PART I

Item 1. BUSINESS

Overview

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

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

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

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

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

Industry Background

Industry overview

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

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

· Potential broad deployment of RFID technology. RFID offers the potential for increased sales, productivity gains and operational cost savings because it enables real-time knowledge of unique product data than can be delivered by conventional technology, such as real time inventory levels, product type, date of manufacture, serial number and expiration date. The technology has been successfully used or is in various stages of deployment such as automated toll tag applications, Exxon Mobil’s Speedpass™, Wal-Mart’s announced store deployment and a Department of Defense logistics initiative. We are targeting the ultra high frequency (“UHF”) reader segment of that market.

Network Infrastructure

Consumers and businesses are continually seeking improved connectivity, mobility, functionality, reliability and bandwidth from voice and data networks. Increased deployment and use of wireless communications systems and the rise of cable and wireless Internet applications have also placed additional demands on network infrastructure.

Wireless communications providers continue to make investments in network infrastructure to expand capacity and offer a broader range of services to support the changing needs of end users while reducing their operating costs. In addition, wireless network operators and service providers have announced their plans for deployment and are deploying their next generation wireless services and networks, referred to in the industry as 2.5G and 3G networks. Sprint has announced its commitment to a future deployment of another next generation 4G network technology utilizing WiMax (Worldwide Interoperability for Microwave Access) technology and there are a number of WiMax network trials being conducted on a worldwide basis. These networks will offer subscribers increased speeds, additional application capabilities, and broader compatible coverage across geographies. To meet these objectives, network operators are building new and upgrading existing mobile networks to offer greater network capacity and speed to deliver voice and data services. These next generation wireless networks require new equipment based on more advanced RF semiconductor technology.

Original equipment manufacturers (“OEMs”) must develop systems to meet the requirements of communications service providers. In meeting these requirements, OEMs face significant market and product performance pressures including lower cost, higher performance, greater reliability and shorter time to market. OEMs are adopting new approaches in designing systems to deliver the performance and feature improvements that service providers require. In a typical communications system, the principal functional blocks are the RF subsystem, which receives, amplifies and transmits signals, the signal processor, which encodes and decodes digitized signals, and the antenna. Since the RF subsystem receives the signal, interfaces with the signal processor, and amplifies and transmits the signal, a system’s

performance and signal quality are significantly affected by the RF subsystem. Some OEMs do not have the internal resources to address every aspect of a system’s RF performance. To lower their production costs and shorten product development cycles, OEMs are seeking innovative RF components from third-party suppliers. We believe that there is a substantial market opportunity for a third-party supplier of high performance RF components who can meet the needs for flexibility, performance and value required by OEMs.

RF components are generally technically sensitive devices that demand circuit design expertise and sophisticated process technology. RF components are tightly coupled to a process technology to achieve their performance. Although there are multiple RF process technologies available to a designer, either through foundries or the suppliers’ internal wafer fabrication facilities, the complexity of adopting a new technology to the end component performance has resulted in companies focusing their efforts in selected product areas which has allowed multiple suppliers to target different segments of the markets.

Radio Frequency Identification (RFID)

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

Profitable and effective commercial RFID systems have been in operation for over a decade. The current market is driven by traditional applications such as security/access control, automobile immobilization, toll collection, and transportation. Many other applications are in the early adoption phase, including pallet tracking, point of sale commerce and baggage handling. There are notable obstacles to overcome before significant growth can be seen, including but not limited to, acceptable industry and application standards, cost, end user education, frequency regulations, power restrictions, indirect channel support and the highly fragmented competitive environment.

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

The RF Challenge

Radio frequency (“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 manufacture RF semiconductors, components and integrated modules are unique and can take many years to develop. 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 cable communications equipment.

The WJ Communications Solution

With the ability to design and manufacture RF semiconductors, components, integrated RF modules and interface these assemblies with other network elements, we enable both current and next generation wireless networks and RFID systems worldwide. Our core technology lies within our advanced RF semiconductor designs.

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

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

· Advanced Device Technology. We have substantial expertise in designing and manufacturing highly linear semiconductor products that amplify and transform signals with minimal distortion and interference.

· Manufacturability. Our ability to rapidly convert new technologies and designs into completed RF semiconductors, integrated modules and highly functional components products results from our design, advanced device technology and our manufacturing engineering expertise.

Business Strategy

Our objective is to be the leading supplier of innovative RF semiconductor products. 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 target multiple growth markets such as power amplifiers, WiMAX and RFID to expand our addressable market opportunities. We believe that as data throughput requirements expand in wireless networks, the ability to meet the RF requirements 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, focusing on the markets for RF semiconductors, modules and components. Due to the commonality of RF requirements in RFID 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 the wireless and cable communications and RFID markets.

· 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 advanced RF solutions. 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 leader and innovator of RF products and believe that we are positioned to provide a broad portfolio of RF technology products. Our RF products are comprised primarily of semiconductors including amplifiers, mixers, RF integrated circuits, transistors, chipsets and multi-chip modules (“MCMs”), and RFID readers and reader modules. Our MCMs integrate multiple RF semiconductors, process technologies and functions in a single package allowing us to significantly reduce cost, power consumption and circuit board space. Our ability to design our semiconductors in multiple process technologies enables us to address a variety of end-markets and applications.

The following table summarizes the sales from our significant product lines:

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

Semiconductor Products and Process Technologies

Our semiconductor products include a broad array of high performance semiconductors that we manufacture for our own use as well as for sale to others. The primary markets for our semiconductor products are the wireless infrastructure markets.

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

We have expertise in designing and manufacturing RF components in multiple process technologies. Some of these processes have been built in our own manufacturing operations and in other cases we have our products manufactured for us by an outside foundry.

We use the following mature processes to support our current product portfolio. These technologies are also used actively in new product design now and will be for the next four to five years.

· Gallium arsenide metal semiconductor field effect transistor (GaAs MESFET)

· Gallium arsenide heterostructure field effect transistor (GaAs HFET)

· Indium gallium phosphide heterojunction bipolar transistor (InGaP HBT)

During 2006, we qualified and introduced into production the 28 Volt version of our 12 Volt InGaP HBT process in our internal wafer fabrication facility and are in the qualification phase with our outside foundry for this process. This new process technology supports our new and expanding line of higher-powered amplifier products that operate at higher supply voltages.

In addition to the processes listed above, we design products using processes from other outside foundries. Products have been released to market based on technologies from these foundries and more new products are being designed using these foundries.

As foundries upgrade their process technologies, we expect that we will continue our design work with the latest processes.

· Silicon On Insulator (SOI)

· Integrated combination of silicon-germanium heterostructure bipolar transistor and complementary metal oxide semiconductor (SiGe BiCMOS)

· Silicon complementary metal oxide semiconductor transistor (CMOS),

Finally, we are continuously evaluating emerging process technologies for their suitability to future product offerings.

Customers

We sell our products principally to our distributor and original equipment manufacturers, including their manufacturing subcontractors. We believe that we have strong relationships with market leaders in all of our target markets. A sample of our revenue-producing customers includes:

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

We depend on a limited number of key customers for a majority of our sales. In 2006, Richardson Electronics, Ltd, our worldwide distributor of our RF semiconductor products, and Celestica each accounted for more than 10% of our sales and in aggregate accounted for approximately 60% of our sales. In 2005, Richardson Electronics, Ltd and Celestica each accounted for more than 10% of our sales and in aggregate accounted for approximately 58% of our sales. In 2004, Richardson Electronic, Ltd and Celestica each accounted for more than 10% of our sales and in aggregate accounted for approximately 63% of our sales. We expect that our key customers will continue to account for a substantial portion of our sales in 2007 and in the foreseeable future. These customers and their respective contributions to our net revenue have varied and will likely continue to vary from period to period. We typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty, and currently do not have agreements with any of our key customers that contain long-term commitments to purchase specified volumes of our products.

Sales, Marketing and Customer Support

· Direct Sales We 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.

· Distributor In June 2002, we entered into a worldwide distributorship agreement with Richardson Electronics, Ltd., a global provider of engineered products. This agreement expanded our previous relationship and includes provisions for joint marketing and promotional activities. We directly compensate vendors for the cost of these specifically identified goods or services or may reimburse Richardson Electronics, Ltd. if they incurred the cost of such specifically identified goods or services on our behalf the value of which is substantiated by invoicing from vendors. Our cost for these activities is recorded in selling and administrative expense as advertising. In addition to Richardson Electronics, Ltd, we have a few select distributors and stocking representatives that address specific market opportunities. The activity with these distributors and stocking representatives is small relative to our activity with Richardson Electronics, Ltd.

· Manufacturer Sales Representatives Our worldwide network of nine independent manufacturer sales representatives is responsible for assisting our direct sales force in calling on potential customers as well as maintaining relationships with non-major accounts. During 2006 we expanded our direct sales team and direct support of our key customers and expect to de-emphasize the use of our manufacturer sales representatives going forward.

· Applications Engineering Our products are highly technical and our customers frequently consult with us to select a component for a given application, determine product performance under specified conditions unique to their system, or test a product for new applications. To meet the needs of our customers, we provide support in all stages of the sales process, from concept definition and product selection to post-sale support. These services are provided by our applications engineering organization, which works closely with our sales organization in all pre- and post-sale activities. We intend to continue to invest in expanding our applications engineering organization to assist our customers.

