Lucent and Nortel issued press releases disclosing reduced customer orders to date in 2002. Our
orders from these major customers fell significantly in 2001 and there can be no assurance that orders will increase in 2002 or not continue to decline. While we have seen some limited recovery in
orders for our mobile wireless products, we expect this slow down in telecom spending to continue in the near term based on customer forecasts for the purchase of our products. The greater the slow
down in demand becomes, the more significant the potential negative impact on our sales, earnings, inventory valuations and cash flow.

Revenues
from product sales are recognized when all of the following conditions are met: the product has been shipped, the Company has the right to invoice the customer at a fixed price,
the collection of the receivable is probable and there are no significant obligations remaining. Generally, title passes upon shipment of the Company's products. Beginning in March 2000, our
contract with Lucent converted to a consignment arrangement under which title to certain of our products does not pass until Lucent utilizes these products in its production processes. Consequently,
we recognize revenue on this contract only when Lucent notifies us of product consumption. Nortel converted its purchases of certain products to a similar consignment arrangement in October, 2000.
Consequently, we recognize revenue on these contracts only when they notify us of product consumption. In addition to our internal sales efforts, we use distributors to sell semiconductor products.
Revenues from distributors are recognized upon shipment based on the following factors: our sales price is fixed and determinable by contract at the time of shipment, payment terms are fixed at
shipment and are consistent with terms granted to other customers, the distributor has full risk of physical loss, the distributors have separate economic substance, we have no obligation with respect
to the resale of the distributors' inventory, and we believe we can reasonably estimate the potential returns from our distributors based on their history and our visibility in the distributors'
success with its

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products and into the market place in general. During the quarter ending July 1, 2001, the Company began using two distributors for sales of certain fixed wireless products. Lacking history
with these new distributors, we are recording revenue on these fixed wireless products at the time of the distributors' sale to the ultimate end customer. We provide a warranty on standard products
and components and products developed for specific customer or program applications. Such warranty generally ranges from 12 to 24 months. We estimate the warranty cost based on our historical
field return rates. To date, we have had no significant warranty returns. We include warranty expense related to these products in cost of goods sold.

Generally,
the selling prices of our products decrease over time as a result of increased volumes and general competitive pressures. We expect that prices will continue to decline as a
result of volume increases and these competitive pressures.

Cost of Goods Sold

Our cost of goods sold consists primarily of:



We
recognize cost of goods sold upon recognition of revenue. We recognize losses on contracts, including purchase order commitments, when identified.

Operating Expenses

Our operating expenses are classified into two general categories: research and development, and selling and administrative. We classify all charges to these two
categories based on the nature of the expenditures. Although each of these two categories includes expenses that are unique to the category type, there are commonly recurring expenditures that are
typically included in these categories, such as wages, fringe benefit costs, depreciation and allocated overhead.

Research and Development

Research and development expense represents wages, supplies and allocated overhead costs to design, develop and improve products and processes. These costs are
expensed as incurred.

Selling and Administrative

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

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Amortization of Deferred Stock Compensation

We have recorded deferred stock compensation representing the differential between the deemed fair value of our common stock and the exercise price at the date of
grant for options or date of sale for stock purchases. We are amortizing this amount using the straight line method over the vesting period of the options granted.

Recapitalization Merger and Other

Recapitalization merger and other expense is a non-recurring expenditure comprised of employee retention and severance compensation, legal,
professional and other costs associated with our recapitalization merger and the sale of our telecommunications group.

Restructuring Charge

Restructuring charge reflects our decision to abandon a new leased facility based on revised anticipated demand for our products and current market conditions. It
is comprised of future lease payments net of anticipated sub-lease income, broker commissions and other facility costs, and an asset impairment charge on tenant improvements. In
determining this estimate, we have made certain assumptions with regards to our ability to sub-lease the space and have reflected off-setting assumed sub-lease
income in line with our best estimate of current market conditions.

Critical Accounting Policies

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

We
believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. See
Note 2 to the audited consolidated financial statements included elsewhere in this annual report for a detailed discussion of all our significant accounting policies.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements", as amended by SAB 101A and
101B. SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services
rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments
regarding the fixed nature of the fee charged for services rendered and products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these
criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. In addition, failure to obtain anticipated orders or delays or
cancellations of orders or significant pressure to reduce prices from key customers could have a material adverse effect on our revenue.

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Based
on specific terms of the customer contract and purchase order, we may negotiate a final delivery and settlement in connection with order cancellations. Due to the uncertain and
often lengthy nature of these negotiations, a substantial portion, if not all, of the inventory subject to the cancellation may be provided for as part of our excess and obsolete inventory provision.
In the fourth quarter of 2001, we reached final agreement with one customer, Marconi Communications, and recognized revenue of $3.5 million related to the delivery of specific fixed wireless
products that have previously been reserved for. We anticipate that similar arrangements will be made with other customers for final deliveries of less than $5 million over the first half of
2002 in addition to our core business.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Management specifically
analyzes accounts receivable and historic bad debts, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for
doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Material
differences may result in the amount and timing of expenses for any period if management made different judgments or utilized different estimates. Our allowances for doubtful accounts were
$1.4 million and $1.7 million as of December 31, 2001 and 2000, respectively. Approximately 84% of our accounts receivable as of December 31, 2001 was concentrated with our
top four customers, each, including their respective manufacturing subcontractors, accounting for more than 10% of our sales and in aggregate accounting for 71% of our sales,.

Provision for Excess and Obsolete Inventory

We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market
value based upon assumptions about future demand and market conditions. Management specifically identifies obsolete products and analyzes historical usage, forecasted production based on demand
forecasts, current economic trends and historical write-offs when evaluating the adequacy of the provision for excess and obsolete inventory. Due to rapidly changing customer forecast and
orders, additional provisions for excess or obsolete inventory, while not currently expected, could be required in the future. In addition, the sale of previously written down inventory could result
from significant unforeseen increases in customer demand. Material differences in estimates of excess and obsolete inventory may result in the amount and timing of cost of sales for any period if
management made different judgments or utilized different estimates.

Income Taxes

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

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

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projected net operating loss for 2002. As of December 31, 2001, our deferred tax asset valuation allowance was $6.6 million.

In
accordance with Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies", we have established certain reserves for income tax contingencies. These
reserves relate to various tax years subject to audit by tax authorities including our Federal tax filings for 1996 to 1999 which are currently being examined. As of December 31, 2001, our
income tax reserve was $10.5 million, which we believe is adequate. However, the ultimate outcome of this estimate may differ from our estimates and the difference may be material.

Restructuring

In September 2001, we decided not to occupy a new leased facility based on revised anticipated demand for our products and current market conditions. This
excess facility, for which we have a ten year commitment, is located adjacent to our current corporate headquarters and was originally developed to house additional administrative and corporate
offices to accommodate planned expansion. This decision has resulted in a pre-tax lease loss of $7.2 million, comprised of future lease payments net of anticipated
sub-lease income, broker commissions and other facility costs, and a pre-tax asset impairment charge of $2.6 million on tenant improvements deemed no longer realizable.
In determining this estimate, we have made certain assumptions with regards to our ability to sub-lease the space and have reflected off-setting assumed sub-lease
income in line with our best estimate of current market conditions. Should there be a significant change in those market conditions, the ultimate loss could be higher and such amount could be
material. We have signed one tenant to cover a portion of the excess leased space. Any sub-lease tenants are subject to the landlord's consent. The lease loss is an estimate under SFAS
No. 5 "Accounting for Contingencies" and represents the low end of the range and adjustments will be made in future periods, if necessary, based upon the then current actual events and
circumstances. We have estimated that the high end of the lease loss could be $10.7 million if operating lease rental rates continue to decrease or should it take longer than expected to find a
suitable tenant or tenants to sub-lease the facility. As of December 31, 2001, our restructuring accrual was $6.8 million.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards ("SFAS") No.121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed of", we review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets
may not be recoverable. Factors we consider that could trigger an impairment review include the following: significant underperformance relative to expected historical or projected, future operating
results; significant changes in the manner of our use of the acquired assets or the strategy for our overall business; significant negative industry or economic trends; or significant technological
changes, which would render equipment and manufacturing process, obsolete. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of these assets to future
undiscounted cash flows expected to be generated by these assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount
of the assets exceeds the fair value of the assets. Through December 31, 2001, the Company has not experienced any such impairments.

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

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Current Operations

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

|                                            |                                                       | Percentage of Sales
Year Ended December 31, |                         
|------------------------------------------- | ----------------------------------------------------- | ------------------------------------------- | ------------------------
|
|Consolidated Statements of Operations Data: |                                                       |                                             |                         
|                                            | Sales                                                 |                                             | 100.0                   
|                                            | Cost of goods sold                                    |                                             | 94.6                    
|                                            |                                                       |                                             |                         
|                                            | Gross profit                                          |                                             | 5.4                     
|                                            | Operating expenses:                                   |                                             |                         
|                                            |                                                       | Research and development                    |                         
|                                            |                                                       | Selling and administrative                  |                         
|                                            |                                                       | Amortization of deferred stock compensation |                         
|                                            |                                                       | Recapitalization merger and other           |                         
|                                            |                                                       | Restructuring charge                        |                         
|                                            |                                                       |                                             |                         
|                                            |                                                       |                                             | Total operating expenses
|                                            |                                                       |                                             |                         
|                                            | Income (loss) from operations                         |                                             | (61.1                   
|                                            | Interest income                                       |                                             | 4.9                     
|                                            | Interest expense                                      |                                             | (0.4                    
|                                            | Other income (expense)  net                          |                                             | 1.1                     
|                                            | Gain on dispositions of real property                 |                                             | 0.5                     
|                                            |                                                       |                                             |                         
|                                            | Income from continuing operations before income taxes |                                             | (55.0                   
|                                            | Income tax (provision) benefit                        |                                             | 20.2                    
|                                            |                                                       |                                             |                         
|                                            | Income (loss) from continuing operations.             |                                             | (34.8                   
|                                            |                                                       |                                             |                         

Comparison of Years Ended December 31, 2001 and 2000

SalesWe recognized $62.2 million and $115.8 million in sales for the fiscal years ended
December 31, 2001 and 2000, respectively. This $53.6 million or 46% decrease in sales resulted primarily from an decrease in fiber optic sales of OC-192 oscillators for use
in long haul fiber optic systems. Fiber optic sales decreased
79% to $10.0 million as our 2001 sales continued to be impacted by the overall weakness in the long haul fiber optic market. Fiber optic sales represented 16% of total sales for 2001. Wireless
product sales during 2001 totaled $32.5 million, representing 52% of total sales and a decrease of 23% over 2000. Semiconductor sales during 2001 totaled $19.8 million, representing 32%
of total sales and a decrease of 22% over 2000. Based on specific terms of the customer contract and purchase order, we may negotiate a final delivery and settlement in connection with order
cancellations. Due to the uncertain and often lengthy nature of these negotiations, a substantial portion, if not all, of the inventory subject to the cancellation may be provided for as part of our
excess and obsolete inventory provision. In the fourth quarter of 2001, we reached final agreement with one customer, Marconi Communications, and recognized revenue of $3.5 million related to
the delivery of specific fixed wireless products that have previously been reserved for. We anticipate that similar arrangements will be made with other customers for final deliveries of less than
$5 million over the first half of 2002 in addition to our core business. Moving forward, we continue to be cautious about the current market environment, but we believe that our core business
will generate approximately $10 to $11 million in quarterly sales over the first half of 2002. However, there can be no assurance that we will generate such a level of sales.

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Cost of Goods SoldOur cost of goods sold for 2001 was $58.9 million, a decrease of $13.1 million or 18% as
compared with cost of goods sold of $72.0 million in 2000. The decrease in cost of goods sold primarily relates to our 46% decrease in sales. As a percentage of sales, our cost of goods sold
increased to 95% of sales in 2001 from 62% in 2000. The increase in our cost of goods sold as a percentage of sales relates to significant unabsorbed overhead, a $6.6 million provision for
excess and obsolete inventory, approximately $983,000 of severance expenses related to manufacturing personnel, and high variable cost on fixed wireless products which were being transitioned into
manufacturing. The significant amount of unabsorbed overhead costs relates to the increased manufacturing infrastructure we put in place to support our customers' demand in the second half of 2000.
This increased infrastructure includes, among other things, a new manufacturing facility and investments in machinery and equipment. During the first quarter of 2001, we recorded a $6.6 million
provision for excess and obsolete inventory largely related to inventory ordered to build base station products for our largest mobile wireless customer. Inventory levels of this product were
purchased based on this customer's forecasted demand which had since been dramatically revised downward. In addition, given the overall slowdown in market demand, we made provisions for other product
lines where customer forecasts have significantly declined. Since the first quarter of 2001, approximately $4.4 million of our previously reserved inventory was consumed by our largest mobile
wireless customer. This decrease in our inventory reserve was offset by an additional $4.4 million in provisions for other product lines where customer demand has significantly weakened. In
total, the amount of our provision for excess and obsolete inventory remained unchanged since the first quarter of 2001. Due to rapidly changing customer forecasts and orders, additional provisions
for excess or obsolete inventory, while not currently expected, could be required in the future. In addition, the sale of previously written down inventory could result from significant unforeseen
increases in customer demand. With respect to our fixed wireless products, we typically experience higher cost of goods sold as a percentage of the selling price during the early stages of a new
product life cycle. Over time, we typically become more efficient through learning and increased volumes, as well as through introducing lower cost elements in the product design. Margin improvement
on our fixed wireless products has remained unrealized due to very low volume production during the second half of 2001. Given the current economic slowdown, the added capacity from our new
manufacturing facility and equipment may not be fully utilized and the ongoing costs thereof will still be incurred until such time as the market demand for our products increases.

Research and DevelopmentOur research and development expense for 2001 was $17.2 million, a decrease of
$1.9 million or 10% as compared with research and development expense of $19.1 million in 2000. The decrease in research and development was primarily attributed to lower overall
overhead costs and an increase in customer funded development. As a percentage of sales, research and development expenses increased to 28% of sales in 2001 from 16% of sales in 2000. The increase in
research and development expense as a percentage of sales primarily relates to our decline in sales. Product research and development is essential to our future success and we expect to continue to
make investments in new product development.

Selling and AdministrativeSelling and administrative expense for 2001 was $13.8 million or 22% of sales, a decrease of
$2.1 million or 13% as compared with selling and administrative expense of $15.9 million or 14% of sales in 2000. The decrease in absolute dollars is primarily related to lower
commission, recruiting, advertising and promotion expenses partially offset by approximately $485,000 of severance expenses and rent expense associated with our two new facilities including excess
office space through August, 2001 (see Note 11 to the audited consolidated financial statements included elsewhere in this annual report). As a percentage of sales, the increase in selling and
administrative expense reflected the significant decrease in sales during 2001.

Amortization of Deferred Stock CompensationAmortization of deferred stock compensation expense in 2001 includes approximately
$593,000 related to the issuance of stock options during 2000 at prices deemed below fair market value. Amortization of deferred stock compensation expense in 2000 includes approximately
$1.0 million related to the sale of stock and issuance of stock options during 2000 at prices

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deemed below fair market value. As of December 31, 2001, the balance of our remaining unamortized deferred stock compensation was approximately $702,000 to be amortized over the next
42 months.

Recapitalization Merger and OtherWe incurred recapitalization merger and other expense of $35.5 million in 2000
related to our recapitalization merger. These expenses include: $16.8 million of compensation expense related to payments to former option holders; $9.8 million of compensation expense
related to bonus, retention, and severance amounts for certain employees; $4.7 million of legal, consulting and accounting fees; and $4.2 million of financial services and other expenses
related to the recapitalization merger transaction.

Restructuring chargeFor 2001, we have recorded a restructuring charge of $9.8 million related to our decision to
abandon our excess facility. In September 2001, we decided not to occupy a new leased facility based on revised anticipated demand for our products and current market conditions. This excess
facility, for which we have a ten year commitment, is located adjacent to our current corporate headquarters and was originally developed to house additional administrative and corporate offices to
accommodate planned expansion. This decision has resulted in a pre-tax lease loss of $7.2 million, comprised of future lease payments net of anticipated sub-lease
income, broker commissions and other facility costs, and a pre-tax asset impairment charge of $2.6 million on tenant improvements deemed no longer realizable. In determining this
estimate, we have made certain assumptions with regards to our
ability to sub-lease the space and have reflected off-setting assumed sub-lease income in line with our best estimate of current market conditions. Should there be
a significant change in those market conditions, the ultimate loss could be higher and such amount could be material. We have signed one tenant to occupy a portion of the excess leased space. Any
sub-lease tenants are subject to the landlord's consent. The lease loss is an estimate under SFAS No. 5 "Accounting for Contingencies" and represents the low end of the range and
adjustments will be made in future periods, if necessary, based upon the then current actual events and circumstances. We have estimated that the high end of the lease loss could be
$10.7 million if operating lease rental rates continue to decrease or should it take longer than expected to find a suitable tenant or tenants to sub-lease the facility. Total cash
outlay for the restructuring is expected to be $7.2 million, with $6.8 million accrued at December 31, 2001 and approximately $400,000 paid out through December 31, 2001.
Of the balance in accrued liabilities as of December 31, 2001, the Company expects approximately $493,000 of the lease loss to be paid out over the next twelve months, and the remaining
$6.3 million to be paid out over the remaining life of the lease of approximately nine years.