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

Manufacturing

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

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

We depend on single or limited source suppliers for the components and materials used in many of our products, including our SiGe processed wafers, 5 Volt, 12 Volt and 28 Volt InGaP HBT processed wafers, gallium arsenide wafers, packaging, electronic components and antennas. 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 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.

We are committed to quality of the management systems governing the manufacture of our products and our systems are ISO 9001 (revision 2000) certified. The International Organization for Standardization (“ISO”) is a network of the national standards institutes of 148 countries including the United States of America. The ISO 9000 family of standards is primarily concerned with “quality management,” meaning the systems the organization utilizes to fulfill: the customer’s quality requirements, and applicable regulatory requirements, while aiming to enhance customer satisfaction, and achieve continual improvement of its performance in pursuit of these objectives. The ISO 9001: 2000 is approved as an American National Standard by the American Society for Quality.

Our systems are regularly assessed by independent certifying bodies, through routine quality system audits, for adherence to ISO 9001 standards.

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. In 2006, we established a design center in China in addition to our centers in San Jose, California and Richardson, Texas. 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 $18.3 million, $18.1 million and $17.2 million for the years 2006, 2005 and 2004, respectively.

Intellectual Property

The protection of our intellectual property is critical to our success. 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 24 United States patents and 15 foreign patents. We currently have a number of patent applications pending in the United States Patent and Trademark Office and throughout the world, including 27 patent applications filed world wide by end of 2006. Our existing United States patents will expire between June 2007 and October 2022. We have chosen to pursue foreign patent protection in selected foreign countries. Our failure to pursue foreign protection in certain 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, perpetual license to use particular thin-film technology and transferable, non-exclusive, perpetual licenses to use particular gallium arsenide technology, and technology used in the field of commercial, or non-military, RF communications. Although our business does not depend on any of the licenses to a material extent, 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.

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

We believe that one of our most important assets is our base of well-trained and experienced employees. As of December 31, 2006, we had 221 employees. We expect a substantial reduction in the number of manufacturing related employees in the first half of 2007 as we complete the planned closure of our Milpitas wafer manufacturing facility. None of our employees are covered by collective bargaining agreements or represented by labor unions, and we have never experienced a work stoppage. We believe our employee relations are good.

Backlog

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

backlog may vary significantly from time to time depending upon the level of capacity available to satisfy unfilled orders. Accordingly, although useful for scheduling production, we do not believe that backlog as of any particular date is necessarily indicative of our 2007 results.

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, quality, level of integration, delivery, price, customer support, reputation and the availability and breadth of product offerings. In each of the markets we serve, we compete primarily with other suppliers of high performance RF components. We also compete with current and potential communications equipment manufacturers who manufacture RF components internally. We expect increased competition from existing competitors and from a number of companies that may enter the RF component market, as well as future competition from companies that may offer new or emerging technologies. 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. Many of our competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products. Current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. In addition, competitors may develop technologies that more effectively address our markets with products that offer enhanced features, lower power requirements or lower cost. Increased competition could result in pricing pressures, decreased gross margins and loss of market share and may materially and adversely affect our business, financial condition and results of operations.

Business Combinations

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

On January 28, 2005 we completed our acquisition of Telenexus, Inc. pursuant to an Agreement and Plan of Merger, dated January 19, 2005, by and between us, WJ Newco, LLC (the “WJ Sub”), Telenexus and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton. Telenexus was merged with and into the WJ Sub effective on January 29, 2005. The WJ Sub was the survivor in the merger and is our wholly owned subsidiary. Telenexus designs, develops, manufactures and markets radio frequency identification reader products for a broad range of industries and markets. By virtue of the merger, we purchased through the WJ Sub all of the assets necessary for the conduct of the RFID business of Telenexus, consisting primarily of, and including, but not limited to RFID modules, baseband processing algorithm technology, applications software and realizations of several reader product designs. The consideration we paid on the closing date in connection with the merger consisted of cash in the amount of $3.0 million, which was paid out of our cash reserves on the closing date, and 2,333,333 shares of our common stock valued at $8.2 million at the closing date. Including acquisition costs of $230,000, the aggregate purchase price for the net assets of Telenexus totaled $11.4 million.

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

Compliance with Environmental, Health and Safety Regulations

We are committed to achieving high standards of environmental quality and product safety, and strive to provide a safe and healthy workplace for our employees, contractors and the communities in which we do business. We have developed environmental, health and safety policies for our business, and internal processes focused on minimizing and properly managing any hazardous materials used in our facilities and products.

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

Our former Scotts Valley and Palo Alto sites have significant environmental liabilities for which in July 1999 we entered into and funded fixed price remediation contracts and obtained cost overrun and unknown pollution conditions insurance coverage. There can be no assurance that this insurance will be sufficient to cover all liabilities related to these two sites.

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 $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 $10.0 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 $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 which could harm our business.

Item 1a. RISK FACTORS

You should carefully consider the risks described below before making an investment decision in our securities. These risk factors are effective as of the date of this Annual Report on Form 10-K and shall be deemed to be modified or superseded to the extent that a statement contained in our future filings modifies or replaces such statement. The forward-looking statements in this Annual Report on Form 10-K involve risks and uncertainties and actual results may differ materially from the results we discuss in the forward-looking statements. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our stock could decline, and you may lose all or part of your investment. The most significant risks and uncertainties known to us that we believe make an investment in our stock speculative or risky are set forth in this section. This section does not include those risks and uncertainties that could apply to any issuer or any offering.

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

We have not recorded operating income since 1999, and we may not be able to achieve revenue or earnings growth or obtain sufficient revenue to sustain profitability. In 2006 our sales were $48.8 million and we incurred an operating loss of $10.8 million compared to sales of $31.6 million and an operating loss of $22.1 million for 2005. In addition, our sales for 2004 were $32.3 million and we incurred an operating loss of $17.3 million. Our accumulated deficit was $182.6 million at December 31, 2006.

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

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

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

· loss of a key customer;

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

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

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

We operate in the highly cyclical semiconductor industry which has experienced significant fluctuations in demand.

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

We have experienced these conditions in our business in the past and may experience such downturns in the future. Future downturns in the semiconductor industry could seriously impact our revenues and harm our business, financial condition and results of operations.

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

Richardson Electronics, Ltd. is the worldwide distributor of our RF semiconductor products. Richardson Electronics, Ltd. is our largest customer and represents 44%, 45% and 52% of sales in 2006, 2005 and 2004, respectively. We cannot assure you that this relationship will improve sales of our products or that it is the most effective method of distribution. If Richardson Electronics, Ltd. fails to successfully market and sell our products, our sales could materially decline. Our agreement with this distributor does not require it to purchase our products and is terminable at any time. If this distribution relationship is discontinued, our sales could decline significantly.

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

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

In addition, most of our sales result from purchase orders or from contracts that can be cancelled on short-term notice. Moreover, it is possible that our customers may develop their own products internally or purchase products from our competitors. Also, events that impact our customers, for example wireless carrier consolidation, can adversely affect our sales. We expect that a few key customers will continue to account for a substantial portion of our revenue in 2007. The loss of, or a reduction in orders from, a significant customer for any reason could cause our sales to decrease.

A majority of our sales are to customers outside of the United States and 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 52%, 44% and 35% of our sales in 2006, 2005 and 2004, respectively. Most of our foreign sales are to customers located in China. 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, difficulties in protecting intellectual property rights, currency fluctuations, and potentially adverse tax consequences, which could adversely affect our business and financial results.

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

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

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

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

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

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

· reduced control over delivery schedules and quality;

· longer lead times;

· the potential lack of adequate capacity during periods when industry demand exceeds available capacity;

· difficulties finding and integrating new subcontractors;

· limited warranties on products supplied to us;

· potential increases in prices due to capacity shortages, currency exchange fluctuations and other factors; and

· potential misappropriation of our intellectual property.

Third party intellectual property claims could harm our business.

We occasionally receive communications from third parties alleging infringement of patent and other intellectual property rights. While we are not subject to any current claims that we believe could be material, there can be no assurance that material claims will not arise in the future. While all of our revenue is derived from products containing our proprietary intellectual property, approximately 7% and 9% of our revenue for 2006 and 2005, respectively, was derived from newly developed technologies which could have a higher risk of infringement claims. We intend to vigorously protect our proprietary intellectual property rights with respect to all of our products. However, we cannot assure you that claims can be amicably disposed of, and it is possible that litigation could ensue. Litigation could result in substantial costs to us and diversion of our resources. If we fail to obtain a necessary license or if we do not prevail in patent or other intellectual property litigation, we could be required to discontinue selling the affected products, to seek to develop non-infringing technologies, which may not be feasible, and to pay monetary damages, any of which could harm our business.

Our quarterly operating results may fluctuate significantly. As a result, we may fail to meet 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 are expected to vary from quarter to quarter due to a number of the factors described in this “Risk Factors” section and in our public filings, 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. For example, during our third quarter 2006 earnings call we provided lower forward guidance and in mid December we pre-announced lower expectations for the fourth quarter of 2006. Subsequent to such announcements, the trading price of our common stock declined significantly.