Interest IncomeInterest income primarily represents interest earned on cash equivalents and short-term
available-for-sale investments. Our interest income for 2001 was $3.0 million, a decrease of approximately $305,000 or 9% as compared with interest income of
$3.3 million in 2000. This decrease primarily resulted from decreased average amounts of funds available for investment and a decrease in interest rates. To the extent we continue to utilize
our cash in the operation of our business, interest income is expected to decrease going forward. Additionally, our interest income will be impacted by changes in the market interest rates of our
investments, which are generally lower than they were a year ago.

Interest ExpenseOur interest expense for 2001 was $238,000, a decrease of $3.2 million or 94% as compared with
interest expense of $3.4 million in 2000. Interest expense during 2001 relates to fees associated with our revolving credit facility and outstanding letters of credit. The expense incurred
during 2000 resulted from interest expense related to our credit facility with CIBC World Markets Corp., which we entered into as part of the recapitalization merger and fully repaid with a portion of
the net proceeds from our initial public offering.

Other Income (Expense)-NetThe other income realized in 2001 was primarily related to a $345,000 realized gain on
the sale of short-term investments, a business interruption insurance settlement of $112,000, net of expenses, related to a power outage at our Milpitas facility and a $235,000 refund of
an insurance premium for potential environmental liabilities on our former Scotts Valley facility. The other

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expense incurred in 2000 is primarily related to losses realized when we liquidated short-term investments to fund in part the recapitalization merger and to higher facility cost
associated with our Palo Alto sub-lease.

Gain on Dispositions of Real PropertyDuring 2001, we recorded a gain on dispositions of real property related to the release
of $500,000 of escrow funds related to our sale of leasehold interests in our Palo Alto site during the fourth quarter of 2000. This gain was partially offset by $175,000 of residual expenses from the
sale of the property. In 2000, our pre-tax gain on the dispositions of real property of
$30.9 million primarily related to our sale of the remaining leasehold interest in our Palo Alto site which resulted in a pre-tax gain of $30.1 million. We vacated this site
in October of 2000.

Income Tax (Provision) BenefitOur effective tax rate in 2001 was a tax benefit of 37% as compared to a tax provision of 269%
in 2000. Our effective tax benefit rate for 2001 approximates our combined federal and state effective tax rates adjusted primarily for valuation allowances against those deferred tax assets that
management believes are not more likely than not to be realized as well as a reduction of certain taxes payable deemed no longer required. The effective tax rate of 2000 reflects the impact of certain
nondeductible expenses related to our recapitalization merger. Beginning in 2002, we have elected to not benefit on-going future net operating losses.

Comparison of Years Ended December 31, 2000 and 1999

SalesSales increased 41% in 2000 to $115.8 million from $82.4 million in 1999 primarily
due to strong demand from our largest customer for our OC-192 oscillators which are used in their OC-192 fiber optic systems. Our fiber optic sales increased
$33.2 million or 218% in 2000 to $48.4 million. We also had strong growth in our semiconductor sales, which increased 62% in 2000 to $25.2 million. During 2000, our wireless
product sales declined 18% to $42.2 million primarily due to the completion, in the second quarter of 1999, of a large fixed wireless project in an emerging market.

Cost of Goods SoldCost of goods sold increased 43% to $72.0 million in 2000 from $50.5 million in 1999. The
increase in cost of sales primarily relates to our 41% increase in sales. As a percentage of sales, our cost of sales increased 1% to 62% of sales in 2000 from 61% in 1999. The increase in our cost of
sales as a percentage of sales relates to higher levels of overhead associated with our new expanded facility in San Jose California which supports our fiber optic and wireless manufacturing.

Research and DevelopmentResearch and development expense increased 13% in 2000 to $19.1 million from
$16.8 million in 1999. The increase in research and development was primarily attributed to increased spending on development of wireless broadband access, semiconductor and fiber optic
products. As a percentage of sales, research and development expenses declined to 16% of sales in 2000 from 20% of sales in 1999. The decline as a percentage of sales is primarily related to expenses
not increasing at the same rate as sales growth.

Selling and AdministrativeSelling and administrative expenses increased 64% to $15.9 million in 2000 from
$9.7 million in 1999. The increase in selling and administrative related to increased spending on sales and marketing, recruiting and human resources, our relocation to our new facility in San
Jose and increases in our bad debt allowance. The increase in our bad debt allowance of $1.2 million was primarily due to a bankruptcy filing by one of our customers and an increase in
potentially uncollectible accounts receivable as our sales grew rapidly. As a percentage of sales, selling and administrative expenses increased to 14% of sales in 2000 from 12% of sales in 1999. The
increase in selling and administrative as a percentage of sales primarily related to increases in our bad debt reserve and cost associated with our relocation to our new facility.

Amortization of Deferred Stock CompensationAmortization of deferred stock compensation expense in 2000 includes approximately
$1.0 million related to the sale of stock and issuance of stock options at prices deemed below fair market value.

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Recapitalization Merger and OtherWe incurred recapitalization merger and other expense of $35.5 million in 2000
related to our recapitalization merger. These expenses include: $16.8 million of compensation expense related to payments to former option holders; $9.8 million of compensation expense
related to bonus, retention, and severance amounts for certain employees; $4.7 million of legal, consulting and accounting fees; and $4.2 million of financial services and other expenses
related to the recapitalization merger transaction. In 1999, we incurred $3.2 million in recapitalization merger and other cost related to our sale of our telecommunications group as well as to
our recapitalization merger.

Interest IncomeInterest income primarily represents interest earned on cash equivalents and short-term
available-for-sale investments. Interest income decreased 35% to $3.3 million in 2000 from $5.1 million in 1999. This decrease primarily resulted from decreased
average amounts of funds available for investment.

Interest ExpenseInterest expense increased to $3.4 million in 2000 from $520,000 in 1999. This increase resulted
primarily from interest expense related to our credit facility with CIBC World Markets Corp. which we entered into as part of the recapitalization merger. The outstanding borrowings on this line of
credit were repaid with a portion of the net proceeds from our initial public offering.

Other Income (Expense)-NetOther income (expense)-net, decreased to $1.4 million of other
expense in 2000 from $412,000 of other income in 1999. This decrease is primarily related to losses realized in the first quarter of 2000 when we liquidated short-term investments to fund
in part the recapitalization merger.

Gain on Dispositions of Real PropertyDuring 2000, our pre-tax gain on the dispositions of real property of
$30.9 million primarily related to our sale of the remaining leasehold interest in our Palo Alto site which resulted in a pre-tax gain of $30.1 million. We vacated this site
in October of 2000. In 1999, we completed the sale of our San Jose, California, facility including a 190,000 square foot building, resulting in net proceeds about $16.9 million and a pretax
gain of $9.7 million. This property was vacated in 1998. Also in 1999, we completed the sale of one of our long-term lease interests in Palo Alto, California to Stanford University,
resulting in net proceeds of approximately $54.0 million and a pre-tax gain of $51.8 million.

Income Tax (Provision) BenefitOur effective tax rate in 2000 was 269% as compared to 38% in 1999. The primary reason our 2000
effective tax rate was significantly higher than the statutory tax rate relates to the impact of certain nondeductible expenses incurred in connection with our recapitalization merger.

Extraordinary item, net of taxesDuring the third quarter of 2000, we repaid all of the outstanding borrowings under our
credit facility and wrote-off, as an extraordinary item, the remaining unamortized deferred financing cost of $3.3 million before income taxes of $1.25 million.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments at December 31, 2001 were $55.7 million, a decrease of $34.1 million or 38%
compared to the balance of $89.8 million at December 31, 2000.

In
December of 2000, we entered into a $25.0 million revolving credit facility ("Revolving Facility") with a bank. The Revolving Facility matures on December 31, 2003 and
contains a $15.0 million sub-limit to support letters of credit. Interest rates on outstanding borrowings are periodically adjusted based on certain financial ratios and are
initially set, at our option, at LIBOR plus 1.0% or Prime minus 0.5%. The Revolving Facility requires that we maintain certain financial ratios and contains limitations on, among other things, our
ability to incur indebtedness, pay dividends and make acquisitions without the bank's permission. We were in compliance with the covenants as of December 31, 2001. The Revolving Facility is
secured by substantially all of our assets. As of December 31, 2001, there were no outstanding borrowings under the Revolving Facility. Our Federal tax filings for 1996 to 1999 are currently
being examined and if the outcome is unfavorable we will need to pay substantial taxes and penalties which will have an adverse impact on our cash position. We currently have approximately
$10.5 million as a contingent liability related to various tax years subject to audit by tax authorities

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Net Cash Provided (Used) by Continuing Operating ActivitiesNet cash provided (used) by continuing operations was ($24.9)
million, $3.4 million and $4.0 million in 2001, 2000 and 1999, respectively. Net income (loss) in 2001, 2000 and 1999 was comprised of ($21.7) million, ($3.0) million and
$42.4 million from continuing operations, respectively, and $30.9 million and $25.5 million from discontinued operations for 2000 and 1999, respectively. During 2000, we also
incurred a $2.1 million loss (net of income tax) from an extraordinary item arising from the early extinguishment of debt. Significant items impacting the difference between net income from
continuing operations and cash flows from continuing operations in 2001 were $15.4 million used by working capital, a $6.3 million increase in our restructuring accrual, an increase of
$9.4 million in deferred tax assets, and a $6.6 million increase in our provision for excess and obsolete inventory. The $15.4 million used in working capital relates to a
$25.9 million decrease in accruals, payables and income taxes and a $2.4 million increase in inventories which were partially offset by a $11.1 million decrease in receivables and
a $1.3 million decrease in other assets. The $25.9 million decrease in accruals, payables and income taxes was partially related to a
$9.6 million income tax payment generated primarily from the approximately $30.1 million pre-tax gain from the sale of our remaining Palo Alto leasehold interest during our
fourth quarter of 2000. Significant items impacting the difference between loss from continuing operations and cash flows from continuing operations in 2000 were $6.3 million used in working
capital, $35.5 million of recapitalization merger cost and $30.2 million of net gains on the disposal of property, plant and equipment. The net gain on the disposal of property, plant
and equipment primarily relates to a $30.1 million gain on the sale of real estate. The $6.3 million used in working capital relates to a $14.8 million increase in inventories and
a $12.4 million increase in receivables which were partially offset by a $15.0 million increase in accruals, payables and income taxes and a $5.9 million decrease in other assets.
Significant items impacting the difference between net income from continuing operations and cash flows from continuing operations in 1999 were $5.1 million used in working capital, net gains
on the disposition of property, plant and equipment of $61.1 million and $21.9 million provided by the utilization of deferred tax assets. The $61.1 million net gain on property,
plant and equipment was primarily related to a $61.7 million gain on the sale of real estate. The $5.1 million used in working capital relates to a $10.0 million decrease in
accruals, payables and income taxes which was partially offset by a $1.4 million decrease in receivables and a $4.1 million decrease in other assets.

Net Cash Provided (Used) by Investing ActivitiesNet cash provided (used) by investing activities was ($227,000),
$71.1 million and $87.8 million in 2001, 2000 and 1999, respectively. In 2001, we used $75.9 million to purchase short-term investments and $11.1 million to
invest in property, plant and equipment which were largely offset by $86.3 million provided by our sale of short-term investments. In 2000, our investing activities provided cash of
$53.7 million from the sale of short-term investments, $62.3 million from the sale of our Telecommunications segment and proceeds related to the release of escrow from our
previous discontinued operations, and $28.0 million of proceeds from real estate sales and asset retirements which was partially offset by $51.4 million used to purchase
short-term investments and $21.4 million used to invest in property, plant and equipment. In 1999, our investing activities provided cash of $26.9 million from the sale of
short-term investments, $19.9 million from the sale of discontinued operations and $70.7 million from the proceeds on real estate sales and asset retirements which were
partially offset by $24.9 million from the purchase of short-term investments and $4.8 million from the purchase of property, plant and equipment. During 2002, we expect to invest
approximately $2.0 to $4.0 million in capital expenditures. We have funded our capital expenditures from cash, cash equivalents and short-term investments and expect to continue to
do so throughout 2002.

Net Cash Provided (Used) by Financing ActivitiesNet cash provided (used) by financing activities totaled $1.4 million,
($145.5) million and ($2.4) million in 2001, 2000 and 1999, respectively. In 2001, we received net cash of approximately $1.4 million from the sale of our common stock to employees through our
employee stock purchase and option plans. In 2000, our net cash used in financing activities primarily related to our recapitalization merger where we repurchased $270.2 million of common stock
and incurred $35.5 million in recapitalization merger cost which was partially offset by the proceeds from the issuance of common and preferred stock of $160.3 million including our
initial public offering in August, 2000. In 1999

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our net cash used in financing activities primarily related to $3.2 million in recapitalization merger and other cost and $2.4 million in dividends paid partially offset by the issuance
of common stock for $3.3 million.

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

Other Matters

Accounting PronouncementsOn June 29, 2001, the Financial Accounting Standards Board, or FASB,
approved for issuance SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". Major provisions of these Statements are as follows: all business
combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before
July 1, 2001; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the
acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite
lives are not amortized but are tested for impairment annually using a fair value approach, except in certain circumstances, and whenever there is an impairment indicator; other intangible assets will
continue to be valued and amortized over their estimated lives; in-process research and development will continue to be written off immediately; all acquired goodwill must be assigned to
reporting units for purposes of impairment testing and segment reporting; effective January 1, 2002, existing goodwill will no longer be subject to amortization. Goodwill arising between
June 29, 2001 and December 31, 2001 will not be subject to amortization. The adoption of SFAS No. 142 in January 2002 will not have a material impact on the Company's
financial statements.

On
October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which establishes one accounting model to be
used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 supercedes
SFAS 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30. SFAS No. 144
requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for fiscal
years beginning after December 15, 2001 with early applications permitted. The Company does not expect the adoption of this statement to have a material effect on its consolidated results of
operations or financial position.

Environmental MattersOf our former production facilities, two have known environmental liabilities of significance, the
Scotts Valley site and the Palo Alto site. Prior to the recapitalization merger, we entered into and funded fixed price remediation contracts, as well as cost overrun and unknown pollution
conditions liability coverage, with respect to both these sites. For a more detailed description, see "BusinessEnvironmental Matters."

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LitigationThe Company is involved in various legal actions which arose in the ordinary course of its business activities.
Management believes the final resolution of these matters should not have a material impact on its results of operations, cash flows, or financial position. For a more detailed description of these
suits, see "BusinessLegal Proceedings."

Recent Events Related to our Independent Auditor, Arthur AndersenOn March 14, 2002 our independent certified public
accountant, Arthur Andersen, LLP, was indicted on federal charges of obstruction of justice in connection with the U.S. government's investigation of Enron. We are required to file periodic financial
statements with the SEC which have been audited or reviewed by an independent, certified public accountant. The SEC has issued a release stating that it will continue to accept financial statements
audited by Arthur Andersen, and interim financial statements reviewed by it, so long as Arthur Andersen is able to make certain representations to us. While Arthur Andersen has made the SEC required
representations to us in connection with our audited financial statements for 2001, there can be no assurance that Arthur Andersen will be able to do so in the future, that the SEC will continue to
accept financial statements audited or reviewed by Arthur Andersen or that Arthur Andersen will be able to perform the required services for us. In such case, we will promptly seek to engage new
independent certified public accountants to perform audit-related services for us. Our ability to timely file our required periodic reports could be impaired if Arthur Andersen becomes unable to make
the required representations to us, the SEC ceases accepting financial statements audited or reviewed by Arthur Andersen or if for any other reason Arthur Andersen is unable to perform audit-related
services for us. If we are unable to timely file our required periodic reports it could have a material adverse effect on us.

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RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

You should carefully consider the risks described below and all other information contained in this report and in our other filings with
the SEC in evaluating us and our business before making an investment decision. If any of the following risks, or other risks and uncertainties that we have not yet identified or that we currently
think are immaterial, actually occur and are material, our business, financial condition and results of operations could be materially and adversely affected. In that event, the trading price of our
common stock could decline and you may lose part or all of your investment.

We have recently incurred substantial operating losses and we anticipate additional future losses.

Our sales for 2001 were $62.2 million compared to $115.8 million for 2000 due to sharply reduced end-customer demand in many of the
communications end-markets which our products address. We incurred a net loss of $21.7 million for 2001.

We
expect that reduced end-customer demand, underutilization of our manufacturing capacity and other factors will continue to adversely affect our operating results in the
near term and we anticipate incurring additional losses in 2002. In order to return to profitability, we must achieve substantial revenue growth and we currently face an environment of uncertain
demand in the markets our products address. We cannot assure you as to whether or when we will return to profitability or whether we will be able to sustain such profitability, if achieved.

Several customers account for a high percentage of our sales and the loss of, or a reduction in orders from, a significant customer could result in a loss of sales.

We depend on a small number of customers for a majority of our sales. During the year ended December 31, 2001, we had four customers which each accounted
for more than 10% of our sales and in aggregate accounted for 71% of our sales. Those customers were Lucent Technologies, Marconi Communications, Nortel Networks and Richardson Electronics including
sales to their respective manufacturing subcontractors. During the year ended December 31, 2000, we had two customers which each accounted for more than 10% of our sales and in aggregate
accounted for approximately 72% of our sales. Those customers were Lucent Technologies and Nortel Networks including sales to their
respective manufacturing subcontractors. In addition, most of our sales result from purchase orders or from contracts that can be cancelled on short-term notice. We anticipate that we will
continue to sell a majority of our products to a relatively small group of customers. The loss of or a reduction in orders from, a significant customer for any reason could cause our sales to
decrease.

During
our fourth quarter of 2000 we began to experience a sequential reduction in demand for our wireless base station and OC-192 optical products which has continued into
the first quarter of 2002. Also, during 2001, we have experienced a reduction in and push out of demand for our GaAs semiconductors. In addition, since the fourth quarter of 2000 and throughout 2001,
three of our largest customers, Lucent, Nortel and Marconi issued press releases discussing the slow down in telecom spending which has resulted in reduced demand for their products and major
reductions in their work forces. In March 2002, Lucent and Nortel issued press releases disclosing reduced customer orders to date in 2002. Our orders from these major customers fell
significantly during 2001 and there can be no assurance that orders will increase in 2002 or not continue to decline. While we have seen some limited recovery in orders for our mobile wireless and
GaAs semiconductor products, we expect this general slow down in telecom spending to continue in the near term based on customer forecasts for the purchase of our products. The greater the slowdown in
demand becomes, the more significant the potential negative impact on our sales, earnings, inventory valuations and cash flow.

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Our future success depends in significant part on strategic relationships with certain of our customers. If we cannot maintain these relationships or if these customers develop
their own solution or adopt a competitor's solutions instead of buying our products, our operating results would be adversely affected.

In the past, we have relied on our strategic relationships with certain customers who are technology leaders in our target markets. We intend to pursue and
continue to form these strategic relationships in the future but we cannot assure you that we will be able to do so. These relationships often require us to develop new products that typically involve
significant technological challenges. Our partners frequently place considerable pressure on us to meet their tight development schedules. Accordingly, we may have to devote a substantial amount of
our limited resources to our strategic relationships, which could detract from or delay our completion of other important development projects. Delays in development could impair our relationships
with our strategic partners and negatively impact sales of the products under development. Moreover, it is possible that our customers may develop their own solutions or adopt a competitor's solution
for products that they currently buy from us. If that happens, our business, financial condition and results of operations could be materially and adversely affected.

Our quarterly operating results may fluctuate significantly. As a result, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause
our stock price to decline.

Our quarterly revenues and operating results have fluctuated significantly in the past and may continue to vary from quarter to quarter due to a number of
factors, many of which are not within our control. If our operating results do not meet our publicly stated guidance or the expectations of securities analysts or investors, our stock price may
decline. Fluctuations in our operating results may be due to a number of factors, including the following:



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Due
to all of the foregoing factors, and the other risks discussed in this report, you should not rely on period-to-period comparisons of our operating results as
an indication of future performance.

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If we are unable to respond to the rapid technological change taking place in our industry, our existing products could become obsolete and we could face difficulties making
future sales.

The markets in which we compete are characterized by rapidly changing technologies, evolving industry standards and frequent improvements in products and
services. If the technologies supported by our products become obsolete or fail to gain widespread acceptance, as a result of a change in industry standards or otherwise, we could face difficulties
making future sales. Our future success will depend on factors including our ability to:



We
must continue to make significant investments in research and development to seek to develop product enhancements, new designs and technologies. If we are unable to develop and
introduce new products or enhancements in a timely manner in response to changing market conditions or customer requirements, or if our new products do not achieve market acceptance, our sales could
decline.

Our existing and potential customers operate in an intensely competitive environment and our success will depend on the success of our customers.

The companies in our target markets, communications equipment companies and service providers, face an extremely competitive environment. Most of the fiber optic
and wireless products we design and sell are customized to work with specific customer's systems. If the companies with whom we establish business relations are not successful in building their
systems, promoting their products, including new revenue-generating services, receiving requisite approvals and accomplishing the many other requirements for the success of their businesses, our
growth will be limited. Furthermore, our customers may have difficulty obtaining parts from other suppliers causing these customers to cancel or delay orders for our products. Moreover, our customers'
success is affected by a number of factors, many of which are out of our control, including:



In
addition, we have limited ability to foresee the competitive success of our customers and to plan accordingly.

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If the fiber optic, broadband cable and wireless communications markets fail to grow or they decline, our sales may not grow or may decline.

Our future growth depends on the success of the fiber optic, broadband cable and wireless communications markets. The rate at which these markets will grow is
difficult to predict. These markets may fail to grow or decline for many reasons, including:



During
2001, the demand for telecom equipment has been very soft and is projected to continue during the first quarter of 2002 and potentially beyond. If the markets for our products in
fiber optic, broadband cable or wireless communications fail to grow, or grow more slowly than we anticipate, the use of our products may decline and our sales could suffer.

If the Internet does not continue to expand and broadband access technologies are not deployed to satisfy the increased bandwidth requirements as we anticipate, sales of our
products may decline.

Our future success depends on the continued growth of the Internet as a widely-used medium for commerce and communications, the continuing increase in
the amount of data transmitted over communications networks and the growth of broadband communications networks to meet the increased demand for bandwidth. If the Internet does not continue to expand
as a widespread communications medium and commercial marketplace, the need for significantly increased bandwidth across networks and the market for broadband communications equipment may not continue
to develop. Future demand for our products is uncertain and will depend to a great degree on the continued growth and deployment of new broadband communications equipment. If this growth does not
continue, sales of our products may decline.

If we fail to accurately forecast component and material requirements for our manufacturing facilities, we could incur additional costs or experience manufacturing delays.

We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the
demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors
such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need six
months or more lead time. As a result, we may be required to make financial commitments in the form of purchase commitments. We lack visibility into the finished goods inventories of our customers and
the end-users. This lack of visibility impacts our ability to accurately forecast our requirements. If we overestimate our component and material requirements, we may have excess
inventory, which would increase our costs. An additional risk for potential excess inventory results from our volume purchase orders with certain material suppliers, which can only be reduced in
certain circumstances. Additionally, if we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our
products to our customers. Any of these occurrences would negatively impact our sales and

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profitability. As we broaden our product lines we must purchase a wider variety of components to utilize in our manufacturing processes. In addition, new product lines contain a greater degree of
uncertainty due to a lack of visibility of customer acceptance and potential competition. Both of these factors will contribute a higher level of inventory risk in our near future.

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

We typically purchase our components and materials through purchase orders, and we have no guaranteed supply arrangements with any of our suppliers. We currently
purchase several key
components and materials used in the manufacture of our products from single or limited source suppliers. In the event one of our sole source suppliers is unable or unwilling to sell us material
components, this could have a significant adverse effect on the Company. Additionally, we may fail to obtain required components in a timely manner in the future. We may also experience difficulty
identifying alternative sources of supply for the components used in our products. We would experience delays if we were required to test and evaluate products of potential alternative suppliers.
Furthermore, financial or other difficulties faced by our suppliers or significant changes in demand for the components or materials they supply to us could limit the availability of those components
or materials to us. In addition, the majority of our semiconductor products are packaged in The Philippines and Hong Kong. Political and economic instability and changes in governmental regulations in
these areas as well as the United States could affect the ability of our overseas vendors to package our products. Any interruption or delay in the supply of our required components, materials or
services, or our inability to obtain these components, materials or services from alternate sources at acceptable prices and within a reasonable amount of time, could impair our ability to meet
scheduled product deliveries to our customers and could cause customers to cancel orders.

We face intense competition, and, if we do not compete effectively in our markets, we will lose sales and have lower margins.

The market for fiber optic and wireless communications services is relatively new, rapidly evolving and intensely competitive, and we expect competition to
intensify further in the future. Many of our current and potential competitors have substantially greater technical, financial, marketing, distribution and other resources than we have. Price
competition is intense and the market prices and margins of products frequently decline after competitors begin making similar products. In addition, we compete with the captive manufacturing
operations of large communications original equipment manufacturers such as Lucent Technologies, Marconi and Nortel Networks who are also our customers. They may decide at any time to satisfy some or
all of their product needs through their own in-house sources. A number of our competitors may have greater name recognition and market acceptance of their products and technologies.
Furthermore, our competitors, or the competitors of our customers, may develop new technologies, enhancements of existing products or new products that offer superior price or performance features.
These new products or technologies could render obsolete our products or the systems of our customers into which our products are integrated.

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

Our
performance is substantially dependent on the continued services and on the performance of our senior management and our highly qualified team of engineers, who have many years of
experience and specialized expertise in our business. Our performance also depends on our ability to retain and motivate our other executive officers and key employees. The loss of the services of any
of our executive officers or

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of a number of our engineers could harm our ability to maintain and build our business. We have no "key man" life insurance policies.

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

We may pursue acquisitions and investments in new businesses, products or technologies that involve numerous risks, including the use of cash and diversion of management's
attention.

In the future, we may make acquisitions of and investments in new businesses, products and technologies or we may acquire operations that expand our manufacturing
capabilities. If we identify an acquisition candidate, we may not be able to successfully negotiate or finance the acquisition. Even if we are successful, we may not be able to integrate the acquired
businesses, products or technologies into our existing business and products. As a result of the rapid pace of technological change in the communications industry, we may misgauge the
long-term potential of the acquired business or technology or the acquisition may not be complementary to our existing business. Furthermore, potential acquisitions and investments,
whether or not consummated, may divert our management's attention and require considerable cash outlays at the expense of our existing operations. In addition, to complete future acquisitions, we may
issue equity securities, incur debt, assume contingent liabilities or have amortization expenses and write-downs of acquired assets, which could affect our profitability.

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

Products as complex as ours frequently contain undetected errors or defects, especially when first introduced or when new versions are released. The occurrence of
errors could result in product returns from and reduced product shipments to our customers. In addition, any failure by our products to properly perform could result in claims against us by our
customers. Such failure also could result in the loss of or delay in market acceptance of our products or harm our reputation. Due to the recent introduction of some of our products, we have limited
experience with the problems that could arise with these products.

Our
purchase agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. However, the limitation of liability
provision contained in these agreements may not be effective as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries.
Although we maintain $25.0 million of insurance to protect against claims associated with the use of our products, our insurance coverage may not adequately cover all claims asserted against
us. In addition, even ultimately unsuccessful claims could result in costly litigation, divert our management's time and resources and damage our customer relationships.

We use a number of specialized technologies, some of which are patented, to design, develop and manufacture our products. Infringement of our intellectual property rights could
hurt our competitive position, harm our reputation and cost us money.

We regard the protection of our copyrights, patents, service marks, trademarks, trade dress and trade secrets as critical to our future success and plan to rely
on a combination of copyright, patent, trademark and trade secret law, as well as on confidentiality procedures and contractual provisions, to protect our proprietary rights. We seek patent protection
for our unique developments in circuit designs, processes and algorithms. Adequate protection of our intellectual property rights may not be available in every country where our products and services
are made available. We intend, as a general policy, to enter into

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confidentiality and invention assignment agreements with all of our employees and contractors, as well as into nondisclosure agreements with parties with which we conduct business, to limit access to
and disclosure of our proprietary information; however, we have not done so on a uniform basis. As a result, we may not have adequate remedies to preserve our trade secrets or prevent third parties
from using our technology without authorization. We cannot assure you that all future employees, contractors and business partners will agree to these contracts, or that, even if agreed to, these
contractual arrangements or the other steps we have taken to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or to deter independent third-party
development of similar technologies. If we are unable to execute these agreements or take other steps to prevent misappropriation of our technology or to deter independent development of similar
technologies, our competitive position and reputation could suffer and we could be forced to make significant expenditures.

We
regularly file patent applications with the U.S. Patent and Trademark Office and in selected foreign countries covering particular aspects of our technology and intend to prosecute
such applications to the fullest extent of the law. Based upon our assessment of our current and future technology, we may decide to file additional patent applications in the future, and may decide
to abandon current patent applications. We cannot assure you that any patent application we have filed or will file will result in an issued patent, or, if patents are issued to us, that such patents
will provide us with any competitive advantages and will not be challenged by third parties or invalidated 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 limit our ability to protect the intellectual property rights that such patents or patent applications were intended to cover. Furthermore, the patents of
others may impair our ability to do business. See "BusinessIntellectual Property" for a more complete description of our intellectual property and our efforts to protect it.

We
have several registered trademarks and service marks, in the United States and abroad, and are in the process of registering others in the United States. Nevertheless, we cannot
assure you that the U.S. Patent and Trademark Office will grant us these registrations. Should we decide to apply to register additional trademarks or service marks in foreign countries, there is no
guarantee that we will be able to secure such registrations. The inability to register or decision not to register in certain foreign countries and adequately protect our trademarks and service marks
could harm our competitive position, harm our reputation and negatively impact our future profitability. For more details, see "BusinessIntellectual Property."

Claims that we are infringing third-party intellectual property rights may result in costly litigation.

As a provider of technologically advanced products, we are at particular risk of becoming subject to litigation based on claims that we are infringing the
intellectual property rights of others. In the past, we have been subject to claims that some of our products infringe the proprietary rights of third parties. We cannot assure you that we will not be
subject to any such claims in the future. Any future similar claims, whether meritorious or not, could be time-consuming to defend, damage our reputation, result in substantial and
unanticipated costs associated with litigation and require us to enter into royalty or licensing agreements, which may not be available on acceptable terms or at all.

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The variability of our manufacturing yields may affect our gross margins.

The success of our business depends largely on our ability to produce our products efficiently through a manufacturing process that results in a large number of
usable products or yields, from any particular production run. In the past, we have experienced significant delays in our product shipments due to lower-than-expected
production yields. Due to the rigid technical requirements for our products and manufacturing processes, our production yields may be negatively affected by a variety of factors, some of which are
beyond our control. For instance, yields may be reduced by:



Our
manufacturing yields also vary significantly among our products due to product complexity and the depth of our experience in manufacturing a particular product. We cannot assure you
that we will not experience problems with our production yields in the future. Decreases in our yields can result in substantially higher costs for our products. If we cannot maintain acceptable
production yields in the future, our gross margin may suffer.

Changes in the regulatory environment of the communications industry may reduce the demand for our products.

The recent deregulation of the telecommunications industry has resulted in an increased number of service providers. Such increase, coupled with the expanding use
of the Internet and data networking
by businesses and consumers, has resulted in the rapid growth of the communications industry. This has led and will likely continue to lead to intense competition, short product life cycles, and, to
some extent, regulatory uncertainty in and outside the United States. The course of the development of the communications industry is difficult to predict. For example, the delays in governmental
approval processes that our customers are subject to, such as the issuance of site permits and the auction of frequency spectrum, have in the past caused, and may in the future cause, the
cancellation, postponement or rescheduling of the installation of communications systems by our customers. A reduction in network infrastructure expenditures could negatively affect the sale of our
products. Moreover, in the short term, deregulation may result in a delay or a reduction in the procurement cycle because of the general uncertainty involved with the transition period of businesses.

Our future profitability could suffer from known or unknown 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 the transactions in which we sold our other businesses, we generally retained
liability arising from events occurring prior to the sale. Some of these liabilities were or have since become known to us, such as the environmental condition of the production facilities we sold. We
may have underestimated the scope of these liabilities, and we may become aware of additional liabilities associated with the following in the future:



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If
these and any other unknown liabilities and obligations exceed our expectations and established reserves, our future profitability could suffer and our capital needs could increase.

If we fail to comply with environmental regulations we could be subject to substantial fines.

Two of our current and former production facilities have significant environmental liabilities for which we have entered into and funded fixed price remediation
agreements and obtained cost-overrun and unknown pollution insurance coverage. We cannot assure you that this insurance will be sufficient to cover all liabilities related to these sites.
In addition, we are subject to a variety of federal, state and local governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or
other hazardous substances used to manufacture our products. In the past, we have been subject to periodic environmental reviews and audits, which have resulted in minor fines. If we fail to comply
with these regulations, substantial fines could be imposed on us, and we could be required to suspend production, alter manufacturing processes or cease operations.

If RF emissions pose a health risk, the demand for our products may decline.

Recent news reports have asserted that some radio frequency emissions from wireless handsets may be linked to various health concerns, including cancer, and may
interfere with various electronic medical devices, including hearing aids and pacemakers. If it were determined or perceived that RF emissions from wireless communications equipment create a health
risk, the market for our wireless customers' products and, consequently, the demand for our products could decline significantly.

Our manufacturing facilities are concentrated in an area susceptible to earthquakes.

Our headquarters and our manufacturing facilities are concentrated in an area where there is a risk of significant earthquake activity. Substantially all of the
production equipment that currently accounts for our sales, as well as planned additional production equipment, is or will be located in a known earthquake zone. We cannot predict the extent of the
damage that our facilities and equipment would suffer in the event of an earthquake or how such damage would affect our business. We do not maintain earthquake insurance.

Our stock price is highly volatile.

The market price of our common stock has fluctuated substantially in the past and is likely to continue to be highly volatile and subject to wide fluctuations.
Since our initial public offering in August, 2000, through January 28, 2002, our common stock has traded at prices as low as $1.9375 and as high as $59.875 per share. These fluctuations have
occurred and may continue to occur in response to various factors, many of which we cannot control, including:



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In
addition, the market prices of securities on the NASDAQ National Market and that of our customers and competitors have been especially volatile. This volatility has significantly
affected the market prices of securities for reasons frequently unrelated to the operating performance of the specific companies. Accordingly, you may not be 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 of their securities have been the subject of securities class action litigation. If we were
the object of a securities class action litigation, it could result in substantial losses and divert management's attention and resources from other matters.

Our business experiences seasonality.

It has been our experience that telecommunication equipment spending is typically lower in the first quarter of the calendar year and higher during the fourth
quarter of the calendar year. This apparent seasonality may be even more pronounced in light of the current economic downturn.

We may need to raise additional capital in the future through the issuance of additional equity or convertible debt securities or by borrowing money, and additional funds may
not be available on terms acceptable to us.