If we are unable to develop and introduce new RF products successfully and in a cost-effective and timely manner or to achieve market acceptance of our new semiconductors, our operating results would be adversely affected.

The future success of our business depends on our ability to develop new RF products for existing and new markets, introduce these products in a cost-effective and timely manner and convince leading equipment manufacturers to select these products for design into their own new products. Our quarterly results in the past have been, and are expected in the future to continue to be, dependent on the introduction of new products and the timely completion and delivery of those products to customers. The development of new semiconductor devices is highly complex, and from time to time we have experienced delays in completing the development and introduction of new products and lower than anticipated manufacturing yields in the early production of such products. Our ability to develop and deliver new semiconductor products successfully will depend on various factors, including our ability to:

· accurately predict market requirements and evolving industry standards;

· accurately define new products;

· timely complete and introduce new product designs;

· timely qualify and obtain industry interoperability certification of our products and the products of our customers into which our products will be incorporated;

· obtain sufficient foundry capacity;

· achieve high manufacturing yields;

· shift our products to smaller geometry process technologies to achieve lower cost and higher levels of design integration; and

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

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

Our new products generally are incorporated into our customers’ products at the design stage. We often incur significant expenditures for the development of a new product without any assurance that an equipment manufacturer will select our product for design into its own product. The value of our semiconductors largely depends on the commercial success of our customers’ products. We cannot assure you that we will continue to achieve design wins or that equipment that incorporates our products will be commercially successful.

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

We announce from time to time new products and design wins for new and existing RF 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 to purchase 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 into 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 revenue. Once a manufacturer of communications equipment has designed a supplier’s semiconductor into its products, the manufacturer may be reluctant to change its source of semiconductors due to the significant costs associated with qualifying a new supplier and potentially redesigning its product. Accordingly, our failure to achieve design wins with equipment manufacturers, which have chosen a competitor’s semiconductor, could create barriers to future sales opportunities with these manufacturers.

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

After we have developed and delivered a RF product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customer may need three to six months or longer to test, evaluate and adopt our products and an additional three to nine months or more to begin volume production of equipment that incorporates our products. In some cases, it may take significantly longer than three to nine months before customers commence volume production of equipment incorporating some of our products. Due to this lengthy sales cycle, we may experience significant delays from the time we increase our expenses for research and development, sales and marketing efforts and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our products to incorporate into its equipment, we have no assurances that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increase the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. In addition, our business, financial condition and results of operations could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products.

The resources devoted to product research and development and sales and marketing may not generate material revenue for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing and inventory expenses in the future that we are not able to recover, and we are not able to compensate for those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions and we still have higher cost products in inventory, our operating results would be harmed.

If we are unable to respond to the rapid technological changes 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.

We must continue to make significant investments in research and development to develop product enhancements, new designs and technologies on a cost effective basis. If we are unable to develop and/or gain access to and introduce new products or enhancements in a timely and cost effective manner in response to changing market conditions or customer requirements, or if our new products do not achieve market acceptance, our sales could decline. Additionally, initial lower margins are typically experienced with new products under development.

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 face an extremely competitive environment. Some of the products we design and sell are customized to work with specific customers’ 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. In addition, we have limited ability to foresee the competitive success of our customers and to plan accordingly.

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

Our future growth depends on the success of the wireless communications market. The rate at which this markets will grow is difficult to predict. This market may fail to grow or decline for many reasons, including:

· insufficient consumer demand for wireless products or services;

· the inability of the various communications service providers to access adequate capital to build their networks;

· inefficiency and poor performance of wireless communications compared to other forms of broadband access; and

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

If the markets for our products in wireless communications declines, fail to grow, or grows more slowly than we anticipate, the use of our products may be reduced and our sales could suffer.

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

We use rolling forecasts based on anticipated product orders to determine our component requirements. It is important that we accurately predict both the demand for our products and the lead times required to obtain the necessary products and/or components and materials. Lead times for components and materials that we, or our outsourced manufacturers, order can vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. Since we rely on outsourced manufacturers, many of these factors will be outside of our direct managerial control. For substantial increases in production levels, our outsourced manufacturers and some suppliers may need six months or more lead-time. As a result, we may be required to make financial commitments in the form of purchase commitments. We lack visibility into the finished goods inventories of our customers and the end-users. This lack of visibility impacts our ability to accurately forecast our requirements. If we overestimate our component, material and outsourced manufactured requirements, we may have excess inventory, which would increase our costs. An additional risk for potential excess inventory results from our volume purchase commitments with certain material

suppliers, which can only be reduced in certain circumstances. Additionally, if we underestimate our component, material, and outsourced manufacturing requirements, we may have inadequate inventory, which could interrupt and delay delivery of our products to our customers. Any of these occurrences would negatively impact our sales and profitability. We have incurred, and may in the future incur, charges related to excess and obsolete inventory. These charges amounted to approximately $1.6 million, $1.0 million and $670,000 in 2006, 2005 and 2004, respectively. While these charges may be partially offset by subsequent sales of previously written-down inventory, there can be no assurance that any such sales will be significant. As we broaden our product lines we must outsource the manufacturing of or purchase a wider variety of components. In addition, new product lines contain a greater degree of uncertainty due to a lack of visibility of customer acceptance and potential competition. Both of these factors will contribute a higher level of inventory risk in our near future.

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

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

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

Our performance is substantially dependent on the continued services and on the performance of our senior management and our highly qualified team of engineers, who have many years of experience and specialized expertise in our business. We have recently undergone changes in our senior management. Our performance also depends on our ability to retain and motivate our other executive officers and key employees. The loss of the services of any of our executive officers or of a number of our engineers could harm our ability to maintain and build our business. We have no “key man” life insurance policies.

Our future success also depends on our ability to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, sales, and marketing personnel. If we fail to attract, integrate and retain the necessary personnel, our ability to maintain and build our business could suffer significantly.

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. If problems occur or become significant, it could result in a reduction in our revenues and increased costs related to inventory write-offs, warranty claims and other expenses which could have a material and adverse affect on our financial condition.

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 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 negatively impact our future profitability.

We regard the protection of our copyrights, patents, service marks, trademarks, trade dress and trade secrets as critical to our future success and 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 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 and financial 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.

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.

We must gain access to improved process technologies.

For our semiconductor products, our future success will depend upon our ability to continue to gain access to new and/or improved process technologies in order to adapt to emerging industry standards or competitive market conditions. 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 gain access to new process technologies in a timely or affordable manner. In addition, products based on these technologies may not achieve market acceptance.

Due to our relationships with foreign vendors, manufacturers, customers and subcontractors, we are subject to international operational, financial and political risks.

We expect to continue to rely on vendors, manufacturers and subcontractors located in China, Malaysia, Thailand, Taiwan and the Philippines. Additionally, we utilize vendors located in such countries in our semiconductor business to source gallium arsenide (“GaAs”) wafers as raw material in our semiconductor fabrication, to fabricate certain products, to assemble certain products and to package the majority of our semiconductor die in plastic. Accordingly, we will be subject to risks and challenges such as:

· compliance with a wide variety of foreign laws and regulations:

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

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

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

· reduced protection for intellectual property rights in some countries; and

· fluctuations in freight rates and transportation disruptions.

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 supply materials or services. Any interruption or delay in the supply of our required components, products, materials or services, or our inability to obtain these components, materials, products 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 semiconductor industry is intensely competitive in each of the markets we serve and is characterized by:

· rapidly changing technology;

· swift product obsolescence;

· manufacturing yield problems;

· price erosion; and

· limited supplies of components and materials.

Our end markets are 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. 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. If we fail to successfully compete in our markets, our business and operating results would be materially and adversely affected.

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

As part of our growth plans, we may make acquisitions of and investments in new businesses, products and technologies. 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, 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.

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

Our strategy includes the potential to acquire technology and products through acquisitions to address our target markets in addition to our internally developed technologies. Integrating completed acquisitions into our existing operations involves numerous risks including the following:

· diversion of management’s attention;

· potential loss of key personnel;

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

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

· ability to develop and introduce new products.

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

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

The 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.

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

Effective internal controls required under Section 404 of the Sarbanes-Oxley Act of 2002 are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our business, reputation and operating results could be harmed. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. For example, “material weaknesses” were identified in our quarter ended December 31, 2005, October 1, 2006, and December 31, 2006 which means that there was “a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.” During these periods, the finance team experienced a high rate of turnover and partially due to the turnover, has been understaffed and had limited training in the Company’s processes and procedures. During the second half of 2006, we substantially hired a new finance team with an expectation to complete the hiring during the first half of 2007. During this period and until we can complete the staffing and training of the finance team, we have a higher risk of deficiencies in our financial reporting. We cannot be certain that the measures we have taken or intend to take will ensure that we maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls or difficulties encountered in their implementation could subject us to regulatory sanctions, harm our business and operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also harm our reputation and cause investors to lose confidence in our reported financial information, which could have a negative impact on the trading price of our stock.

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:

· ownership of the intellectual property we have sold;

· the potential infringement by our sold businesses of the intellectual property of others;

· the regulatory compliance of our sold defense business;

· export control compliance with respect to our defense products purchased by the United States and foreign governments; and

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

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, we could be required to suspend production, alter manufacturing processes or cease operations.

Two of our former production facilities at Scotts Valley and Palo Alto 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 two 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 any of which could have a material negative effect on our sales, income and business 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.

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 for at least the next twelve months. 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 may 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 stockholders 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:

· whether we operate on a positive cash flow basis;

· the market acceptance of our products;

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

· volume price discounts;

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

· the levels of inventory and accounts receivable that we maintain;

· capital improvements to new and existing facilities;

· technological advances;

· our competitors’ response to our products; and

· our relationships with suppliers and customers.

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.

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

On October 30, 2006, our Board of Directors committed us to a restructuring plan to close and exit our Milpitas fabrication facility during the first quarter of 2007. The Milpitas fabrication facility currently produces a substantial portion of our gallium arsenide semiconductor products. Our lease of the fabrication facility expired on November 14, 2006 and in accordance with the terms of the lease we are holding over, whereby the lease converts to a month-to-month lease, until the closure is complete. We plan to produce additional wafer inventory at the fabrication facility until closure. During this holdover period, we are at risk for termination of our use of the facility before such time as we complete our closing and exiting of the fabrication facility. If this should occur, we might not have enough additional wafer inventory to buffer any delayed qualifications from customers or ramp-up issues with Global Communication Semiconductors, Inc.

Our facilities are concentrated in an area susceptible to earthquakes.

Our 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.

Risks Related to Our Stock

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

We registered for resale up to 25,492,044 shares of common stock by Fox Paine Capital Fund, L.P., FPC Investors, LP, WJ Coinvestment Fund I, LLC, WJ Coinvestment Fund III, LLC and WJ Coinvestment Fund IV, LLC (together the “Fox Paine Entities”) pursuant to an agreement providing for registration rights. The Fox Paine Entities are collectively our largest stockholder. As of December 31, 2006, the Fox Paine Entities beneficially owned 38% of our common stock which represents approximately 25.5 million of our 67.3 million outstanding shares of common stock. Our stock is not heavily traded and our stock prices can fluctuate significantly. As such, sales of substantial amounts of our common stock into

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

Furthermore, future sales of substantial amounts of common stock by our officers, directors and other stockholders, including any sales under a Rule 10b5-1 sales plan, in the public market or otherwise 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.

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

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

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

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

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

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

· amending our charter or by-laws; and

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

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

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

In addition, Fox Paine receives management fees from us which could influence their decisions regarding us. Under our management agreement with Fox Paine, we are obligated to pay Fox Paine 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. Due to our losses incurred, we have not been required to pay management fees to Fox Paine since 2001.

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. In addition, the sale of a substantial number of shares of our common stock by Fox Paine could result in the loss of Fox Paine’s services to us as well as the services of members of Fox Paine on our board of directors which could adversely effect our business.

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 December 31, 2006, our common stock has traded at prices as low as $0.560 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:

· shares sold by the selling stockholders;

· quarter-to-quarter variations in our operating results;

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

· general conditions in the semiconductor industry and telecommunications and data communications equipment markets;

· changes in earnings estimates or investment recommendations by analysts;

· changes in investor perceptions; or

· changes in expectations relating to our products, plans and strategic position or those of our competitors or customers.

In addition, the market prices of securities on the NASDAQ Global 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.

We do not expect to pay any dividends for the foreseeable future.

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

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

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

Item 1b. UNRESOLVED STAFF COMMENTS

Not applicable.

Item 2. PROPERTIES

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

In September 2001, we decided to abandon the smaller building at our San Jose facility based on revised anticipated demand for our products and market conditions and as of December 31, 2006, we have

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

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

Item 3. LEGAL PROCEEDINGS

From time to time we are involved in litigation, regulatory proceedings and claims that are incidental to the conduct of our business in the ordinary course. While we currently believe that any adverse outcome of such matters would not materially affect our business or financial condition, there can be no assurance that this will ultimately 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 2006.

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, 2006, 2005 and 2004 and the selected balance sheet data as of December 31, 2006 and 2005 are derived from our audited consolidated financial statements which are included elsewhere in this annual report on Form 10-K. The statements of operations data for the years ended December 31, 2003 and 2002 and the selected consolidated balance sheet data as of December 31, 2004, 2003 and 2002 are derived from our audited consolidated financial statements which are not included in this annual report on Form 10-K. The historical results are not necessarily indicative of results to be expected for any future period.

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

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

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

During 2004, $8.5 million of the purchase price for the acquisition of the wireless infrastructure business and associated assets from EiC was allocated to IPRD.

For further discussion, see Management’s Discussion and Analysis of Financial Condition and the Results of Operations under the caption “Acquired In-process Research and Development Expenses” included elsewhere in this Form 10-K.

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

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

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,” “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, those factors described in “Risk Factors” above. 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 on Form 10-K. 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” above for a discussion of certain factors that could cause future actual results to differ from those described in the following discussion.

Overview

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

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

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

Sales

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

A majority of our sales in 2006 were to customers outside of the United States. Sales to customers outside of the United States accounted for approximately 52%, 44% and 35% of our sales in 2006, 2005 and 2004, respectively. Most of our foreign sales were to customers located in China.

We depend on a small number of customers for a majority of our sales. Sales to our customers, which individually account for more than 10% of our total annual sales were, in aggregate, 60%, 58% and 63% of our sales in December 31, 2006, 2005 and 2004, respectively. 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. If the markets for our products decline, fail to grow, or grow more slowly than we anticipate, the use of our products may be reduced with a significant negative impact on our sales, earnings, inventory valuations and cash flow. Generally, the selling prices of our products tend to decrease over time as a result of increased volumes or general competitive pressures and in general we expect that prices will continue to decline as a result of volume increases or these competitive pressures.

Cost of Goods Sold

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

We recognize cost of goods sold upon recognition of revenue. We recognize losses on contracts, including purchase order commitments, when identified. We have not recognized such losses during 2006, 2005 or 2004.

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. We generate revenues

from development contracts with customers that have enabled us to accelerate our own product development efforts. Such development revenues have only partially funded our product development activities, and we generally retain ownership of the products developed under these arrangements. As a result, we classify all development costs related to these contracts as research and development expenses.

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.

Critical Accounting Policies and Estimates

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

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. See Note 2 to the consolidated financial statements included elsewhere in this Form 10-K for a detailed discussion of all our significant accounting policies.

Business Combinations

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

Critical estimates in valuing certain intangible assets include but are not limited to: future expected cash flows from acquired developed technologies and patents, expected costs to develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed, customer contracts, customer lists, distribution agreements, also the brand awareness and the market position of the acquired products and assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.

Revenue Recognition

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

(4) are based on management’s judgments regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees.

Effective for our second quarter ended July 3, 2005, we changed the application of our revenue recognition policy regarding our distributors. We had previously recognized revenue upon shipment to our distributors less estimated reserves for distributor right of return, authorized price reductions for specific end-customer sales opportunities and price protection based on known events and historical trends. Effective for our second quarter ended July 3, 2005, we recognize revenue from our distribution channels when our distributors have sold the product to the end customer. Historically, we have received stock rotation requests from our distributors that were within the amounts estimated and contractually allowed with only one exception of an insignificant amount. However, the request for stock rotation during our second quarter ended July 3, 2005 was higher than the amount contractually allowed. Our management, with the concurrence of our Audit Committee, believed the increasing percentage of our new product introductions makes it likely that stock rotation reserves will continue to be difficult to estimate based on historical patterns and contractual provisions. Based on this change in facts and circumstances and our management’s future expectations, we believed that we could no longer reasonably estimate the amount of future returns from our distributors as of July 3, 2005. Accordingly, beginning in our second quarter of 2005, recognition of revenue and associated cost of sales on shipments to distributors is deferred until the resale to the end customer. This change in application resulted in a $4.1 million revenue deferral in our second quarter of 2005. Although revenue is deferred until resale, title of products sold to distributors transfers upon shipment. Accordingly, shipments to distributors are reflected in the consolidated balance sheets as accounts receivable and a reduction of inventories at the time of shipment. Deferred revenue and the corresponding cost of sales on shipments to distributors are reflected in the consolidated balance sheet on a net basis as “Deferred margin on distributor inventory.” For further discussion, see Note 2 to the consolidated financial statements included elsewhere in this Form 10-K.

Through the quarter ended April 3, 2005, revenues from our distributors were recognized upon shipment based on the following factors: our sales price was fixed or determinable by contract at the time of shipment, payment terms were fixed at shipment and were consistent with terms granted to other customers, the distributor had full risk of physical loss, the distributor had separate economic substance, we had no obligation with respect to the resale of the distributor’s inventory, and we believed we could reasonably estimate the potential returns from our distributor based on their history and our visibility in the distributor’s success with its products and into the market place in general. In accordance with Financial Accounting Standards Board (“FASB”) Statement No. 48 “Revenue Recognition When Right of Return Exists”, we accrued a reserve based on our reasonable estimate of future returns based on historical trends and contractual limitations. As of April 3, 2005, our distributor stock rotation reserve was $178,000.