We believe that the cash, cash equivalents and investments on hand, the cash we expect to generate from operations and borrowings under our line of credit will be
sufficient to meet our liquidity and capital spending requirements at least through the end of 2002. However, it is possible that we may need to raise additional funds to fund our activities during
and/or beyond that time. We could raise these funds by selling more stock to the public or to selected investors, or by borrowing money. In addition, even though we many not need additional funds, we
may still elect to sell additional equity securities or obtain credit facilities for other reasons. We may not be able to obtain additional funds on favorable terms, or at all. If adequate funds are
not available, we may be required to curtail our operations significantly or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain
technologies or potential markets. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In
addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock.

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



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In
addition, we may require additional capital to accommodate planned growth, hiring, infrastructure and facility needs or to consummate acquisitions of other businesses, products or
technologies.

Our business operations may be effected by the California utility outages.

Our headquarters and our manufacturing facilities are concentrated in the State of California, which experienced power shortages and outages earlier in 2001.
Substantially all of the production equipment that currently accounts for our sales, as well as planned additional production equipment, is or is currently expected to be located in California. We
cannot predict when these outages will occur and the extent these outages will disrupt our business operations and delay delivery of our products. Any delays in product deliveries could result in a
loss of sales and a loss of customers which could impact our profitability.

Our controlling stockholder has the ability to take action that may adversely affect our business, our stock price and our ability to raise capital.

As of December 31, 2001, Fox Paine & Company, LLC ("Fox Paine") is the indirect beneficial owner of 66.1% of our outstanding share capital. As a
result, Fox Paine has and will continue to have control over the outcome of matters requiring stockholder approval, including the power to:



Fox
Paine also will be able to delay, prevent or cause a change in control relating to us. Fox Paine's control over us and our subsidiaries, and its ability to delay or prevent a change
in control relating to us could adversely affect the market price of our common stock.

In
addition, Fox Paine receives management fees from us which could influence their decisions regarding us.

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

The
sale of a substantial number of shares of our common stock by Fox Paine or the perception that such sale could occur, could negatively affect the market price of our common stock and
could also materially impair our future ability to raise capital through an offering of securities.

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

We sell a significant portion of our product to customers outside of the United States. Sales to customers outside of the United States accounted for
approximately 42%, 53% and 29% of our sales in 2001, 2000 and 1999, respectively. We expect that sales to customers outside of the United States will continue to account for a significant portion of
our sales. Although all of our foreign sales are denominated in U.S. dollars, such sales are subject to certain risks, including, among others, changes in regulatory requirements, the imposition of
tariffs and other trade barriers, the existence of political, legal and economic instability in foreign markets, language and cultural barriers, seasonal reductions in business activities, our ability
to receive timely payment and collect our accounts receivable, currency fluctuations, and potentially adverse tax consequences, which could adversely affect our business and financial results.

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Future sales of our common stock could depress its market price.

Sales of substantial amounts of common stock by our officers, directors and other stockholders in the public, 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 the adverse effect a price decline would have on holders of our common stock, that decline would impede
our ability to raise capital through the issuance of additional shares of common stock or other equity or convertible debt securities.

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

We have announced a significant number of new products and design wins for new and existing products. Achieving a design win with a customer does not create a
binding commitment from that customer to purchase our products. Rather, a design win is solely an expression of interest by potential customers in purchasing our products and is not supported by
binding commitments of any nature. Accordingly, a customer may choose at any time to discontinue using our products in their designs or product development efforts. Even if our products are chosen to
be incorporated in our customer's products, we still may not realize significant revenues from that customer if their products are not commercially successful. A design win may not generate revenue if
the customer's product is rejected by their end market. Typically, most new products or design wins have very little impact on near-term revenue. It may take well over a year before a new
product or design win generates meaningful revenue.

We must develop or otherwise gain access to improved process technologies.

For our semiconductor products, our future success will depend upon our ability to continue to improve existing process technologies, to develop or acquire new
process technologies, and to adapt our process technologies to emerging industry standards. In the future, we may be required to transition one or more of our products to process technologies with
smaller geometries, other materials or higher speed in order to reduce costs and/or improve product performance. We may not be able to improve our process technologies and develop or otherwise gain
access to new process technologies in a timely or affordable manner. In addition, products based on these technologies may not achieve market acceptance.

Recent events related to our independent auditor, Arthur Andersen.

On March 14, 2002 our independent certified public accountant, Arthur Andersen, LLP, was indicted on federal charges of obstruction of justice in
connection with the U.S. government's investigation of Enron. We are required to file periodic financial statements with the SEC which have been audited or reviewed by an independent, certified public
accountant. The SEC has issued a release stating that it will continue to accept financial statements audited by Arthur Andersen, and interim financial statements reviewed by it,
so long as Arthur Andersen is able to make certain representations to us. While Arthur Andersen has made the SEC required representations to us in connection with our audited financial statements for
2001, there can be no assurance that Arthur Andersen will be able to do so in the future, that the SEC will continue to accept financial statements audited or reviewed by Arthur Andersen or that
Arthur Andersen will be able to perform the required services for us. In such case, we will promptly seek to engage new independent certified public accountants to perform audit-related services for
us. Our ability to timely file our required periodic reports could be impaired if Arthur Andersen becomes unable to make the required representations to us, the SEC ceases accepting financial
statements audited or reviewed by Arthur Andersen or if for any other reason Arthur Andersen is unable to perform audit-related services for us. If we are unable to timely file our required periodic
reports it could have a material adverse effect on us.

47

---

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

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

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

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

Expected Maturity Dates

Expected Maturity
Amounts
(in thousands)

Weighted
Average Interest
RateCash equivalents:2002

$
24,404

2.04
%Short-term investments:2002


30,457

2.48
%Fair value at December 31, 2001

$
54,861


48

---



Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                       |  | Page
|------------------------------------------------------ |  | ----
|Report of Independent Public Accountants               |  | 50  
|Consolidated Balance Sheets                            |  | 51  
|Consolidated Statements of Operations                  |  | 52  
|Consolidated Statements of Comprehensive Income (Loss) |  | 54  
|Consolidated Statements of Stockholders' Equity        |  | 55  
|Consolidated Statements of Cash Flows                  |  | 57  
|Notes to Consolidated Financial Statements             |  | 58  

49

---



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To
the Stockholders and Board of Directors of
WJ Communications, Inc.:

We
have audited the accompanying consolidated balance sheets of WJ Communications, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of WJ Communications, Inc. and
subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States of America.

ARTHUR
ANDERSEN LLP

San
Jose, California
January 22, 2002

50

---



WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        CONSOLIDATED BALANCE SHEETS

|                                              |                                                                                                                                                                       | December 31, |        
|--------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | -------
|
|
|ASSETS                                        |                                                                                                                                                                       |              |        
|CURRENT ASSETS:                               |                                                                                                                                                                       |              |        
|                                              | Cash and equivalents                                                                                                                                                  |              | $      
|                                              | Short-term investments                                                                                                                                                |              |        
|                                              | Receivables (net of allowances for doubtful accounts of $1,398 and $1,736 at December 31, 2001 and 2000, respectively)                                                |              |        
|                                              | Inventories                                                                                                                                                           |              |        
|                                              | Deferred income taxes                                                                                                                                                 |              |        
|                                              | Other                                                                                                                                                                 |              |        
|                                              |                                                                                                                                                                       |              |        
|                                              | Total current assets                                                                                                                                                  |              |        
|                                              |                                                                                                                                                                       |              |        
|PROPERTY, PLANT AND EQUIPMENT, net            |                                                                                                                                                                       |              | 32,214 
|OTHER ASSETS                                  |                                                                                                                                                                       |              | 220    
|                                              |                                                                                                                                                                       |              |        
|                                              |                                                                                                                                                                       | $            | 127,016
|                                              |                                                                                                                                                                       |              |        
|LIABILITIES AND STOCKHOLDERS' EQUITY          |                                                                                                                                                                       |              |        
|CURRENT LIABILITIES:                          |                                                                                                                                                                       |              |        
|                                              | Accounts payable                                                                                                                                                      |              | $      
|                                              | Accrued expenses                                                                                                                                                      |              |        
|                                              | Payroll and profit sharing                                                                                                                                            |              |        
|                                              | Accrued workers' compensation                                                                                                                                         |              |        
|                                              | Restructuring accrual (Note 11)                                                                                                                                       |              |        
|                                              | Income taxes                                                                                                                                                          |              |        
|                                              |                                                                                                                                                                       |              |        
|                                              | Total current liabilities                                                                                                                                             |              |        
|                                              |                                                                                                                                                                       |              |        
|OTHER LONG-TERM OBLIGATIONS (Notes 5 and 11)  |                                                                                                                                                                       |              | 17,534 
|                                              |                                                                                                                                                                       |              |        
|COMMITMENTS AND CONTINGENCIES (Notes 5 and 8) |                                                                                                                                                                       |              |        
|STOCKHOLDERS' EQUITY:                         |                                                                                                                                                                       |              |        
|                                              | Preferred stock, $0.01 par value-authorized and unissued, 10,000,000 shares; no shares outstanding                                                                    |              |        
|                                              | Common stock, $0.01 par value-authorized, 100,000,000 shares at December 31, 2001; outstanding: 55,980,258 and 55,245,052 at December 31, 2001 and 2000, respectively |              |        
|                                              | Additional paid-in capital                                                                                                                                            |              |        
|                                              | Retained deficit                                                                                                                                                      |              |        
|                                              | Deferred stock compensation                                                                                                                                           |              |        
|                                              | Other comprehensive income (loss)                                                                                                                                     |              |        
|                                              |                                                                                                                                                                       |              |        
|                                              | Total stockholders' equity                                                                                                                                            |              |        
|                                              |                                                                                                                                                                       |              |        
|                                              |                                                                                                                                                                       | $            | 127,016
|                                              |                                                                                                                                                                       |              |        

See notes to consolidated financial statements.

51

---



WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                                     |                                                                                                          | Year Ended               |        
|------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------- | ------------------------ | -------
|
|
|Sales                                                                                |                                                                                                          | $                        | 62,220 
|Cost of goods sold                                                                   |                                                                                                          |                          | 58,860 
|                                                                                     |                                                                                                          |                          |        
|Gross profit                                                                         |                                                                                                          |                          | 3,360  
|Operating expenses:                                                                  |                                                                                                          |                          |        
|                                                                                     | Research and development                                                                                 |                          |        
|                                                                                     | Selling and administrative                                                                               |                          |        
|                                                                                     | Amortization of deferred stock compensation (*)                                                          |                          |        
|                                                                                     | Recapitalization merger and other                                                                        |                          |        
|                                                                                     | Restructuring charge (Note 11)                                                                           |                          |        
|                                                                                     |                                                                                                          |                          |        
|                                                                                     |                                                                                                          | Total operating expenses |        
|                                                                                     |                                                                                                          |                          |        
|Income (loss) from operations                                                        |                                                                                                          |                          | (37,994
|Interest income                                                                      |                                                                                                          |                          | 3,015  
|Interest expense                                                                     |                                                                                                          |                          | (238   
|Other income (expense)net                                                           |                                                                                                          |                          | 693    
|Gain on dispositions of real property                                                |                                                                                                          |                          | 325    
|                                                                                     |                                                                                                          |                          |        
|Income (loss) from continuing operations before income taxes                         |                                                                                                          |                          | (34,199
|Income tax (provision) benefit                                                       |                                                                                                          |                          | 12,528 
|                                                                                     |                                                                                                          |                          |        
|Income (loss) from continuing operations                                             |                                                                                                          |                          | (21,671
|Discontinued operations (Note 12):                                                   |                                                                                                          |                          |        
|                                                                                     | Income (loss) from discontinued operations, net of income taxes (benefit) of $91 and $(967) respectively |                          |        
|                                                                                     | Gain on disposition, net of income taxes of $20,471 and $1,458 respectively                              |                          |        
|                                                                                     |                                                                                                          |                          |        
|Income (loss) before extraordinary item                                              |                                                                                                          |                          | (21,671
|Extraordinary itemearly extinguishment of debt, net of income tax benefit of $1,250 |                                                                                                          |                          |       
|                                                                                     |                                                                                                          |                          |        
|Net income (loss)                                                                    |                                                                                                          | $                        | (21,671
|                                                                                     |                                                                                                          |                          |        

See
notes to consolidated financial statements.

52

---

|                                                                                       |                                          | Year Ended                                        
|-------------------------------------------------------------------------------------- | ---------------------------------------- | --------------------------------------------------
|
|
|Basic per share amounts:                                                               |                                          |                                                   
|                                                                                       | Income (loss) from continuing operations |                                                   
|                                                                                       | Discontinued operations:                 |                                                   
|                                                                                       |                                          | Income (loss) from operations, net of income taxes
|                                                                                       |                                          | Gain on disposition, net of income taxes          
|                                                                                       | Extraordinary item, net of income taxes  |                                                   
|                                                                                       |                                          |                                                   
|Net income (loss)                                                                      |                                          | $                                                 
|                                                                                       |                                          |                                                   
|Basic average shares                                                                   |                                          |                                                   
|Diluted per share amounts:                                                             |                                          |                                                   
|                                                                                       | Income (loss) from continuing operations |                                                   
|                                                                                       | Discontinued operations:                 |                                                   
|                                                                                       |                                          | Income (loss) from operations, net of income taxes
|                                                                                       |                                          | Gain on disposition, net of income taxes          
|                                                                                       | Extraordinary item, net of income taxes  |                                                   
|                                                                                       |                                          |                                                   
|Net income (loss)                                                                      |                                          | $                                                 
|                                                                                       |                                          |                                                   
|Diluted average shares                                                                 |                                          |                                                   
|(*) Amortization of deferred stock compensation excluded
  from the following expenses |                                          |                                                   
|                                                                                       |                                          | Cost of goods sold                                
|                                                                                       |                                          | Research and development                          
|                                                                                       |                                          | Selling and administrative                        
|                                                                                       |                                          |                                                   
|                                                                                       |                                          | $                                                 
|                                                                                       |                                          |                                                   

See
notes to consolidated financial statements.

53

---



WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

|                            |                                                                                                                               | Year Ended                                                                  |        
|--------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -------
|
|
|Net income (loss)           |                                                                                                                               | $                                                                           | (21,671
|Other comprehensive income: |                                                                                                                               |                                                                             |        
|                            | Unrealized holding gains (losses) on securities arising during period                                                         |                                                                             |        
|                            |                                                                                                                               | Less: reclassification adjustment for gains (losses) included in net income |        
|                            |                                                                                                                               |                                                                             |        
|                            | Net unrealized holding gains (losses) on securitiesnet of income tax benefit (provision) of $5, $(132) and $130 respectively |                                                                             |        
|                            |                                                                                                                               |                                                                             |        
|Comprehensive income (loss) |                                                                                                                               | $                                                                           | (21,679
|                            |                                                                                                                               |                                                                             |        

See
notes to consolidated financial statements.

54

---



WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

|                           |                                                                                   | Common Stock |              | Preferred Stock |        |         |  
|-------------------------- | --------------------------------------------------------------------------------- | ------------ | ------------ | --------------- | ------ | ------- | -
|
|
|
|Balance, December 31, 1998 |                                                                                   | 196,430,610  |              | $               | 34,454 |         | 
|                           | Net income                                                                        |              |             |                 |        |        |  
|                           | Dividends declared$0.02 per share                                                |              |             |                 |        |        |  
|                           | Stock option transactions                                                         |              | 4,066,860    |                 |        | 3,344   |  
|                           | Unrealized holding losses on securitiesnet of taxes of $130                      |              |             |                 |        |        |  
|                           |                                                                                   |              |              |                 |        |         |  
|Balance, December 31, 1999 |                                                                                   | 200,497,470  |              |                 | 37,798 |         | 
|                           | Net income                                                                        |              |             |                 |        |        |  
|                           | Stock option transactions                                                         |              | 163,287      |                 |        | 186     |  
|                           | Common stock redemption related to recapitalization merger                        |              | (197,034,960 | )               |        | (33,017 | )
|                           | Common stock issued                                                               |              | 46,334,240   |                 |        | 55,057  |  
|                           | Subscription for common stock                                                     |              | 3,806,465    |                 |        | 5,417   |  
|                           | Repayments on subscriptions                                                       |              |             |                 |        |        |  
|                           | Cost associated with issuance of common stock                                     |              |             |                 |        |        |  
|                           | Preferred stock issued                                                            |              |             |                 |        |        |  
|                           | Cost associated with issuance of preferred stock                                  |              |             |                 |        |        |  
|                           | Conversion of preferred to common/recognition of beneficial conversion            |              | 1,498,800    |                 |        | 15      |  
|                           | Deferred stock compensation                                                       |              |             |                 |        | 4,234   |  
|                           | Amortization of deferred stock compensation                                       |              |             |                 |        |        |  
|                           | Common stock redemption related to employee termination                           |              | (20,250      | )               |        | (22     | )
|                           | Conversion to Delaware corporation $.01 par value common stock at reincorporation |              |             |                 |        | (69,116 | )
|                           | Unrealized holding gains on securitiesnet of taxes of $132                       |              |             |                 |        |        |  
|                           |                                                                                   |              |              |                 |        |         |  
|Balance, December 31, 2000 |                                                                                   | 55,245,052   |              |                 | 552    |         | 
|                           | Net loss                                                                          |              |             |                 |        |        |  
|                           | Common stock issued                                                               |              | 113,455      |                 |        | 1       |  
|                           | Stock option transactions                                                         |              | 621,751      |                 |        | 7       |  
|                           | Amortization of deferred stock compensation                                       |              |             |                 |        |        |  
|                           | Elimination of deferred compensation related to stock options forfeited           |              |             |                 |        |        |  
|                           | Unrealized holding losses on securitiesnet of taxes of $5                        |              |             |                 |        |        |  
|                           |                                                                                   |              |              |                 |        |         |  
|Balance, December 31, 2001 |                                                                                   | 55,980,258   |              | $               | 560    |         | 
|                           |                                                                                   |              |              |                 |        |         |  

See notes to consolidated financial statements.

55

---

|                           |                                                                                   | Retained
Earnings
(Deficit) |         | Other
Comprehensive
Income (Loss) |   | Deferred
Stock
Compensation |      | Subscriptions
Receivable |        | Total
Stockholders'
Equity |  
|-------------------------- | --------------------------------------------------------------------------------- | --------------------------- | ------- | --------------------------------- | - | --------------------------- | ---- | ------------------------ | ------ | -------------------------- | -
|
|Balance, December 31, 1998 |                                                                                   | $                           | 99,073  |                                   | $ | 152                         |      | $                        |       |                            | $
|                           | Net income                                                                        |                             |         | 67,840                            |   |                             |     |                          |        |                           |  
|                           | Dividends declared$0.02 per share                                                |                             |         | (2,371                            | ) |                             |     |                          |        |                           |  
|                           | Stock option transactions                                                         |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Unrealized holding losses on securitiesnet of taxes of $130                      |                             |         |                                  |   |                             | (355 | )                        |        |                           |  
|                           |                                                                                   |                             |         |                                   |   |                             |      |                          |        |                            |  
|Balance, December 31, 1999 |                                                                                   |                             | 164,542 |                                   |   | (203                        | )    |                          |       |                            |  
|                           | Net income                                                                        |                             |         | 25,914                            |   |                             |     |                          |        |                           |  
|                           | Stock option transactions                                                         |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Common stock redemption related to recapitalization merger                        |                             |         | (237,086                          | ) |                             |     |                          |        |                           |  
|                           | Common stock issued                                                               |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Subscription for common stock                                                     |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Repayments on subscriptions                                                       |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Cost associated with issuance of common stock                                     |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Preferred stock issued                                                            |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Cost associated with issuance of preferred stock                                  |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Conversion of preferred to common/recognition of beneficial conversion            |                             |         | (9,982                            | ) |                             |     |                          |        |                           |  
|                           | Deferred stock compensation                                                       |                             |         |                                  |   |                             |     |                          |        | (4,244                     | )
|                           | Amortization of deferred stock compensation                                       |                             |         |                                  |   |                             |     |                          |        | 1,042                      |  
|                           | Common stock redemption related to employee termination                           |                             |         | (90                               | ) |                             |     |                          |        |                           |  
|                           | Conversion to Delaware corporation $.01 par value common stock at reincorporation |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Unrealized holding gains on securitiesnet of taxes of $132                       |                             |         |                                  |   |                             | 207  |                          |        |                           |  
|                           |                                                                                   |                             |         |                                   |   |                             |      |                          |        |                            |  
|Balance, December 31, 2000 |                                                                                   |                             | (56,702 | )                                 |   | 4                           |      |                          | (3,202 | )                          |  
|                           | Net loss                                                                          |                             |         | (21,671                           | ) |                             |     |                          |        |                           |  
|                           | Common stock issued                                                               |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Stock option transactions                                                         |                             |         |                                  |   |                             |     |                          |        |                           |  
|                           | Amortization of deferred stock compensation                                       |                             |         |                                  |   |                             |     |                          |        | 593                        |  
|                           | Elimination of deferred compensation related to stock options forfeited           |                             |         |                                  |   |                             |     |                          |        | 1,907                      |  
|                           | Unrealized holding losses on securitiesnet of taxes of $5                        |                             |         |                                  |   |                             | (8   | )                        |        |                           |  
|                           |                                                                                   |                             |         |                                   |   |                             |      |                          |        |                            |  
|Balance, December 31, 2001 |                                                                                   | $                           | (78,373 | )                                 | $ | (4                          | )    | $                        | (702   | )                          | $
|                           |                                                                                   |                             |         |                                   |   |                             |      |                          |        |                            |  

See notes to consolidated financial statements.

56

---



WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                |                                                                                                 | Year Ended                                                  |                                    
|----------------------------------------------- | ----------------------------------------------------------------------------------------------- | ----------------------------------------------------------- | -----------------------------------
|
|
|OPERATING ACTIVITIES:                           |                                                                                                 |                                                             |                                    
|                                                | Net income (loss)                                                                               |                                                             | $                                  
|                                                | Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: |                                                             |                                    
|                                                |                                                                                                 | Recapitalization merger costs                               |                                    
|                                                |                                                                                                 | Non-cash restructuring charge                               |                                    
|                                                |                                                                                                 | Depreciation and amortization                               |                                    
|                                                |                                                                                                 | Extraordinary item, net of income taxes                     |                                    
|                                                |                                                                                                 | Net gain on disposals of property, plant and equipment      |                                    
|                                                |                                                                                                 | Deferred income taxes                                       |                                    
|                                                |                                                                                                 | Amortization of deferred stock compensation                 |                                    
|                                                |                                                                                                 | Amortization of deferred financing costs                    |                                    
|                                                |                                                                                                 | Provision for (reduction in) doubtful accounts              |                                    
|                                                |                                                                                                 | Write-off of uncollectible accounts to allowance            |                                    
|                                                |                                                                                                 | Provision for excess and obsolete inventory                 |                                    
|                                                |                                                                                                 | Net results of discontinued operations and gain on disposal |                                    
|                                                |                                                                                                 | Net changes in:                                             |                                    
|                                                |                                                                                                 |                                                             | Receivables                        
|                                                |                                                                                                 |                                                             | Inventories                        
|                                                |                                                                                                 |                                                             | Other assets                       
|                                                |                                                                                                 |                                                             | Accruals, payables and income taxes
|                                                |                                                                                                 |                                                             | Restructuring liabilities          
|                                                |                                                                                                 |                                                             |                                    
|                                                | Net cash provided (used) by continuing operating activities                                     |                                                             |                                    
|                                                | Net cash provided (used) by discontinued operations                                             |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|                                                | Net cash provided (used) by operating activities                                                |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|INVESTING ACTIVITIES:                           |                                                                                                 |                                                             |                                    
|                                                | Purchases of property, plant and equipment                                                      |                                                             |                                    
|                                                | Purchase of short-term investments                                                              |                                                             |                                    
|                                                | Proceeds from sale of short-term investments                                                    |                                                             |                                    
|                                                | Proceeds from sale of discontinued operations                                                   |                                                             |                                    
|                                                | Proceeds on real property sales and assets retirements                                          |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|                                                | Net cash provided (used) by investing activities                                                |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|FINANCING ACTIVITIES:                           |                                                                                                 |                                                             |                                    
|                                                | Proceeds from issuance of long-term debt                                                        |                                                             |                                    
|                                                | Payments on long-term borrowings and capital leases                                             |                                                             |                                    
|                                                | Net proceeds from issuances of common and preferred stock                                       |                                                             |                                    
|                                                | Financing costs                                                                                 |                                                             |                                    
|                                                | Repurchase of common stock                                                                      |                                                             |                                    
|                                                | Recapitalization merger costs                                                                   |                                                             |                                    
|                                                | Dividends paid                                                                                  |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|                                                | Net cash provided (used) by financing activities                                                |                                                             |                                    
|                                                |                                                                                                 |                                                             |                                    
|Net increase (decrease) in cash and equivalents |                                                                                                 |                                                             | (23,754                            
|Cash and equivalents at beginning of year       |                                                                                                 |                                                             | 48,970                             
|                                                |                                                                                                 |                                                             |                                    
|Cash and equivalents at end of year             |                                                                                                 | $                                                           | 25,216                             
|                                                |                                                                                                 |                                                             |                                    
|Other cash flow information:                    |                                                                                                 |                                                             |                                    
|                                                | Income taxes paid (net of refunds)                                                              |                                                             | $                                  
|                                                | Interest paid                                                                                   |                                                             |                                    
|Noncash investing and financing activities:     |                                                                                                 |                                                             |                                    
|                                                | Preferred stock dividend-assumed beneficial conversion                                          |                                                             | $                                  

See notes to consolidated financial statements.

57

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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-Johnson Company, the "Company") was founded in 1957 in Palo Alto, California. The Company was originally
incorporated in California and reincorporated in Delaware in August 2000. For more than 30 years, the Company developed and manufactured microwave devices for government electronics and
space communications systems used for intelligence gathering and communication. In 1996, the Company began to develop commercial applications for its military technologies. The Company's continuing
operations design, develop and manufacture innovative, high quality broadband communications products that enable voice, data and image transport over fiber optic, broadband cable and wireless
communications networks around the world. The Company's products are comprised of advanced, highly functional components and integrated assemblies which address the radio frequency challenges faced by
both current and next generation broadband communications networks. The Company's products are used in the network infrastructure supporting and facilitating mobile communications, broadband high
speed data transmission and enhanced voice services. The Company previously operated through other segments and has treated its former Government Electronics, Semiconductor Equipment and
Telecommunication segments as discontinued operations. All segments classified as discontinued operations were divested by March 31, 2000.

On
October 25, 1999, an affiliate of Fox Paine entered into a recapitalization merger transaction with the Company. The recapitalization merger transaction was the culmination of
a strategy implemented by the predecessor Board of Directors in February 1999 to seek to maximize shareholder value by pursuing the sale of the Company in its entirety or as separate business
groups. The predecessor Board decided to divest the microwave products group in 1997, the semiconductor products group in 1999 and the telecommunications group in early 2000, in some cases along with
associated real estate assets. The Company replaced the majority of its senior management and its entire Board of Directors upon the closing of the recapitalization merger on January 31, 2000.
Since the recapitalization merger, the Company has been focused exclusively on providing product solutions that enable and facilitate the development of fiber optic, broadband cable and wireless
network infrastructure. In April 2000, the Company changed its name from Watkins-Johnson Company to WJ Communications, Inc. to highlight its focus on the commercial broadband
communications markets. The Company reincorporated in
Delaware and effected a 3-for-2 stock split on August 15, 2000. The Company completed its initial public offering ("IPO") on August 18, 2000. Net proceeds from
the IPO were approximately $88.4 million after deducting underwriters' discounts and commissions and expenses.

In
the recapitalization merger, FP-WJ Acquisition Corp., a newly-formed corporation wholly-owned by Fox Paine, merged into the Company. All of our
pre-recapitalization shareholders except, with respect to a portion of its shares, a family trust of which Dean A. Watkins is a co-trustee and beneficiary, became entitled to
receive cash in exchange for their shares of the pre-recapitalization common stock. Dr. Watkins is the Company's co-founder and was the Chairman of its Board of
Directors at the time of the recapitalization merger. As a result of the rollover of a portion of the interest in the Company's equity held by Dr. Watkins' trust pursuant to an agreement
entered into with the trust at the time the Company entered into the merger agreement, the Company was able to account for the merger as a recapitalization for financial accounting purposes.

The
Company's statement of operations includes the costs of the recapitalization merger as an expense. In addition, as a result of the continuing significant ownership interest of the
pre-recapitalization stockholders, no adjustments were made to the historical carrying amounts of our assets and liabilities as a result of the recapitalization merger. Furthermore, the
premium paid in cash to stockholders in excess of that historical cost is shown as a reduction of stockholders' equity.

58

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2.    SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATIONThe consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all
intercompany balances and transactions. The Company disposed of its Government Electronics segment in October 1997, Semiconductor Equipment segment in July 1999, and Telecommunications
segment in January 2000. The consolidated financial statements reflect such dispositions and results of operations of these businesses as discontinued operations. For additional information on
discontinued operations, see Note 12.

RECLASSIFICATIONSCertain
reclassifications have been made to the prior year financial statements to conform to the current year presentation.

CASH
EQUIVALENTS AND SHORT-TERM INVESTMENTSCash and equivalents consist of money market funds and commercial paper acquired with remaining maturity periods of
90 days or less and are stated at cost plus accrued interest which approximates market value. Short-term investments consist primarily of high-grade debt securities (A
rating or better) with maturity greater than 90 days from the date of acquisition and are classified as available-for-sale. Short-term investments classified
as available-for-sale are reported at fair market value with unrealized gains or losses excluded from
earnings and reported as other comprehensive income (loss), a separate component of stockholders' equity, net of tax, until realized. Realized gains and losses are included in the accompanying
consolidated statements of operations as other income (expense)net.

INVENTORIESInventories
are stated at the lower of cost, using average-cost basis, or market. Cost of inventory items is based on purchase and production cost
including labor and overhead. Provisions, when required, are made to reduce excess inventories to their estimated net realizable values. It is possible that estimates of net realizable values can
change in the near term. During the first quarter of 2001, the Company recorded a $6.6 million provision for excess and obsolete inventory largely related to inventory ordered to build base
station products for the Company's largest mobile wireless customer. Inventory levels of this product were purchased based on this customer's forecasted demand which had since been dramatically
revised downward. In addition, given the overall slowdown in market demand, the Company made provisions for other product lines where customer forecasts have significantly declined. Since the first
quarter of 2001, approximately $4.4 million of the Company's previously reserved inventory was consumed by the Company's largest mobile wireless customer. This decrease in the reserve was
offset by additional provisions for other product lines where customer demand has significantly weakened. In total, the amount of the Company's provision for excess and obsolete inventory remained
unchanged since the first quarter of 2001. Inventories, net of provisions for excess and obsolete amounts, at December 31, 2001 and 2000 consisted of the following (in thousands):

December 31,2001

2000Finished goods

$
3,665

$
1,367Work in progress


595


4,413Raw materials and parts


5,998


8,677$
10,258

$
14,457


PROPERTY,
PLANT AND EQUIPMENTProperty, plant and equipment are stated at cost. Provision for depreciation and amortization is primarily based on the
straight-line method over the assets' estimated useful lives ranging from two to ten years. Costs incurred to maintain property, plant and equipment that do not increase the useful life of
the underlying asset are expensed as incurred. Leases which at inception assure the lessor full recovery of the fair market value of the property over the lease

59

---

term were capitalized and amortized over the lease term in accordance with Statement of Financial Accounting Standards ("SFAS") No. 13 "Accounting for Leases." See Note 14 for
discussion of the disposition of the Company's capitalized leases.

At
December 31, 2001 and 2000, property, plant and equipment consisted of the following (in thousands):

December 31,2001

2000Buildings and improvements

$
10,136

$
9,241Machinery and equipment


42,692


34,581Construction in progress


186


2,11353,014


45,935Accumulated depreciation and amortization


(20,800
)

(16,675
)Property, plant and equipmentnet

$
32,214

$
29,260


LONG-LIVED
ASSETSIn accordance with Statement of Financial Accounting Standards ("SFAS") No.121, "Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to be Disposed of", the Company periodically reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of these assets to future undiscounted cash flows
expected to be generated by these assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the
discounted future cash flows resulting from the use of the assets over their average remaining useful life. Through December 31, 2001, the Company has not experienced any such impairments.

OTHER
ASSETSAt December 31, 2001 and 2000, other assets consisted of the following (in thousands):

December 31,2001

2000Deferred income taxes

$


$
1,598Notes receivable





175Other


220


318$
220

$
2,091


REVENUE
RECOGNITIONRevenues from product sales are recognized when all of the following conditions are met: the product has been shipped, the Company has the right to
invoice the customer at a fixed price, the collection of the receivable is probable and there are no significant obligations remaining. Generally, title passes upon shipment of the Company's products.
Beginning in March 2000, the Company's contract with a significant customer converted to a consignment arrangement under which title to certain of the Company's products does not pass until
this significant customer utilizes the Company's products in its production processes. A second significant customer converted its purchases of certain products to a similar consignment arrangement in
October, 2000. Consequently, revenue is recognized on these contracts only when these customers notify the Company of product consumption. In addition to the Company's own sales efforts, the Company
uses distributors to sell semiconductor products.

60

---

Revenues from these distributors are recognized upon shipment based on the following factors: the sales price is fixed or determinable by contract at the time of shipment, payment terms are fixed at
shipment and are consistent with terms granted to other customers, the distributor has full risk of physical loss, the distributors have separate economic substance, the Company has no obligation with
respect to the resale of the distributors' inventory, and the Company believes it can reasonably estimate the potential returns from its distributors based on their history and its visibility in the
distributors' success with its products and into the market place in general. During the quarter ending July 1, 2001, the Company began using two distributors for sales of certain fixed
wireless products. Lacking history with these new distributors, the Company is recording revenue on these fixed wireless products at the time of the distributors' sale to the ultimate end customer.
Order cancellations from any of our customers could have a significant negative impact on our business. Based on specific terms of the
customer contract and purchase order, the Company may negotiate a final delivery and settlement in connection with such order cancellations. Due to the uncertain and often lengthy nature of these
negotiations, a substantial portion, if not all, of the inventory subject to the cancellation may be provided for as part of the Company's excess and obsolete inventory provision. In the fourth
quarter of 2001, the Company reached final agreement with one customer, Marconi Communications, and recognized revenue of $3.5 million related to the delivery of specific fixed wireless
products that have previously been reserved for.

Any
anticipated losses on contracts are charged to earnings when identified. The Company provides a warranty on standard products and components and products developed for specific
customers or program applications. Such warranty generally ranges from 12 to 24 months. The Company estimates the cost of warranty based on its historical field return rates.

The
Company depends on a small number of customers for a majority of its sales. During the year ended December 31, 2001, the Company had four customers which each accounted for
more than 10% of its sales and in aggregate accounted for 71% of its sales. Those customers were Lucent Technologies, Marconi Communications, Nortel Networks and Richardson Electronics including sales
to their respective manufacturing subcontractors. During the year ended December 31, 2000, the Company had two customers which each accounted for more than 10% of its sales and in aggregate
accounted for approximately 72% of its sales. Those customers were Lucent Technologies and Nortel Networks including sales to their respective manufacturing subcontractors.