Beginning in September 2003, we entered into a program where the distributor would receive a credit if it sold specific product at a reduced price to specific end-customers pre-authorized by us. We maintain a log of all such pre-authorized price reductions which we accrue as a reduction to revenue in the period that the pre-authorization occurs per issue 4 of EITF 01-9 “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Through the quarter ended April 3, 2005, the Ship & Debit Allowance was offset solely by an offset to revenue. Since we began recognizing revenue from our distribution channels only when our distributors have sold the product to the end customer, the Ship & Debit allowance will offset revenue only when the products with pre-authorized price reductions have shipped to the end-customer otherwise it will offset “Deferred margin on distributor inventory.” As of December 31, 2006 and 2005 our Ship & Debit Allowance was $249,000 and $34,000, respectively.

If we reduce the prices of our products as negotiated with the distributor, the distributor may receive a credit for the difference between the price paid by the distributor and the reduced price on applicable unsold products remaining in the distributor’s inventory on the effective date of the price reduction

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

We may enter into contracts to perform research and development for others meeting the requirements of Statement of Financial Accounting Standards No. 68 “Research and Development Arrangements”. Revenue under these development agreements is recognized when applicable contractual non-refundable milestones have been met, including deliverables, and in any case, does not exceed the amount that would be recognized using the percentage-of-completion accounting method based on the actual physical completion of work performed and the ratio of costs incurred to total estimated costs to complete the contract in accordance with Accounting Research Bulletin 45 “Long-Term Construction Type Contracts” using the relevant guidance in the American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. For contracts including significant software development efforts, the provisions of SOP 97-2 “Software Revenue Recognition” are also followed. Given the duration and nature of these development contracts, we believe that recognizing revenue under the percentage completion method best represents the legal and economic results of contract performance on a timely basis. Losses on contracts are recognized when determined. Revisions in estimates are reflected in the period in which the conditions become known. These development contracts with customers have enabled us to accelerate our own product development efforts. Such development revenues have only partially funded our product development activities, and we generally retain ownership of the products developed under these arrangements. As a result, we classify all development costs related to these contracts as research and development expenses. The achievement of contractual milestones is evidenced by written documentation provided by the customer in accordance with the applicable terms and conditions of each contract. In any period, progress on the contract is based on input measures (direct labor dollars, direct material costs and direct outside processing costs) in the ratio of costs incurred to total estimated costs. Estimated costs to complete are provided by engineering personnel directly involved in the development program and are reviewed by management and finance personnel for reasonableness given the known facts and circumstances. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. If different conditions were to prevail such that accurate estimates could not be made, then the use of the completed contract method would be required and the recognition of all revenue and costs would be deferred until the project was completed. Such a change could have a material impact on our results of operations. If we bill the customer prior to performing services under the development agreement, the amounts are recorded as deferred revenue. Our balance of deferred revenue was $424,000 and nil at December 31, 2006 and December 31, 2005, respectively.

Stock-based Compensation

We adopted the provisions of, and account for stock-based compensation in accordance with, SFAS 123R effective January 1, 2006. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

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

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

We estimate the expected term of options granted by reviewing annual historical employee exercise behavior of option grants with similar vesting periods and the expected life assumptions of semiconductor peer companies. Our estimate of pre-vesting option forfeitures is based on historical pre-vest termination rates and those of semiconductor peer companies and we record stock-based compensation expense only for those awards that are expected to vest. We considered (along with our own actual experience) the forfeiture rates of semiconductor peer companies due to our lack of extensive history. Our volatility assumption is forecasted based on our historical volatility over the expected term. We base the risk-free interest rate that we use in the option-pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option-pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. All share based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating loss, net loss and net loss per share. In addition, we have issued options, restricted stock and performance accelerated restricted stock units whose vesting is based on the achievement of specified performance targets. Stock-based compensation expense for these awards is recognized when achievement of the performance targets is probable, except for the performance accelerated restricted stock units where stock based compensation expense is recognized both on a graded vesting basis and when achievement of the performance targets is probable. As a result of the unpredictability of the vesting of the performance-based options, restricted stock and performance accelerated restricted stock units, our stock-based compensation expense is subject to fluctuation. The guidance in SFAS 123R and SAB 107 is relatively new. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of stock-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

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

Write-down of Excess and Obsolete Inventory

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

Valuation of Intangible Assets and Goodwill

We periodically evaluate our intangible assets and goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” for indications of impairment whenever events or changes in

circumstances indicate that the carrying value may not be recoverable. Intangible assets include goodwill and purchased technology. Factors we consider important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, or significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset over its remaining useful life is made. If this evaluation indicates that the intangible asset is not recoverable, the net carrying value of the related intangible asset will be reduced to fair value, and the remaining amortization period may be adjusted. Any such impairment charge could be significant and could have a material adverse effect on our reported financial statements if and when an impairment charge is recorded. If an impairment charge is recognized, the amortization related to intangible assets would decrease during the remainder of the fiscal year.

Income Taxes

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

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

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

Restructuring

During fiscal 2002 and 2001, we recorded significant restructuring charges representing the direct costs of exiting certain product lines or businesses and the costs of downsizing our business. Such charges were established in accordance with the then applicable accounting standards: Emerging Issues Task Force Issue 94-3 (“EITF 94-3”) “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” and Staff Accounting Bulletin No. 100, “Restructuring and Impairment Charges.” These charges include abandoned leased properties comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and asset impairment charges on tenant improvements deemed no longer realizable. In determining these estimates, we make certain assumptions with regards to our ability to sublease the space and reflect offsetting assumed sublease income in line with our best estimate of current market conditions. Should there be a further significant change in market conditions, the ultimate losses on these could be

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

On October 30, 2006, the Company’s Board of Directors committed the Company to a restructuring plan to close and exit the Company’s Milpitas fabrication facility (“fab”) during the first quarter of 2007. The Milpitas fab produces some of the Company’s gallium arsenide semiconductor products and has substantial excess capacity. The Company’s lease of the fab expired on November 14, 2006 and in accordance with the terms of the lease the Company is continuing the lease on a month-to-month basis until the closure is complete. The 2006 restructuring benefit and reversals are established in accordance with the provisions of SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities”.

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

Impairment of Long-Lived Assets

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

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

Current Operations

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, changing market conditions and other factors, the historical percentages and comparisons set forth below may not reflect our expected future operations.

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

Comparison of Years Ended December 31, 2006, 2005 and 2004

Sales

We recognized sales of $48.8 million, $31.6 million and $32.3 million in 2006, 2005 and 2004, respectively. The increase in sales in 2006 is due to the substantial increase in demand for our products in the wireless infrastructure market particularly related to the growth of 3G systems. This increased demand was particularly strong in Asia where sales increased 69% and Europe where sales increased 209%. Part of the sales growth in Asia and Europe is attributable to our direct shipments to our distributor’s newly established overseas stocking hubs rather than shipping through the distributor’s stocking hub in the United States which gives us greater visibility to end customer demand. Over the comparable twelve-month periods, we have experienced an approximate 1% decrease in the mix weighted average selling price of our semiconductor products. Units shipped in 2006 increased to 23.9 million units from 17.0 million units in 2005. Sales in the comparable period in 2005 were also impacted by the change in application of our revenue recognition policy regarding sales to our distributors resulting in a $4.1 million revenue deferral in our second quarter of 2005. For further discussion, see Note 2 to the condensed consolidated financial statements included elsewhere in this Form 10-K.

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

due to our acquisition of Telenexus representing $1.2 million of our sales in 2005. During 2005, we have experienced an approximate 4% decrease in the average selling price of our semiconductor products due to competitive pressure. The increase in our 2005 sales was partially offset by a change in the application of our revenue recognition policy from revenue recognition upon shipment to our distributors to revenue recognition when our distributors have sold the product to the end customer as discussed above under “Critical Accounting Policies and Estimates”.

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

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

Cost of Goods Sold

Our cost of goods sold for 2006 was $23.7 million, an increase of $6.8 million or 40% as compared with cost of goods sold of $16.9 million in 2005. Our cost of goods sold for 2005 increased by $1.6 million or 11% as compared with cost of goods sold of $15.3 million in 2004. As a percentage of sales, our cost of goods sold decreased to 49% in 2006 from 54% in 2005 which increased from 47% in 2004. The 2006 decrease in our cost of goods sold as a percentage of sales reflects a favorable change in our product sales mix to higher margin semiconductor products. This decrease was partially offset by inventory write-downs to reduce excess inventories to their estimated net realizable value amounting to $1.6 million for 2006. The majority of the excess inventory write-down related to a faster than anticipated industry transition to lead-free parts. We also revised our depreciation estimates for certain equipment in the wafer fabrication facility resulting in increased depreciation of $337,000 in the fourth quarter over what the depreciation amount would have been. See note 12 to the consolidated financial statements for further information on our restructuring plan to close and exit our Milpitas fabrication facility in the first quarter of 2007. The 2005 increase in our cost of goods sold as a percentage of sales and in absolute dollars reflected an increase percentage of newer products in our product mix, which had not yet achieved the volumes, or yields of our more mature products

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

Research and Development

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

The increase in research and development expense as a percentage of sales from 2004 to 2005 reflects the factors noted above as well as the decrease in sales. We generate revenues from development contracts with customers that have enabled us to accelerate our own product development efforts. Such

development revenues have only partially funded our product development activities, and we generally retain ownership of the products developed under these arrangements. As a result, we classify all development costs related to these contracts as research and development expenses. We recorded revenue of $770,000 and $832,000 under such development agreements in 2006 and 2005, respectively.