INCOME
TAXESIn accordance with SFAS No. 109, "Accounting for Income Taxes", the consolidated financial statements include provisions for deferred income taxes using
the liability method for transactions that are reported in one period for financial accounting purposes and in another period for income tax purposes. Deferred tax assets are recognized when
management believes realization of future tax benefits of temporary differences is more likely than not. In estimating future tax consequences, generally all expected future events are considered
(including available carryback claims), other than enactment of changes in the tax law or rates. Valuation allowances are established for those deferred tax assets where management believes it is not
more likely than not such assets will be realized.

PER
SHARE INFORMATIONBasic earnings per share is computed using the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if stock options were exercised or converted into common stock, however, such adjustments are excluded when they are considered anti-dilutive.

FISCAL
YEARThe Company's fiscal year consists of 52 or 53 weeks ending on December 31st of each year. The years ended 2001, 2000 and 1999 included 52
weeks each.

61

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CONCENTRATION
OF RISKThe success of the Company is dependent on a number of factors. These factors include the ability to manage and adequately finance anticipated growth,
the need to satisfy changing and increasingly complex customer requirements especially in the fiber optics and wireless markets, dependency on a small number of customers and a limited number of key
personnel, and suppliers, and competition from companies with greater resources.

USE
OF ESTIMATESThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

STOCK-BASED
COMPENSATIONThe Company accounts for stock-based compensation granted to employees and directors under the intrinsic value method as defined in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Proforma disclosures for net income and earnings per share as if the fair value based method was used are included
in Note 6 in accordance with SFAS 123 "Accounting for Stock-based Compensation."

RECENT
ACCOUNTING PRONOUNCEMENTSOn June 29, 2001, Financial Accounting Standards Board, or FASB,approved for issuance
SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". Major provisions of these Statements are as follows: all business combinations initiated after
June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; intangible
assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold,
transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but are
tested for impairment annually using a fair value approach, except in certain circumstances, and whenever there is an impairment indicator; other intangible assets will continue to be valued and
amortized over their estimated lives; in-process research and development will continue to be written off immediately; all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting; effective January 1, 2002, existing goodwill will no longer be subject to amortization. Goodwill arising between June 29, 2001 and
December 31, 2001 will not be subject to amortization. The adoption of SFAS No. 142 in January 2002 will not have a material impact on the Company's financial statements.

On
October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which establishes one accounting model to be
used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 supercedes
SFAS 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30. SFAS No. 144
requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for fiscal
years beginning after December 15, 2001 with early
applications permitted. The Company does not expect the adoption of this statement to have a material effect on its consolidated results of operations or financial position.

62

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3.    FINANCIAL INSTRUMENTS AND SHORT-TERM INVESTMENTS

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, short-term
investments and receivables. The Company invests in a variety of financial instruments such as money market funds, commercial paper and high quality corporate bonds, and, by policy, limits the amount
of credit exposure with any one financial institution or commercial issuer. During the year ended December 31, 2001, the Company had four customers which, including sales to their respective
manufacturing subcontractors, each accounted for more than 10% of its sales and in aggregate accounted for 71% of its sales. These customers account for 84% of the Company's accounts receivable at
December 31, 2001. During the year ended December 31, 2000, the Company had two customers which, including sales to their respective manufacturing subcontractors, each accounted for more
than 10% of its sales and in aggregate accounted for approximately 72% of its sales. These customers account for 72% of the Company's accounts receivables at December 31, 2000. The Company
performs ongoing credit evaluations and maintains an allowance for doubtful accounts based upon the expected collectibility of receivables.

The
carrying value of cash and equivalents, short-term investments, receivables and accounts payable are a reasonable approximation of their fair market value due to the
short-term maturities of those instruments.

The
fair value of the amortized cost of available-for-sale securities at December 31, 2001 and 2000, including unrealized holding gains and losses, are
presented in the table which follows. Fair values are based on quoted market prices. Available-for-sale securities are classified as current assets and have an average maturity
of less than 6 months. Gross proceeds from the sale of short-term investments were $84.7 million and $53.7 million during 2001 and 2000, respectively. Gross gains and
losses realized on such sales or maturities were not material. For the purpose of determining gross realized gains and losses, the cost of securities sold is based upon specific identification.

Financial
instrument and short-term investments are summarized, as follows (in thousands):

December 31,2001

2000Cost

$
30,463

$
40,808Unrealized holding gains (losses)


(6
)

7Market value

$
30,457

$
40,815


4.    LONG-TERM DEBT

In December of 2000, the Company entered into a $25.0 million revolving credit facility ("Revolving Facility") with a bank. The Revolving Facility matures
on December 31, 2003 and contains a $15.0 million sub-limit to support letters of credit. Interest rates on outstanding borrowings are periodically adjusted based on certain
financial ratios and are initially set, at the Company's option, at LIBOR plus 1.0% or Prime minus 0.5%. The Revolving Facility requires the Company to maintain certain financial ratios and contains
limitations on, among other things, the Company's ability to incur indebtedness, pay dividends and make acquisitions without the bank's permission. The Company was in compliance with the covenants as
of December 31, 2001. The Revolving Facility is secured by substantially all of the Company's assets. As of December 31, 2001, there were no outstanding borrowings under the Revolving
Facility.

63

---

On
January 31, 2000, the Company entered into a credit facility ("Facility") with CIBC World Markets Corp., among others. The Facility included a $25 million term A loan, a
$15 million term B loan and a $15 million five-year revolver maturing in 2004. The Facility was repaid with a portion of the proceeds from the Company's initial public
offering.

The
Company has letters of credit of $5.2 million outstanding as of December 31, 2001 against which no amounts have been drawn.

5.    OTHER LONG-TERM OBLIGATIONS

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

December 31,2001

2000Environmental remediation

$
143

$
159Restructuring accrual (Note 11)


6,338


Deferred rent and deposits


563


191Deferred income taxesreserves for income tax contingencies (Note 7)


10,490


10,490Total

$
17,534

$
10,840


ENVIRONMENTAL
REMEDIATIONAs discussed in Note 8, the Company is obligated to remediate groundwater contamination at its former Palo Alto, California, facility.

LEASESIn
2000, the Company entered into a lease on a new facility located in San Jose, California. The new facility consists of two buildings: a larger building of
approximately 82,000 square feet and a smaller building of approximately 42,000 square foot. Both buildings are leased for ten years. The larger building has a beginning base monthly rent of $158,340
for the first twelve months, which increases by 4% over each succeeding twelve month period. The smaller building has a beginning base monthly rent of $94,500 for the first twelve months which will
also increase by 4% over each succeeding twelve month period. The Company also has noncancellable operating leases for its Milpitas facility and certain equipment expiring on various dates through the
year 2006. In September 2001, the Company decided to abandon the smaller building at its San Jose facility based on revised anticipated demand for its products and current market conditions
(see Note 11 for further discussion of the Company's lease loss liability accrual). The Company has signed one tenant to occupy a portion of the excess leased space and is actively seeking
others. This sub-tenant has a two year lease occupying approximately 27% of the building and is paying a beginning base rent of approximately $25,300. Any sub-lease tenants are
subject to the landlord's consent.

64

---

Minimum
lease commitments net of sub-lease income as of December 31, 2001 under noncancellable leases are as follows (in thousands):

Operating LeasesLease payments:2002

$
3,5262003


3,7622004


4,0902005


4,2272006


4,349Remaining years


15,703Total

$
35,657


Rent
expense included in continuing operations for property and equipment relating to operating leases is as follows (in thousands):

2001

2000

1999Real property

$
3,454

$
1,610

$
408Equipment


160


176


148Total

$
3,614

$
1,786

$
556


The
2001 rent expense includes the rent expense for the Company's abandoned leased building for the period from March, 2001 through August, 2001 which totals $567,000. Beginning in
September, 2001, all remaining outstanding lease payments for this property were accrued as part of the restructuring charge (see Note 11).

In
October 2000 the Company moved its operations from Palo Alto, California to its new facility in San Jose, California, and sold the remaining Palo Alto lease rights to a third
party for $28.5 million in December, 2000 (see Note 14). In connection with this sale, the Company recorded a pre-tax gain of $30.1 million.

The
Company sub-leased a portion of its former Palo Alto, California facility under a short-term operating lease which expired in October 2000. Included in
Other Income (Expense), net for 2000 and 1999 is approximately $(411,000) and $400,000, respectively, of income (loss) after expenses from this sub-lease agreement.

6.    STOCKHOLDERS' EQUITY

STOCK SPLITDuring the first quarter of fiscal 2000, the Company effected a stock split of twenty shares of common stock for every one share of
outstanding common stock. In addition, in August of 2000, in connection with the Company's initial public offering, the Company effected a stock split of three shares of common stock for every two
shares of common stock outstanding. All share and per share amounts in these financial statements have been adjusted to give effect to these stock splits.

RECAPITALIZATION
MERGERIn conjunction with the recapitalization merger during January 2000, the Company repurchased all of its then outstanding common stock for a
cash payment of

65

---

approximately $270 million except for an approximate 8.5% voting and economic interest retained by the Watkins Trust (see Note 1).

SERIES
A PREFERRED STOCKIn July 2000, the Company sold 1,498,800 shares of its Series A Preferred Stock to a group of investors. Proceeds from these sales
totaled approximately $11.2 million, net of expenses. Under the terms of the Series A Preferred Stock, the shares converted into common stock of the Company simultaneous with the
Company's IPO in August, 2000. In connection with this conversion, the Company recorded a $10.0 million non-cash preferred stock dividend based on an assumed beneficial conversion.
This amount was computed based upon the difference between the IPO price and the price paid for the preferred stock.

STOCK
OPTION PLANSDuring 2000, the Company's "2000 Stock Incentive Plan" and "2000 Non-Employee Director Stock Compensation Plan" (collectively the "Plans") were
adopted and approved by the board of directors and our shareholders. The Plans may grant incentive awards in the form of options to purchase shares of the Company's common stock, restricted shares,
common stock and stock appreciation rights to participants, which include non-employee directors, officers and employees of and consultants to the Company and its affiliates. The total
number of shares of common stock reserved and available for grant under the Plans is 17,070,000 shares. Stock options may include incentive stock options, nonqualified stock options or both, in each
case, with or without stock appreciation rights.

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

Activity
under the stock option plans during 2001 and 2000 are set forth below:

Shares

Weighted Average
Exercise Price2000Granted

15,211,195

$
1.69Exercised

(26,296
)
$
1.37Terminated

(47,450
)
$
1.88At December 31:Outstanding

15,137,449

$
1.69Exercisable

2,192,264

$
1.37Reserved for future grants

1,906,254


66

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Shares

Weighted Average
Exercise Price2001Granted

1,714,500

$
2.67Exercised

(621,751
)
$
1.37Terminated

(1,293,416
)
$
3.82At December 31:Outstanding

14,936,782

$
1.64Exercisable

4,078,820

$
1.48Reserved for future grants

3,485,170


Prior
to the Company's initial public offering, the board of directors determined the fair market value of its stock for purposes of issuing common stock options based upon recent sales
of its securities and other market factors.

In
conjunction with the issuance of certain stock options in 2000, 14,277,795 options were granted at an average exercise price of $1.37 per share which was equal to the weighted average
fair value of $1.37 per share at the date of grant. This fair value was determined by using the same fair value used in the recapitalization merger transaction which was completed in
January 2000. Additionally, the Company granted 791,000 options where the weighted average exercise price of $5.31 per share was less than the deemed weighted average fair value of $10.08 per
share. In addition, the Company sold 81,000 shares of common stock where the weighted average sales price of $3.82 per common share was less than the deemed weighted average fair value of $9.51 per
share. The Company has recorded deferred stock compensation in the aggregate amount of $2,337,000, net of forfeitures, representing the differential between the deemed fair value of the Company's
common stock and the exercise price at the date of grant for options or date of sale for stock purchases. The Company is amortizing this amount using the straight line method over the vesting period
of the options granted. The Company recorded $593,000 and $1,042,000 of deferred stock compensation expense for the years ended December 31, 2001 and December 31, 2000, respectively, in
the accompanying financial statements. Subsequent to the IPO, the fair market value of the stock for purposes of issuing common stock options is based upon the market price of the Company's stock on
the date of grant. The Company has granted 1,856,900 options at a weighted average fair value of $3.55 per share subsequent to the IPO. The Plans provide that options granted under the Plans will have
a term of no more than 10 years. Options granted under the Plans have vesting periods ranging from immediate to 9 years. The provisions of the Plans provide that under certain
circumstances, such as a change in control, the achievement of certain performance objectives, or certain liquidity events, the outstanding option may be subject to accelerated vesting.

67

---

The
following table summarizes information concerning currently outstanding and exercisable options at December 31, 2001:

Options Outstanding

Options ExercisableRange of Exercise Price

Number
Outstanding

Weighted
Average Years
of Remaining
Contractual Life

Weighted
Average
Exercise Price

Number
Exercisable

Weighted
Average
Exercise
Price$1.37 to $1.37

13,184,342

8.1

$
1.37

4,030,570

$
1.37$2.22 to $2.96

1,447,500

9.5

$
2.39

$3.81 to $3.85

40,000

9.8

$
3.83

$6.67 to $9.75

225,050

8.8

$
8.67

39,850

$
8.29$12.94 to $16.00

23,750

8.7

$
15.20

5,000

$
15.54$26.75 to $26.75

16,140

8.6

$
26.75

3,400

$
26.75$1.37 to $26.75

14,936,782

8.2

$
1.64

4,078,820

$
1.48


EMPLOYEE
STOCK PURCHASE PLAN ("ESPP")On May 23, 2001, at the Company's Annual Meeting of Stockholders, the Company's stockholders approved the adoption of the
Company's 2001 Employee Stock Purchase Plan (the "Purchase Plan") to be effective as of May 1, 2001. Up to 1,500,000 shares of Common Stock may be issued under the Purchase Plan. The details of
the Purchase Plan can be found in the Company's Schedule 14A "Information Required in Proxy Statement" filed with the Securities and Exchange Commission on April 27, 2001. Under the
plan, all eligible employees may purchase shares of the Company's common stock at six-month intervals at 85% of fair market value (calculated in the manner provided under the plan).
Employees purchase such stock using payroll deductions, which may not exceed 15% of their total cash compensation. In fiscal 2001, 120,816 shares were issued under this plan at an average price of
$2.21. At December 31, 2001, 1,379,184 shares were available for future issuance under the plan.

ACTIVITY
RELATED TO ALL STOCK OPTION PLANS PRIOR TO THE RECAPITALIZATION MERGER

WATKINS-JOHNSON
STOCK OPTION PLANSThe Watkins-Johnson Stock Option Plans provided for grants of nonqualifying and incentive stock options to certain key employees and
officers. Options were granted at the market price on the date of grant and expire at the tenth anniversary date. One-third of the options granted were exercisable on each of the second,
third and fourth anniversary dates following the grant. This plan was terminated at the time of the recapitalization merger on January 31, 2000.

The
Nonemployee Directors Stock Option Plan provided for a fixed schedule of options to be granted through the year 2005. Nonemployee directors of the Company were automatically granted
90,000 shares of common stock each year that they remain a director of the Company. The options were granted at the market price on the date of grant and were to expire on the tenth anniversary date.
The options granted become exercisable six months after the date of grant. As included in the table below, options for 630,000 shares were granted at $0.83 in 1999. This plan was terminated at the
time of the recapitalization merger on January 31, 2000.

68

---

Stock
option transactions included in the consolidated statements of stockholders' equity are shown net of retirement of outstanding shares used in payment for options exercised and
include tax benefits related to sales under stock option plans of $653,000 for 1999.

Shares

Weighted Average
Exercise Price1999Granted

5,145,000

$
0.79
(1)Exercised

4,066,860

$
0.66Terminated

8,410,140

$
1.13At December 31:Outstanding

36,229,860

$
0.87Exercisable

24,194,640

$
0.90


Shares

Weighted Average
Exercise Price2000Exercised

137,490

$
1.12Terminated

36,092,370

$
0.87At December 31:Outstanding



$



---

As
part of the recapitalization merger, as discussed in Note 1, vesting of all outstanding options was accelerated and the fully vested options were surrendered in exchange for
the right to receive $1.37 per share in cash, therefore all of the Watkins-Johnson stock option plans discussed above were terminated.

PRO
FORMA INFORMATIONSTOCK BASED COMPENSATION

As
discussed in Note 2, the Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in
accounting for its plans. As discussed in Note 6, pre-IPO, the Company granted certain options and sold certain shares of common stock below the deemed fair value. As such, the
Company recorded deferred stock compensation of $2,337,000, net of forfeitures, of which $593,000 and $1,042,000 of deferred stock compensation expense was recognized in the years 2001 and 2000
($582,000 related to options), respectively. Subsequent to the IPO, the fair market value of the stock for purposes of issuing common stock options is based upon the market price of the Company's
stock on the date of grant. Accordingly, no further compensation expense has been recognized for its stock-based compensation plans.

Pro
forma information regarding results of operations and net income (loss) per share is required by FASB Statement No. 123 for stock-based awards to employees as if the Company
had accounted for such awards using a valuation method permitted under Statement No. 123.

69

---

Stock-based awards granted subsequent to the initial public offering have been valued using the Black-Scholes option pricing model. Among other things, the Black-Scholes model considers the expected
volatility of the of the Company's stock price, determined in accordance with Statement No. 123, in arriving at an option valuation. Estimates and other assumptions necessary to apply the
Black-Scholes model may differ significantly from assumptions used in calculating the value of options granted prior to the initial public offering under the minimum value method.