Product research and development is essential to our future success and we expect to continue making investments in new product development and engineering talent. In 2007 we will continue to focus our research efforts and resources on semiconductor development targeting multiple growth markets such as RF amplifiers, mixer and converters for wireless infrastructure, Base Station Power amplifiers, WiMAX and RFID. We will also explore process capabilities of third party foundries and develop products under new process technologies such as SiGe BiCMOS. We expect expenditures for new product development to increase although we expect a decrease in overall R&D expense during 2007 as a result of significantly reducing process development costs as we move towards a fabless semiconductor manufacturing model.

Selling and Administrative

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

The increase in expense during 2005 related to a $1.2 million charge for a former CEO separation agreement, a $754,000 increase related to the acquired administrative operations of Telenexus, $445,000 of professional fees related to a potential strategic business combination which we decided not to consummate, a $412,000 increase in legal fees resulting from additional corporate governance requirements, a $646,000 charge related to severance and a $398,000 increase in external sales representatives commission due to the increase in semiconductor sales over the prior year’s period. These increased costs were partially offset by a $267,000 decrease in bonus expense and a $156,000 decrease in insurance premiums.

Acquired In-process Research and Development Expenses

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

During 2004, $8.5 million of the purchase price for the acquisition of the wireless infrastructure business and associated assets from EiC was allocated to acquired in-process research and development expense (“IPRD”). Projects that qualify as in-process research and development represent those that have not yet reached technological feasibility and have no future alternative use. Technological feasibility is defined as being equivalent to a beta-phase working prototype in which there is no remaining risk relating to the development.

Restructuring Charges

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

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

During 2004, we reversed the lease loss associated with our internal wafer fabrication facility (“fab”) and remaining severance accrual under the Third Quarter 2002 and Fourth Quarter 2002 Restructuring Plans due to our assessment and subsequent decision to not close our fab as we believed at that time that integrating the newly acquired fab from EiC with our pre-existing fab will offer the Company certain benefits over outsourcing the pre-existing fab. This reversal was partially offset by a net increase in the lease loss accrual for our other leased facilities based on reductions in sublease occupancy rates and a net increase in facility operating costs.

Interest Income

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

Interest Expense

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

Income Tax Benefit

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

The tax benefit for 2005 of $120,000 resulted as the statute of limitations had expired on certain estimated federal tax exposures. In 2004, we recorded a tax benefit of $7.7 million resulted from a revision of our estimated income tax contingency liability due to our receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns. As of December 31, 2006, the balance of the contingent income tax liability was $419,000.

Liquidity and Capital Resources

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

On January 23, 2007, WJ Communications, Inc. (the “Company”) entered into a fifth amendment which extends the maturity date from January 21, 2007 to June 30, 2008 of its Amended and Restated Loan and Security Agreement (the “Credit Facility”) between Comerica Bank and the Company dated September 23, 2003 and as amended June 13, 2005, July 12, 2005, September 28, 2005, and December 27, 2005. Comerica also provided the Company with a letter agreement that, starting on January 22, 2007, the Company had a 30-day grace period until the credit facility automatically expired during which period the credit facility remained in full force without lapse or termination. Interest rates on outstanding borrowings are periodically adjusted based on certain financial ratios and are initially set, at our option, at LIBOR plus 2.0% or Prime less 0.25%. The Revolving Facility requires us to maintain certain financial ratios, (such as a minimum unrestricted cash balance and a minimum tangible net worth), and contains limitations on, among other things, our ability to incur indebtedness, pay dividends and make acquisitions without the bank’s permission. The Revolving Facility is secured by substantially all of our assets. We were in compliance with the covenants as of December 31, 2006. As of December 31, 2006 and December 31, 2005, there were no outstanding borrowings under the Revolving Facility. We have letters of credit of $3.2 million available as of December 31, 2006 and 2005 that are being used as collateral on our leased facilities.

Net Cash Used by Operating Activities

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

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

The most significant cash item impacting the difference between net loss and cash flows used in operations in 2005 was $223,000 used by working capital. The $223,000 used by working capital primarily relates to a $2.7 million decrease in restructuring liabilities which were partially offset by a $1.6 million increase in accruals and accounts payable and a $516,000 decrease in inventories. The $2.7 million decrease in restructuring liabilities primarily relates to payments against the remaining lease loss accrual. The $1.6 million increase in accruals and accounts payable relates primarily to the timing of payments within terms. Non-cash items included in net loss in 2005 included $3.1 million of depreciation and amortization and $3.4 million of IPRD related to our acquisition of Telenexus, Inc.

The most significant cash item impacting the difference between net loss and cash flows used in operations in 2004 was $7.6 million used in working capital. The $7.6 million used in working capital primarily relates to a $2.3 million increase in receivables, a $2.4 million decrease in restructuring liabilities, a $1.0 million increase in other assets and a decrease of $867,000 in income tax contingency liability. Our receivables increased $2.3 million due to increased shipments during the fourth quarter of 2004. The $2.4 million decrease in restructuring liabilities primarily relates to payments against the remaining lease loss accrual. The increase in other assets of $1.0 million is primarily due to a $576,000 accrual of a settlement related to the termination of the supply agreement with EiC (see Note 4 to the consolidated financial statements included elsewhere in this Form 10-K) and a $560,000 increase in accrued interest receivable related to our investments. The decrease of $867,000 in income taxes payable relates to payments resulting from an audit of our 1996 through 2000 returns. Non-cash items included in net loss in 2004 included $2.8 million of depreciation and amortization, $8.5 million of IPRD related to our acquisition of the wireless infrastructure business and associated assets from EiC and $7.7 million related to a decrease in our income tax contingency liability resulted from a revised estimate of our tax contingency liability related to the audit of our 1996 through 2000 tax returns as a result of our receipt of the final assessment from the Internal Revenue Service.

Net Cash Provided (Used) by Investing Activities

Net cash provided (used) by investing activities was $5.8 million, ($1.5) million and $18.2 million in 2006, 2005 and 2004, respectively. In 2006, we realized $29.6 million in proceeds from the sale and maturities of our short term investments which was partially offset by $21.9 million used to purchase short-term investments and $2.1 million to invest in property, plant and equipment. In 2005, we used $34.9 million to purchase short-term investments, $3.2 million to acquire Telenexus, Inc. including associated acquisition costs and $1.5 million to purchase equipment which was partially offset by $37.6 million in proceeds we realized from the sale and maturities of our short-term investments. In 2004, we realized $89.2 million in proceeds from the sale of short term investments which was partially offset by $59.3 million used to purchase short-term investments, $10.7 million of acquisition and costs related to the EiC transaction (see Note 4 to the consolidated financial statements included elsewhere in this Form 10-K) and $878,000 to invest in property, plant and equipment. During 2007, we expect to invest approximately $4.0 million to $5.0 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 during 2007

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

Net Cash Provided by Financing Activities

Net cash provided by financing activities totaled $1.8 million, $1.7 million and $10.7 million in 2006, 2005 and 2004, respectively. In 2006, we received net proceeds of $2.1 million from the sale of our common stock to employees through our employee stock purchase and options plans. In 2005, we received net proceeds of approximately $1.9 million from the sale of our common stock to employees through our employee stock purchase and option plans which was partially offset by $201,000 representing 117,439

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

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

Contractual Obligations

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

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

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

(2) Purchase obligations are primarily orders for raw material, processed silicon wafers and assembly and test services. While the purchase orders are generally cancelable without penalty, certain vendor agreements provide for percentage-based cancellation fees or minimum restocking charges based on the nature of the product or service. We expect to receive and pay for these materials and services within the next six months.

(3) The only component of Other Long-Term Liabilities that requires us to make cash payments is a restructuring accrual of $10.5 million relating to the future operating lease payments on certain facilities that were included in our restructuring plans (See Note 12 to the consolidated financial statements included elsewhere in this Form 10-K). We will make these payments through 2011. We included these amounts in the operating lease total in the table above. Excluding payments under the operating lease component included in the restructuring accrual, the other components of Other Long-Term Liabilities do not contractually require us to make cash payments and primarily consist of estimated operating costs on restructured facilities, deferred rent and estimated environmental costs

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

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

The expected timing of payment of the obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

Off-Balance Sheet Arrangements

We do not have any special purpose entities or off-balance sheet financing arrangements except for operating leases as discussed in Note 10 to the consolidated financial statements included elsewhere in this Form 10-K.

Change in Filer Status

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

Other Matters

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

The Company is currently evaluating the impact of adopting FIN 48 on our Consolidated Financial Statements.

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

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

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

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.”

Litigation—From time to time we are involved in litigation, regulatory proceedings and claims that are incidental to the conduct of our business in the ordinary course. While we currently believe that any adverse outcome of such matters would not materially affect our business or financial condition, there can be no assurance that this will ultimately be the case.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

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

See notes to consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)

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

See notes to consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)

(In thousands, except share amounts)

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

See notes to consolidated financial statements.

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

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

See notes to consolidated financial statements.

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

1. ORGANIZATION AND OPERATIONS OF THE COMPANY

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

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.

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS—Cash and cash equivalents consist of money market funds and commercial paper acquired with remaining maturities 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 maturities 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—net.

FAIR VALUE OF FINANCIAL INSTRUMENTS—The carrying value of cash and equivalents, receivables and accounts payable are a reasonable approximation of their fair market value due to the short-term maturities of those instruments. Short-term investments are classified as available-for-sale and 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.

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

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

PROPERTY, PLANT AND EQUIPMENT—Property, plant 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 four to ten years. Leasehold improvements are amortized over the shorter of the remaining lease term or the asset’s useful life. Costs incurred to maintain property, plant and equipment that do not increase the useful life of the underlying asset are expensed as incurred. Asset retirement obligations are amortized over the useful life of the related asset.

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

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

IMPAIRMENT OF LONG-LIVED ASSETS—In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Factors the Company considers 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 use of the acquired assets or the strategy for the overall business; significant negative industry or economic trends; or significant technological changes, which would render equipment and manufacturing processes obsolete. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of these assets to future undiscounted cash flows expected to be generated by these assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets The Company recognized an impairment loss of $637,000 in 2006 relating to certain acquired intangible assets that the Company discontinued using in 2006 (see Note 5). No impairment losses were incurred in 2005 and 2004. The Company revised its depreciation estimates for certain equipment in the wafer fabrication facility resulting in increased depreciation of $337,000 in the fourth quarter over what the depreciation amount would have been. See note 12 to the condensed consolidated financial statements for

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

further information on the Company’s restructuring plan to close and exit the Milpitas fabrication facility in the first quarter of 2007.

REVENUE RECOGNITION—The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition.” SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees. Effective the second quarter ended July 3, 2005, the Company changed the application of its revenue recognition policy regarding its distributors. The Company had previously recognized revenue upon shipment to its distributors less estimated reserves for distributor right of return, authorized price reductions for specific end-customer sales opportunities and price protection based on known events and historical trends. Effective for the second quarter ended July 3, 2005, the Company recognizes revenue from its distribution channels when its distributors have sold the product to the end customer. Historically, the Company has received stock rotation requests from the Company’s distributors that were within the amounts estimated and contractually allowed with only one exception of an insignificant amount. However, the request for stock rotation during our second quarter ended July 3, 2005 was higher than the amount contractually allowed. The Company’s management, with the concurrence of the Company’s Audit Committee, believes the increasing percentage of new products introduced by the Company makes it likely that stock rotation reserves will continue to be difficult to estimate based on historical patterns and contractual provisions. Based on this change in facts and circumstances and our management’s future expectations, the Company believes that the Company can no longer reasonably estimate the amount of future returns from our distributors as of July 3, 2005. Accordingly, recognition of revenue and associated cost of sales on shipments to distributors is deferred until the resale to the end customer. This change in application resulted in a $4.1 million revenue deferral in the Company’s second quarter of 2005, which is reflected in the accompanying consolidated statements of operations for 2005. Although revenue is deferred until resale, title of products sold to distributors transfers upon shipment. Accordingly, shipments to distributors are reflected in the consolidated balance sheets as accounts receivable and a reduction of inventories at the time of shipment. Deferred revenue and the corresponding cost of sales on shipments to distributors are reflected in the consolidated balance sheet on a net basis as “Deferred margin on distributor inventory.”

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

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

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

Distributor Price Protection: If the Company reduces the prices of its products as negotiated with the distributor, the distributor may receive a credit for the difference between the price paid by the distributor and the reduced price on applicable unsold products remaining in the distributor’s inventory on the effective date of the price reduction assuming that inventory is less than 24 months old as determined by the original invoice date. When the Company recognized revenue upon shipment to its distributors, the Company reserved for distributor price protection per issue 4 of EITF 01-9 based on specific identification of its initiated price reductions and the associated reported distributor inventory. There were no such price reductions in 2006, 2005 or 2004.

Development Contracts: The Company may enter into contracts to perform research and development for others meeting the requirements of Statement of Financial Accounting Standards No. 68 “Research and Development Arrangements”. Revenue under these development agreements is recognized when applicable contractual non-refundable milestones have been met, including deliverables, and in any case, does not exceed the amount that would be recognized using the percentage-of-completion accounting method based on the actual physical completion of work performed and the ratio of costs incurred to total estimated costs to complete the contract in accordance with Accounting Research Bulletin 45 “Long-Term Construction Type Contracts” using the relevant guidance in the American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. For contracts including significant software development efforts, the provisions of SOP 97-2 “Software Revenue Recognition” are also followed. Given the duration and nature of these development contracts, the Company believes that recognizing revenue under the percentage completion method best represents the legal and economic results of contract performance on a timely basis. Losses on contracts are recognized when determined. Revisions in estimates are reflected in the period in which the conditions become known. These development contracts with customers have enabled the Company to accelerate its own product development efforts. Such development revenues have only partially funded its product development activities, and the Company generally retains ownership of the products developed under these arrangements. As a result, the Company classifies all development costs related to these contracts as research and development expenses. The achievement of contractual milestones is evidenced by written documentation provided by the customer in accordance with the applicable terms and conditions of each contract. In any period, progress on the contract is based on input measures (direct labor dollars, direct material costs and direct outside processing costs) in the ratio of costs incurred to total estimated costs. Estimated costs to complete are provided by engineering personnel directly involved in the development program and are reviewed by management and finance personnel for reasonableness given the known facts and circumstances. A number of internal and external factors can

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

RECEIVABLES ALLOWANCES—Receivables amounts on the balance sheet are shown net of the following allowances (in thousands):

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

PRODUCT WARRANTY—The Company generally sells products with a limited warranty of product quality and a limited indemnification of customers against intellectual property infringement claims related to the Company’s products. Such warranty generally ranges from 12 to 24 months. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but unidentified issues based on historical activity. The Company generally sells products with a limited warranty of product quality and a limited indemnification of customers against intellectual property infringement claims related to the Company’s products. Such warranty generally ranges from 12 to 24 months. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but unidentified issues based on historical activity. The Company estimates the cost of warranty based on the warranty period for the product, the historical field return rates for a given product or family of products and the average cost required to repair or replace the product. Allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods. Components of the reserve for warranty costs during 2006, 2005 and 2004 consisted of the following (in thousands):

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

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 loss per share is computed using the daily weighted average number of common shares outstanding for the period. Diluted loss per share includes the above and reflects the potential dilution that could occur if stock options whose exercise price are less than the average share price for the period were exercised or converted into common stock and shares related to contributions under the Employee Stock Purchase Plan for pending purchases, however, such adjustments are excluded when they are anti-dilutive. In determining the dilutive effect of the stock options, the number of shares resulting from the assumed exercise of the options is reduced by the number of shares that could have been purchased by the Company with the proceeds from the exercise of such options including excess tax benefits and unamortized deferred stock compensation.

CONCENTRATION OF CREDIT RISK—Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and trade receivables. The Company maintains cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company invests in a variety of financial instruments such as money market funds, commercial paper and high quality corporate bonds, and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. At December 31, 2006, two customers represented 23% and 20% of the total accounts receivable balance. At December 31, 2005, three customers represented 32%, 15% and 13% of the total accounts receivable balance, respectively. The Company maintains an allowance for doubtful accounts based upon the expected collectibility of receivables.

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. Key estimates include allowance for doubtful accounts, reserves for sales returns, write-down of excess and obsolete inventories, income tax contingency reserves, valuation of deferred tax assets and restructuring accruals. Actual results could differ from those estimates.

STOCK-BASED COMPENSATION—Effective January 1, 2006, the Company adopted the provisions of, and accounts for stock-based compensation in accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”, (“SFAS 123R”) which replaced Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, (“SFAS 123”) and supersedes APB Opinion No. 25 , “Accounting for Stock Issued to Employees”, (“APB 25”). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

vesting period. The Company elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures which included adjustments for estimated forfeitures. See Note 8 for further information regarding our stock-based compensation assumptions and expenses, including pro-forma disclosures for prior periods as if the Company had recorded stock-based compensation expense.

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

On November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. SFAS 123 (R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123R. The Company has adopted this simplified method.

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

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

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

balance sheet, statement of operations and the related financial statements disclosures. Early adoption of the guidance in SAB 108 is encouraged in the interim periods of fiscal year ending after November 15, 2006. The Company adopted SAB 108 as of the year ended December 31, 2006. The adoption did not have a material impact on its consolidated results of operations and financial condition.