For
2001, the fair value of options granted was estimated assuming no expected dividends, a weighted average expected life of 4.0 years from vest date, a weighted average
risk-free interest rate of 4.1% and an expected volatility of 1.20. The weighted average fair value of these options is $2.11. For 2001, the fair value of employee stock purchase rights
was estimated assuming no expected dividends, a weighted average expected life of 6 months, a weighted average risk-free interest rate of 3.9% and an expected volatility of 1.20.
The weighted average fair value of these employee stock purchase rights is $3.50.

For
2000, the fair value of the Company's stock-based awards granted to employees prior to the initial public offering was estimated assuming no expected dividends, a weighted average
expected life of 5.5 years, a weighted average risk-free interest rate of 6.6% and no expected volatility. For 2000, the fair value of options granted after the initial public
offering was estimated assuming no expected dividends, a weighted average expected life of one year from vest date, a weighted average risk-free interest rate of 4.6% and an expected
volatility of 1.42. The weighted average fair value of these options is $6.22.

The
weighted average fair value of options granted during 2001, 2000 and 1999 was $2.11, $0.77 and $0.38, respectively. The weighted average fair value of employee stock purchase rights
granted in 2001, 2000 and 1999 was $3.50, $0 and $0, respectively. Had compensation cost for all of the Company's stock option plans been determined based upon the fair value at the grant date for
awards under these plans, and amortized to expense over the vesting period of the awards consistent with the methodology prescribed under SFAS 123, "Accounting for Stock-Based Compensation,"
the Company's pro forma net income (loss) for 2001, 2000 and 1999 would have been $(22.4) million, $25.0 million, and $67.4 million, respectively, or $(0.40), $0.24, and $0.35 per basic
and diluted share, respectively. The weighted average

70

---

fair value of options calculated on the date of grant and purchase rights using the option-pricing models along with the weighted average assumptions used are as follows:

2001

2000

1999Employee Stock Option PlansFair value

$
2.11

$
0.77

$
0.38Dividend yield


0.0
%

0.0
%

1.5
%Volatility


120.0
%

142.0
%(1)

42.9
%Risk free interest rate at the time of grant


4.1
%

6.6
%

4.8
%Expected term to exercise (in months from the vest date)


48.0


12.0
(1)

6.6Employee Stock Purchase PlanFair value

$
3.50





Dividend yield


0.0
%




Volatility


120.0
%




Risk free interest rate at the time of grant


3.9
%




Expected term to exercise (in months from the vest date)


6.0








---

The
Black-Scholes model used by the Company to calculate option values, as well as other currently accepted option valuation models, were developed to estimate the fair values of freely
tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require highly subjective assumptions, including
future stock price volatility, and expected time until exercise, which greatly affect the calculated values.

7.    INCOME TAXES

The provision for (benefit from) federal and state tax expense on income (loss) from continuing operations consists of the amounts below. Foreign income from
continuing operations was insignificant for all years.

2001

2000

1999(in thousands)Current:U.S

$
(5,311
)
$
4,754

$
21,175State


73


1,167


3,004Total current


(5,238
)

5,921


24,179Deferred:U.S


(9,613
)

(527
)

2,680State


2,323


(687
)

(476
)Total

$
(12,528
)
$
4,707

$
26,383


71

---

The
differences between the effective income tax rate in 2000 was applied to income (loss) from continuing operations and the statutory federal income tax rate are as follows:

2001

2000

1999Statutory federal tax rate

(35.0
)%
35.0
%
35.0
%Foreign sales benefit

(0.9
)
(28.5
)
(0.7
)Research and development credit

(1.0
)
(34.0
)
(0.7
)State taxes, net of federal tax benefit

(4.5
)
6.0

3.6Non-deductible expenses(1)



289.0

0.1Other

0.8

1.0

1.1Tax reserve no longer required

(15.4
)


Change in valuation allowance

19.4



Effective tax rate

(36.6
)%
268.5
%
38.4
%


---

Deferred
tax assets are recognized when management believes realization of future tax benefits of temporary differences is more likely than not. In estimating future tax consequences,
all expected future events are considered (including available carryback claims), other than enactment of changes in the tax law or rates. Valuation allowances are established for those deferred tax
assets where management believes it is not more likely than not such assets will be realized. Deferred tax amounts are comprised of the following at December 31 (in thousands):

2001

2000Net operating loss

$
9,470

$
Restructuring accrual


3,788


Fixed assetsdepreciation


(2,808
)

(1,484
)Accounts receivable valuation


468


686Inventory valuation


4,469


3,029Research and development credit


2,312


1,571Employee benefit related accruals


807


969Non-deductible amortization


1,449


1,454Other non-deductible expenses


884


687Total deferred tax assets


20,839


6,912Valuation allowance


(6,637
)

Total deferred tax assets

$
14,202

$
6,912Deferred tax liabilitiesreserves for tax contingencies (Note 5)

$
10,490

$
10,490


The
Company in accordance with Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies" has established certain reserves for income tax contingencies.
These reserves relate to various tax years subject to audit by tax authorities including the Company's Federal tax filings for 1996 to 1999 which are currently under examination.

72

---

8.    ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES

In 1991, the Company recorded a $5.2 million charge for estimated remediation actions and cleanup costs. The Company continues to be in compliance with the
remedial action plans being monitored by various regulatory agencies at its former Palo Alto site. In 2001, the Company recorded an additional provision of $100,000 to offset unanticipated program
oversight, remediation actions and cleanup costs associated decommissioning our former Palo Alto site. Expenditures charged against the provision totaled $46,000, $338,000, and $2,628,000 for the
years 2001, 2000 and 1999, respectively. Included in the 1999 expenditures was a payment of $2.4 million for required remedial services to be performed and a related insurance policy to assure
compliance for the duration of the remedial action plans. The Company believes any remaining unaccrued or uninsured environmental liabilities should not have a material effect on the Company's results
of operations or financial position.

In
addition to the above matters, the Company is involved in various legal actions which arose in the ordinary course of its business activities. Management believes the final resolution
of these matters should not have a material impact on its results of operations, cash flows, or financial position.

9.    EMPLOYEE BENEFIT PLANS

The Company has an Employees' Investment 401(k) Plan that covers substantially all employees and provides that the Company match employees' salary deferrals up to
3% of eligible employee compensation. The amounts charged to continuing operations were $574,000, $558,000 and $480,000 in 2001, 2000, and 1999, respectively.

EMPLOYEE
STOCK OWNERSHIP PLAN ("ESOP")Prior to the recapitalization merger, the Company had an ESOP to encourage employee participation and long-term ownership
of company
stock. This plan was terminated on January 31, 2000 in conjunction with the recapitalization merger. The Board approved a contribution equal to 1% of eligible employee compensation for 1999,
which resulted in a charge to continuing operations of $159,000. The ESOP held 5,231,100 shares of common stock at December 31, 1999, and there were no unallocated or unearned shares held by
the ESOP. Dividends paid with respect to common stock held by the ESOP were used to purchase additional shares and were not material for all years presented.

10.    SEVERANCE COSTS

During the year ended December 31, 2001, the Company incurred severance costs of approximately $1.5 million related to a reduction of 201 employees,
all of whom were terminated and all amounts accrued (including approximately $66,400 as of December 31, 2001 included in Payroll and Profit Sharing) were paid subsequent to December 31,
2001.

11.    RESTRUCTURING CHARGE

In September 2001, the Company decided to abandon a new leased facility based on revised anticipated demand for its products and current market conditions.
This excess facility, for which the Company has a ten year commitment, is located adjacent to the Company's current corporate headquarters and was originally developed to house additional
administrative and corporate offices to accommodate planned expansion. This decision has resulted in a pre-tax lease loss of $7.2 million, comprised of future lease payments net of
anticipated sub-lease income, broker commissions and other facility costs, and a pre-tax asset impairment charge of $2.6 million on tenant improvements deemed no longer
realizable. In determining this estimate, the Company has made certain assumptions with regards to

73

---

its ability to sub-lease the space and has reflected off-setting assumed sub-lease income in line with the Company's best estimate of current market conditions.
Should there be a significant change in those market conditions, the ultimate loss could be higher and such amount could be material. The Company has signed one tenant to cover a portion of the excess
leased space. Any sub-lease tenants are subject to the landlord's consent. The lease loss is an estimate under SFAS No. 5 "Accounting for Contingencies" and represents the low end
of the range and adjustments will be made in future periods, if necessary, based upon the then current actual events and circumstances. The Company has estimated that the high end of the lease loss
could be $10.7 million if operating lease rental rates continue to decrease or should it take longer than expected to find a suitable tenant or tenants to sub-lease the facility.
Adjustments to the restructuring reserve will be made in future periods, if necessary, based upon the then current actual events and circumstances.

The
following table summarizes restructuring charges recorded during the second half of 2001 (in millions):

Lease Loss

Asset ImpairmentRestructuring charges

$
7.2

$
2.6Cash charges


(0.2
)

Non-cash charges





(2.6
)Accrual balance as of September 30, 2001

$
7.0

$
Cash charges


(0.2
)

Non-cash charges





Accrual balance as of December 31, 2001


6.8

$



Total
cash outlay for the restructuring is expected to be $7.2 million, with $6.8 million accrued at December 31, 2001 and approximately $400,000 paid out through
December 31, 2001. Of the balance in accrued liabilities as of December 31, 2001, the Company expects approximately $493,000 of the lease loss to be paid out over the next twelve months,
and the remaining $6.3 million to be paid out over the remaining life of the lease of approximately nine years.

12.    BUSINESS SEGMENT REPORTING AND DISCONTINUED OPERATIONS

In 1997, the Company adopted SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." As discussed below, three divested segments
are being reported as discontinued operations. The Government Electronics segment was divested in October 1997, the Semiconductor Equipment segment was divested in July 1999 and the
Telecommunications segment was divested in January 2000. As an integrated telecommunications products provider, the Company currently has one reportable segment. The Company designs,
manufactures and services radio frequency communications products used in network infrastructure. The Company's products enable voice, video and data transport over fiber optic, broadband cable and
wireless systems that provide the backbone for cellular and internet communications. While the Company's chief decision-maker monitors the sales of various products, operations are managed and
financial performance evaluated based upon the sales and production of multiple products employing common manufacturing and research and development resources; sales and administrative support; and
facilities. This allows the Company to leverage its costs in an effort to maximize return. Management

74

---

believes that any allocation of such shared expenses to various products would be impractical, and currently does not make such allocations internally.

The
chief decision-maker does, however, monitor sales by products at a more detailed level than those depicted in the Company's historical general purpose financial statements as follows
(in thousands):

Year EndedDecember 31,
2001

December 31,
2000

December 31,
1999Semiconductor

$
19,757

$
25,239

$
15,625Fiber optic


10,003


48,402


15,228Wireless


32,460


42,156


51,551Total

$
62,220

$
115,797

$
82,404


During
the year ended December 31, 2001, our larger customers began to outsource a greater percentage of their manufacturing. As such, the Company believes it is more meaningful
in terms of concentration of risk and historic comparisons to combine the sales to manufacturing subcontractors with the end customer who ultimately controls product demand. Sales to individual
customers representing greater than 10% of Company consolidated sales during at least one of the past three years are as follows (in thousands):

Year EndedDecember 31,
2001

December 31,
2000

December 31,
1999Company A(1)

$
18,979

$
31,820

$
44,931Company B


8,891


51,529


17,876Company D


9,286


1,550


Company E


6,921


7,706


2,611


---

During
the year ended December 31, 2001, the Company had four customers which each accounted for more than 10% of its sales and in aggregate accounted for 71% of its sales. Those
customers were Lucent Technologies, Marconi Communications, Nortel Networks and Richardson Electronics including sales to their respective manufacturing subcontractors. During the year ended
December 31, 2000, the Company had two customers which each accounted for more than 10% of its sales and in aggregate accounted for approximately 72% of its sales. Those customers were Lucent
Technologies and Nortel Networks including sales to their respective manufacturing subcontractors. During the year ended December 31, 1999, the Company had two customers which each accounted
for more than 10% of its sales and in aggregate accounted for approximately 76% of its sales. Those customers were Lucent Technologies and Nortel Networks including sales to their respective
manufacturing subcontractors.

75

---

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

Year EndedDecember 31,
2001

December 31,
2000

December 31,
1999United States

$
36,068

$
54,620

$
58,110Export Sales from United States:Canada


9,110


43,907


18,079Europe


13,599


13,260


3,791Korea


1,030


1,230


1,194Other


2,413


2,780


1,230Total

$
62,220

$
115,797

$
82,404


Foreign
operations' sales and identifiable assets are less than ten percent of consolidated totals.

The
Company's continuing operations' operating profit (loss) and long-lived assets as of year end by geographic area are substantially all located in the United States.

All
significant amounts outstanding related to net assets of the discontinued segments have been settled as of December 31, 2000.

Summarized
below are operating results of the discontinued segments (in thousands).

Year EndedDecember 31,
2000

December 31,
1999Net sales

$
1,873

$
120,556Gross profit


861


44,136Income before income taxes

$
303

$
8,694Income taxes provision (benefit)


91


(967
)Gain on dispositionnet of income tax benefit of $20,471 and $1,458 for the years ending December 31, 2000 and 1999, respectively


30,706


15,829Income from discontinued operations

$
30,918

$
25,490


Included
in the results of the discontinued operations were corporate administrative expenses which totaled $0 in 2000 and $4.2 million in 1999. Corporate
administrative expenses comprised of costs incurred in support of the discontinued operations including; international finance and accounting; information systems support; legal, treasury, credit and
cash management; risk management functions, including insurance and environmental. Such charges were based on business volume, services and needs of operations provided.

On
January 14, 2000, the Company completed the sale of substantially all of the Telecommunications segment's assets to a unit of Marconi North America, Inc., a subsidiary
of the General Electric Company p.l.c. of the United Kingdom. Net proceeds from the sale of approximately $57.8 million and an estimated pre-tax gain of approximately
$43.2 million are included in the Company's financial results in the first quarter of 2000.

76

---



13. EARNINGS PER SHARE CALCULATION

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

Year Ended December 31,2001

2000

1999Income (loss) from continuing operations

$
(21,671
)
$
(2,954
)
$
42,350Preferred stock dividendassumed beneficial conversion





(9,982
)

Income (loss) available to common shareholders from continuing operations (numerator)

$
(21,671
)
$
(12,936
)
$
42,350Denominator for basic per share:Weighted average shares outstanding


55,629


63,337


192,584Denominator for diluted per share:Weighted average shares outstanding


55,629


63,337


192,584Effect of dilutive stock options








5,757Diluted average common shares


55,629


63,337


198,341Basic net income (loss) per share from continuing operations

$
(0.39
)
$
(0.20
)
$
0.22Diluted net income (loss) per share from continuing operations

$
(0.39
)
$
(0.20
)
$
0.21


For
the year ended December 31, 2001, the incremental shares from the assumed exercise of 14,936,783 stock options are not included in computing the dilutive per
share amounts because continuing operations resulted in a loss and the effect of such assumed conversion would be anti-dilutive. For the year ended December 31, 2000, the
incremental shares from the assumed exercise of 15,137,449 stock options are not included in computing the dilutive per share amounts because continuing operations resulted in a loss and the effect of
such assumed conversion would be anti-dilutive. Weighted average options outstanding to purchase 11,790,000 shares of common stock were not included in the computation of diluted per share
amount in 1999 because the weighted average exercise price was greater than the average market price of the common shares. Weighted average exercise price of $1.33 in 1999 exceeded the average market
price of $0.99.

14. REAL ESTATE TRANSACTIONS

In October, 2000 the Company moved its operations from Palo Alto, California to San Jose, California and sold the remaining leasehold interest to a third party
for $28.5 million in December, 2000. The Company recorded a pre-tax gain of $30.1 million in connection with this sale which included the relief of its obligations under its
previous capital lease.

The
Company leased approximately 16 acres of land and certain buildings located in Palo Alto, California from Stanford University under a long-term lease with an original
expiration date of 2056. In 1999, the Company agreed to an early termination of the lease resulting in net proceeds of approximately $54.0 million and a pre-tax gain of
approximately $51.8 million. The escrow for this property included a $5.0 million security deposit which was released on January 14, 2000 after a letter of guarantee was posted by
CIBC World Markets Corp. on behalf of the Company. On December 27, 1999, the Company paid

77

---

CIBC World Markets Corp. $6.1 million in advance of receiving the funds from escrow, which was also refunded on January 31, 2000. The $11.1 million aggregate was recorded as a
deposit as of December 31, 1999. As part of the previously mentioned agreement, the Company occupied the property rent free until October 2000 in order to allow operational transition.
The gain on the sale from the early termination of the lease has been reduced by approximately $2 million to reflect the estimated fair
market rent of the facility through October 2000. This deferred gain was amortized over a twelve month period through October 2000 as an offset to the estimated future rent expense in
accordance with SFAS No. 13, Accounting for Leases.

In
1999, the Company completed the sale of its remaining San Jose, California facility including a 190,000 square foot building resulting in net proceeds of $16.9 million and a
pre-tax gain of $9.7 million.

15. RELATED PARTY TRANSACTIONS

On January 31, 2000, as part of the recapitalization merger, the Company entered into a management agreement with Fox Paine & Company, LLC ("Fox
Paine"). Fox Paine is the majority stockholder in the Company. Under that agreement, the Company paid Fox Paine a management fee of $122,800 for the year ended December 31, 2001 and, for each
subsequent year, a fee in the amount of 1% of the prior year's income before interest expense, interest income, income taxes, depreciation and amortization and equity in earnings (losses) of minority
investments, calculated without regard to the fee. The Company believes the fee represents fair value for the services rendered by Fox Paine. In exchange for its management fee, Fox Paine assists the
Company with its strategic planning, budgets and financial projections and helps the Company identify possible strategic acquisitions and to recruit qualified management personnel. Fox Paine also
helps develop and enhance customer and supplier relationships on behalf of the Company and consults with management on various matters including tax planning and public relations strategies, economic
and industry trends and executive compensation. In connection with this agreement, the Company has agreed to indemnify Fox Paine against various liabilities that may arise as a result of the
management services it will perform. The Company has also agreed to reimburse Fox Paine for its expenses incurred in providing these services. The Company paid Fox Paine approximately $25,000 for the
reimbursement of expenses incurred by Fox Paine for the year ended December 31, 2001.

During
2000, the Company paid Fox Paine an aggregate of $3.5 million for assistance in obtaining debt financing and advisory services in connection with the recapitalization
merger. In addition, the Company paid Fox Paine a management fee of $110,000 for the year ended December 31, 2000 for the advisory services rendered by Fox Paine subsequent to the
recapitalization merger. The Company also reimbursed Fox Paine approximately $125,000 for its expenses incurred in providing these services for the year ended December 31, 2000.

16. QUARTERLY FINANCIAL DATAUNAUDITED

The following table sets forth, for the periods presented, selected data from our consolidated statements of operations on a quarterly basis. The consolidated
statements of operations data have been derived from our unaudited consolidated financial statements. In the opinion of management, these statements have been prepared on substantially the same basis
as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial information for the
periods presented. This information should be read in

78

---

conjunction with the consolidated financial statements and notes to those financial statements included elsewhere in this filing.

|                                            |                                                                            | Three Months Ended                  |                         
|------------------------------------------- | -------------------------------------------------------------------------- | ----------------------------------- | ------------------------
|
|
|Consolidated Statements of Operations Data: |                                                                            |                                     |                         
|                                            | Sales                                                                      |                                     | $                       
|                                            | Cost of goods sold                                                         |                                     |                         
|                                            |                                                                            |                                     |                         
|                                            | Gross profit                                                               |                                     |                         
|                                            | Operating expenses:                                                        |                                     |                         
|                                            |                                                                            | Research and development            |                         
|                                            |                                                                            | Selling and administrative          |                         
|                                            |                                                                            | Amortization of deferred stock comp |                         
|                                            |                                                                            | Recapitalization merger and other   |                         
|                                            |                                                                            | Restructuring charge                |                         
|                                            |                                                                            |                                     |                         
|                                            |                                                                            |                                     | Total operating expenses
|                                            |                                                                            |                                     |                         
|                                            | Loss from operations                                                       |                                     |                         
|                                            | Interest income                                                            |                                     |                         
|                                            | Interest expense                                                           |                                     |                         
|                                            | Other income (expense)net                                                 |                                     |                         
|                                            | Gain on disposition of real property                                       |                                     |                         
|                                            |                                                                            |                                     |                         
|                                            | Loss from continuing operations before income taxes                        |                                     |                         
|                                            | Income tax benefit                                                         |                                     |                         
|                                            |                                                                            |                                     |                         
|                                            | Loss from continuing operations                                            |                                     | $                       
|                                            |                                                                            |                                     |                         
|                                            | Loss from continuing operations per sharebasic                            |                                     | $                       
|                                            |                                                                            |                                     |                         
|                                            | Loss from continuing operations per sharediluted                          |                                     | $                       
|                                            |                                                                            |                                     |                         
|                                            | Shares used to calculate loss from
continuing operations per sharebasic   |                                     |                         
|                                            | Shares used to calculate loss from
continuing operations per sharediluted |                                     |                         

79

---

|                                            |                                                                                     | Three Months Ended                  |                         
|------------------------------------------- | ----------------------------------------------------------------------------------- | ----------------------------------- | ------------------------
|
|
|Consolidated Statements of Operations Data: |                                                                                     |                                     |                         
|                                            | Sales                                                                               |                                     | $                       
|                                            | Cost of goods sold                                                                  |                                     |                         
|                                            |                                                                                     |                                     |                         
|                                            | Gross profit                                                                        |                                     |                         
|                                            | Operating expenses:                                                                 |                                     |                         
|                                            |                                                                                     | Research and development            |                         
|                                            |                                                                                     | Selling and administrative          |                         
|                                            |                                                                                     | Amortization of deferred stock comp |                         
|                                            |                                                                                     | Recapitalization merger and other   |                         
|                                            |                                                                                     | Restructuring charge                |                         
|                                            |                                                                                     |                                     |                         
|                                            |                                                                                     |                                     | Total operating expenses
|                                            |                                                                                     |                                     |                         
|                                            | Income (loss) from operations                                                       |                                     |                         
|                                            | Interest income                                                                     |                                     |                         
|                                            | Interest expense                                                                    |                                     |                         
|                                            | Other income (expense)net                                                          |                                     |                         
|                                            | Gain on disposition of real property                                                |                                     |                         
|                                            |                                                                                     |                                     |                         
|                                            | Income (loss) from continuing operations before income taxes                        |                                     |                         
|                                            | Income tax (provision) benefit                                                      |                                     |                         
|                                            |                                                                                     |                                     |                         
|                                            | Income (loss) from continuing operations                                            |                                     | $                       
|                                            |                                                                                     |                                     |                         
|                                            | Income (loss) from continuing operations per sharebasic                            |                                     | $                       
|                                            |                                                                                     |                                     |                         
|                                            | Income (loss) from continuing operations per sharediluted                          |                                     | $                       
|                                            |                                                                                     |                                     |                         
|                                            | Shares used to calculate income (loss) from
continuing operations per sharebasic   |                                     |                         
|                                            | Shares used to calculate income (loss) from
continuing operations per sharediluted |                                     |                         

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REPORT OF MANAGEMENT

The management of the Company is responsible for the preparation, integrity and objectivity of its consolidated financial statements. These statements have been
prepared in conformity with accounting principles generally accepted in the United States of America and include amounts based on the best estimates and judgments of management. Financial information
included elsewhere in this report is consistent with that in the financial statements.

The
Company maintains a system of internal accounting controls designed to provide reasonable (but not absolute) assurance at a reasonable cost that assets are safeguarded against loss
or unauthorized use, and that transactions are executed in accordance with management's authorization and reliable for preparation financial statements in conformity with generally accepted accounting
principles. The selection, training and development of qualified personnel, the establishment and communication of accounting and administrative policies and procedures and a program of internal
audits are important objectives of these control systems.

Arthur
Andersen LLP, independent public accountants, are retained to provide an objective, independent review as to management's discharge of its responsibilities insofar as they relate
to the fairness of reported operating results and financial position. Their accompanying report is based on audits of the Company's financial statements for each of the three years in the period ended
December 31, 2001 conducted in accordance with auditing standards generally accepted in the United States of America, which require a review of the system of internal accounting controls and
tests of accounting procedures and records to the extent necessary for the purpose of their audits.

The
Board of Directors, through its Audit Committee, which is consisting solely of outside directors and directors affiliated with Fox Paine, oversees management's responsibilities in
the preparation of the financial statements and selects the independent auditors, subject to stockholder ratification. The Audit Committee meets regularly with the independent auditors and
representatives of financial and non-financial management to review the activities of each and to assure that each is properly discharging its responsibilities. To ensure complete
independence, representatives of Arthur Andersen LLP have full access to meet with the Audit Committee, with or without management representatives present, to discuss the results of their examinations
and their opinions on the adequacy of internal controls and the quality of financial reporting.

|Signature                                           |  | Title                                        |  | Date     
|--------------------------------------------------- |  | -------------------------------------------- |  | ---------
|                                                    |  |                                              |  |          
|/s/MICHAEL R. FARESE, PH.D.Michael R. Farese, Ph.D. |  | President, Chief Executive Officer, Director |  | 3/28/2002
|/s/WILLIAM R. SLAKEYWilliam R. Slakey               |  | Chief Financial Officer                      |  | 3/28/2002
|/s/WRAY T. THORNWray T. Thorn                       |  | Audit Committee Chair                        |  | 3/28/2002

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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There has been no disagreements with our independent accountants on any matter of accounting principles or practices, financial statement disclosure or auditing
scope or procedure with respect to our consolidated financial statements that if not resolved to the independent accountants' satisfaction, would have caused them to make reference to the subject
matter of the disagreement in connection with their reports.

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



Item 11. EXECUTIVE COMPENSATION

The information under the caption "Executive Compensation and Other Information," appearing in the Company's definitive Proxy Statement for the 2001 Annual
Meeting of Stockholders to be held on May 22, 2002 which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001, is incorporated
herein by reference.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information under the caption "Ownership of Securities," appearing in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Stockholders to
be held on May 22, 2002 which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001, is incorporated herein by reference.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information under the heading "Certain Transactions," appearing in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Stockholders to be
held on May 22, 2002 which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001, is incorporated herein by reference.

82

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PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K



|                                                                  |  | Page
|----------------------------------------------------------------- |  | ----
|Report of Independent Public Accountants on Supplemental Schedule |  | 88  
|Schedule IIValuation and Qualifying Accounts                     |  | 89  





Exhibit
Number

Exhibit Description2.1

Agreement and Plan of Merger, dated October 25, 1999, by and between FP-WJ Acquisition Corp. and the Registrant***3.1

Certificate of Incorporation of the Registrant**3.2

By-Laws of the Registrant**4.1

Specimen of Common Stock Certificate***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**4.3

Investor's Rights Agreement, dated as of July 25, 2000 by and between the Registrant and Cisco Systems, Inc.**4.4

Investor's Rights Agreement, dated as of July 25, 2000 by and between the Registrant and Investor International (Cayman) Limited**4.5

Co-Sale/Redemption Rights Agreement, dated as of July 25, 2000, by and among Fox Paine and affiliates, Cisco Systems, Inc., and the Registrant**4.6

Co-Sale/Redemption Rights Agreement, dated as of July 25, 2000, by and among Fox Paine and affiliates, Investor International (Cayman) Limited, and the Registrant**10.1

Credit Agreement, dated as of January 31, 2000, by and among the Registrant and Canadian Imperial Bank of Commerce, BT Commercial Corporation, IBM Credit Corporation, CIBC World Markets Corp. and certain other
lenders listed on the signature pages therto**10.2

First Amendment, dated as of March 21, 2000, to the Credit Agreement listed as Exhibit 10.1**10.3

Employment Agreement, dated as of January 31, 2000, by and between the Registrant and Malcolm J. Caraballo**


83

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10.4

Employment Agreement, dated as of January 31, 2000, by and between the Registrant and Tomas R. Kritzer**10.5

Employment Agreement, dated as of January 31, 2000, by and between the Registrant and Ralph E. Hoover, Jr.**10.6

Employment Agreement, dated as of January 31, 2000, by and between the Registrant and Rainer N. Growitz**10.7

Employment Agreement, dated as of June 26, 2000, by and between the Registrant and William T. Freeman**10.8

WJ Communications, Inc. 2000 Stock Incentive Plan**10.9

Lease (Phase I) dated March 24, 2000, by and between the Registrant and 401 River Oaks, LLC**10.10

Lease (Phase II) dated March 24, 2000, by and between the Registrant and 401 River Oaks, LLC**10.11

Lease and Agreement between the Registrant and Morrco Properties Company dated October 31, 1975*****10.12

Assignment of Lease Agreement, dated as of December 30, 1997, by and between the Registrant and Taylor Woodrow Property Company, Inc.******10.13

Agreement for Option to Amend Sub-lease, Amendment of Sub-lease and Joint Escrow Instructions, dated as of March 6, 2000, by and between the Registrant and 3333 Hillview Associates LLC**10.14

First Amendment, dated as of March 15, 2000 to the Agreement for Option to Amend Sub-lease, Amendment of Sub-lease and Joint Escrow Instructions listed at Exhibit 10.13**10.15

Second Amendment, dated as of March 22, 2000 to the Agreement for Option to Amend Sub-lease, Amendment of Sub-lease and Joint Escrow Instructions listed at Exhibit 10.13**10.16

Third Amendment, dated as of March 29, 2000 to the Agreement for Option to Amend Sub-lease, Amendment of Sub-lease and Joint Escrow Instructions listed at Exhibit 10.13**10.17

Management Agreement, dated as of January 31, 2000, by and between Registrant and Fox Paine & Company, LLC**10.18

WJ Communications, Inc. 2000 Non-Employee Director Stock Compensation Plan*10.19

Employment Agreement, dated as of October 29, 2001, by and between the Registrant and William R. Slakey10.20

Employment Agreement, by and between the Registrant and Michael R. Farese, Ph.D.


84

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16.1

Letter re. Change in Certifying Accountant from Deloitte & Touche LLP**23.1

Consent of Independent Public Accountants24.1

Power of Attorney (see signature page)99

Letter to SEC re: Assurances of Arthur Andersen


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|*      |  | Incorporated by reference to exhibit 99.2 to the Registration Statement on Form S-8 filed by the Registrant on December 21, 2000.                                              
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**     |  | Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form S1 filed by the Registrant on August 16, 2000, Commission File No. 333-38518.
|***    |  | Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form 8-A filed by the Registrant on August 14, 2000.                              
|****   |  | Incorporated by reference to an exhibit to the Registrant's Form 8-K filed on October 28, 1999, Commission File No. 1-5631.                                                    
|*****  |  | Incorporated by reference to exhibit 2(c) to the Registration Statement on Form 10K filed by the Registrant in 1977, Commission File No. 1-5631.                               
|****** |  | Incorporated by reference to exhibit 10-z to the Registration Statement on Form 10K filed by the Registrant in 1998, Commission File No. 1-5631.                               



85

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California, on the 28th day of March 2002.

|                    |  | WJ COMMUNICATIONS, INC.
(Registrant)
|------------------- |  | ------------------------------------
|Date March 28, 2002 |  | By:                                 

POWER OF ATTORNEY

We, the undersigned officers and directors of WJ Communications, Inc., do hereby constitute and appoint Michael R. Farese, Ph.D., and William R. Slakey,
and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange
Commission, 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 thing requisite or necessary to
be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated:

|Signature                                           |  | Title                                                                      |  | Date     
|--------------------------------------------------- |  | -------------------------------------------------------------------------- |  | ---------
|/s/MICHAEL R. FARESE, PH.D.Michael R. Farese, Ph.D. |  | President, Chief Executive Officer
(principal executive officer), Director |  | 3/28/2002
|/s/WILLIAM R. SLAKEYWilliam R. Slakey               |  | Chief Financial Officer (principal financial officer)                      |  | 3/28/2002
|/s/DAVID R. PULVINODavid R. Pulvino                 |  | Controller                                                                 |  | 3/28/2002
|/s/W. DEXTER PAINE, IIIW. Dexter Paine, III         |  | Chairman of the Board                                                      |  | 3/28/2002
|/s/SAUL A. FOXSaul A. Fox                           |  | Director                                                                   |  | 3/28/2002
|/s/JASON B. HURWITZJason B. Hurwitz                 |  | Director                                                                   |  | 3/28/2002
|                                                    |  |                                                                            |  |          

86

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|/s/WRAY T. THORNWray T. Thorn                   |  | Director |  | 3/28/2002
|----------------------------------------------- |  | -------- |  | ---------
|/s/CHARLES E. ROBINSONCharles E. Robinson       |  | Director |  | 3/28/2002
|/s/JAMES R. KRONERJames R. Kroner               |  | Director |  | 3/28/2002
|/s/J. THOMAS BENTLEYJ. Thomas Bentley           |  | Director |  | 3/28/2002
|/s/CHRISTOPHER B. PAISLEYChristopher B. Paisley |  | Director |  | 3/28/2002

87

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE

To
WJ Communications, Inc.:

We
have audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated financial statements of WJ Communications, Inc. as of
December 31, 2001, 2000 and 1999 and for the three years then ended included in this annual report and have issued our report thereon dated January 22, 2002. Our audits were made for the
purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying schedule is the responsibility of the Company's management and is presented for the purpose of
complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the
basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth herein in relation to the basic financial statements taken as a
whole.



San
Jose, California
January 22, 2002

88

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WJ COMMUNICATIONS, INC. AND SUBSIDIARIES        VALUATION AND QUALIFYING ACCOUNTS AND RESERVES        FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999

|Description                  |                               | Balance at
Beginning of
Period  |       | Charged (Credits)
to Costs and
Expenses |       | Charged to
Other
Accounts |   | Write-offs |       | Balance at
End of
Period
|---------------------------- | ----------------------------- | ------------------------------- | ----- | --------------------------------------- | ----- | ------------------------- | - | ---------- | ----- | ------------------------
|
|Year ended December 31, 2001 |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             | Deducted from asset accounts: |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               | Allowance for doubtful accounts |       | $                                       | 1,736 |                           | $ | (130       | )     | $                       
|                             |                               | Sales return allowance          |       |                                         |      |                           |   | 60         |       |                         
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               |                                 | Total |                                         | $     | 1,736                     |   | $          | (70   | )                       
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         
|Year ended December 31, 2000 |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             | Deducted from asset accounts: |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               | Allowance for doubtful accounts |       | $                                       | 504   |                           | $ | 1,232      |       | $                       
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               |                                 | Total |                                         | $     | 504                       |   | $          | 1,232 |                         
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         
|Year ended December 31, 1999 |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             | Deducted from asset accounts: |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               | Allowance for doubtful accounts |       | $                                       | 500   |                           | $ | 8          |       | $                       
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         
|                             |                               |                                 | Total |                                         | $     | 500                       |   | $          | 8     |                         
|                             |                               |                                 |       |                                         |       |                           |   |            |       |                         

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