3. INVESTMENTS

Available-for-Sale Investments

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

														Classified on Balance Sheet as:
	Purchase/			Gross			Gross							Cash
	Amortized			Unrealized			Unrealized				Aggregate			and Cash			Short-term
	Cost			Gains			Losses				Fair Value			Equivalents			Investments
As of December 31, 2006
Corporate debt securities		$	11,695		$	—		$	—			$	11,695		$	3,296		$	8,399
Money market funds		12,750			—			—				12,750			12,750			—
Total		$	24,445		$	—		$	—			$	24,445		$	16,046		$	8,399

As of December 31, 2005
Corporate debt securities		$	16,069		$	—		$	(9	)		$	16,060		$	1,001		$	15,059
Money market funds		10,773			—			—				10,773			10,773			—
U. S. government agency		999			—			(6		)		993			—			993
Total		$	27,841		$	—		$	(15	)		$	27,826		$	11,774		$	16,052

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

Impairment of Investments

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

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

3. INVESTMENTS (Continued)

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

Risk Management

The Company generally places its investments with high-credit-quality counterparties and, by policy, all financial instruments and counterparties must maintain the following minimally acceptable credit ratings: commercial deposits and corporate obligations A2/A, commercial paper A-1/P-1, municipal notes MIG 1/S and P-1, municipal bonds AAA and asset back securities AAA. The Company, by policy, also limits the amount of credit exposure with any one financial institution or commercial issuer. No significant concentration of credit risk existed at December 31, 2006.

4. BUSINESS COMBINATIONS

EiC Acquisition

On June 18, 2004, the Company completed its acquisition of the wireless infrastructure business and associated assets from EiC. The aggregate purchase price was $13.3 million. In connection with the acquisition, $1.5 million in cash and 294,118 shares of common stock were held in escrow as security against certain financial contingencies. On March 30, 2005, the Company made a claim against the escrow account for unpaid invoices issued under the supply agreement. The Company received those funds on May 4, 2005. The uncontested amount was released to EiC on April 5, 2005 per the escrow agreement and the residual balance of the $1.5 million was released to EiC on May 4, 2005. On March 24, 2006, the Company made a claim against 147,059 of the 294,118 shares in the escrow account pending resolution of claims made by a vendor regarding a pre-acquisition contact and released the uncontested 147,059 shares from the escrow. The Company reached a settlement with EiC on May 25, 2006 resulting in the remaining 147,059 shares being released from escrow on June 16, 2006.

The EiC acquisition agreement contained contingency clauses which could have required the Company to pay further consideration of up to $14 million if specific revenue and gross margin targets were achieved by March 31, 2005 and March 31, 2006, of which $7 million of the additional compensation related to the period ended March 31, 2005. The Company has determined that the revenue and gross margin targets were not met for both the periods ended March 31, 2005 and March 31, 2006, and this was communicated to EiC. EiC subsequently notified the Company that it disagrees with the Company’s conclusions. While the Company believes EiC’s assertions are without merit and has notified EiC of such, there can be no assurances as to the eventual outcome of this matter.

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

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

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

4. BUSINESS COMBINATIONS (Continued)

summarizes the allocation of the total purchase price of the EiC acquisition, as of the date of the acquisition (in thousands):

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

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

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

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

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

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

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

4. BUSINESS COMBINATIONS (Continued)

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

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

Telenexus Acquisition

On January 28, 2005, the Company completed its acquisition of Telenexus, Inc. (“Telenexus”). Pursuant to an Agreement and Plan of Merger, dated January 19, 2005, by and between the Company, WJ Newco, LLC (the “WJ Sub”), Telenexus and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton (collectively the “Shareholders”), Telenexus merged with and into the WJ Sub effective on January 29, 2005. The WJ Sub was the survivor in the merger and is a wholly owned subsidiary of the Company. Telenexus designs, develops, manufactures and markets radio frequency identification (“RFID”) reader products for a broad range of industries and markets. By virtue of the merger, the Company purchased through the WJ Sub all of the assets necessary for the conduct of the RFID business of Telenexus, consisting primarily of, and including, but not limited to RFID modules, baseband processing algorithm technology, applications software and realizations of several reader product designs. The consideration paid by the Company on the closing date in connection with the merger consisted of cash in the amount of $3.0 million, which was paid out of the Company’s cash reserves on the closing date, and 2,333,333 shares of the Company’s common stock valued at $8.2 million at the closing date. Including acquisition costs of $230,000, the aggregate purchase price for the net assets of Telenexus totaled $11.4 million. Of the closing consideration, cash in the amount of $500,000 and 333,333 shares of the Company’s common stock was held in escrow with respect to any indemnification matters under the merger agreement.

The outstanding cash balance of the escrow account less any properly noticed unpaid or contested amounts was to be distributed within two days after October 28, 2005. The Company released the full amount of the cash balance of the escrow account on October 31, 2005. The 333,333 shares in the escrow account less any shares for any properly noticed unpaid or contested amounts have been fully distributed. The fair value of the Company’s common stock was determined based on the average closing price per share of the Company’s common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (January 31, 2005). In addition to the closing consideration, the sellers may be entitled to further compensation of up to $2.5 million in cash and up to 833,333 shares of the Company’s common stock if the Company achieves certain revenue targets by July 28, 2006. The Company determined that the revenue targets were not met and communicated its conclusion to the selling shareholders. Any change in the fair value of the net assets of Telenexus or any additional consideration to the Shareholders would change the amount of the purchase price allocable to goodwill. Two of the Shareholders, Richard J. Swanson and Wilfred K. Lau also entered into three-year employment agreements with the Company. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations”

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

4. BUSINESS COMBINATIONS (Continued)

(“SFAS No. 141”), and accordingly the Company’s consolidated financial statements from January 28, 2005 include the impact of the acquisition.

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

Net tangible assets	$	579
In-process research and development	3,400
Amortizable intangible assets:
Developed technology	40
Customer relationships	900
Trademarks and trade names	700
Non-competition agreements	400
Goodwill	5,401
Total purchase price	$	11,420

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

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

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

4. BUSINESS COMBINATIONS (Continued)

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

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

5. GOODWILL AND INTANGIBLE ASSETS

In connection with the acquisition of the wireless infrastructure business and associated assets from EiC on June 18, 2004, the Company recorded $1.8 million of goodwill. Adjustments to the EiC goodwill subsequent to the EiC acquisition date, resulted primarily from a $576,000 benefit from the termination settlement of the associated supply agreement with EiC and partially offset by $152,000 of additional registration statement related expenses. In connection with the acquisition of Telenexus on January 28, 2005, the Company recorded $5.5 million of goodwill. Adjustments to the Telenexus goodwill through December 2006, subsequent to the Telenexus acquisition date, resulted primarily from collection of a previously unrecognized pre-acquisition accounts receivable and finalization of direct acquisition costs. This goodwill was based upon the values assigned to the transactions at the time they were announced in

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

5. GOODWILL AND INTANGIBLE ASSETS (Continued)

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

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

The Company periodically evaluates its goodwill in accordance with SFAS No. 142 for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business, or significant negative industry or economic trends. If these criteria indicate that the value of the goodwill may be impaired, an evaluation of the recoverability of the net carrying value is made. Irrespective of the aforementioned circumstances where impairment indicators are present, the Company is required by SFAS No. 142 to test its goodwill for impairment at least annually. The Company has chosen the end of its fiscal month of May as the date of its annual impairment test. The Company has determined its goodwill was not impaired as of May 31, 2006.

The Company’s Chief Operating Decision Maker (“CODM”) is the CEO. While the Company’s CODM monitors the sales of various products, operations are managed and financial performance evaluated based upon the sales and production of multiple products employing common manufacturing and research and development resources; sales and administrative support; and facilities. This allows the Company to leverage its costs in an effort to maximize return. The Company believes that any allocation of such shared expenses to various products would be impractical, arbitrary and currently does not make such allocations internally. As such, the Company considers itself a single reporting unit.

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

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

5. GOODWILL AND INTANGIBLE ASSETS (Continued)

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

As of December 31, 2006:

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

As of December 31, 2005:

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

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

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

5. GOODWILL AND INTANGIBLE ASSETS (Continued)

personnel are amortized to operating expense. The Company expects that annual amortization of acquired intangible assets to be as follows (in thousands):

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

6. BORROWING ARRANGEMENTS

On January 23, 2007, WJ Communications, Inc. entered into a fifth amendment which extends the maturity date from January 21, 2007 to June 30, 2008 of its Amended and Restated Loan and Security Agreement (the “Credit Facility”) between Comerica Bank and the Company dated September 23, 2003 and as amended June 13, 2005, July 12, 2005, September 28, 2005, and December 27, 2005. Comerica also provided the Company with a letter agreement that, starting on January 22, 2007, the Company had a 30-day grace period until the credit facility automatically expired during which period the credit facility remained in full force without lapse or termination. 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 2.0% or Prime less 0.25%. The Revolving Facility requires the Company to maintain certain financial ratios, (such as a minimum unrestricted cash balance and a minimum tangible net worth), and contains limitations on, among other things, its ability to incur indebtedness, pay dividends and make acquisitions without the bank’s permission. The Revolving Facility is secured by substantially all of the Company’s assets. The Company was in compliance with the covenants as of December 31, 2006. As of December 31, 2006 and December 31, 2005, there were no outstanding borrowings under the Revolving Facility. The Company has letters of credit of $3.2 million available as of December 31, 2006 that are being used as collateral on its leased facilities.

7. OTHER LONG-TERM OBLIGATIONS

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

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

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

8. STOCKHOLDERS’ EQUITY

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

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

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

STOCK OPTION PLANS—During 2000, the Company’s “2000 Stock Incentive Plan” and “2000 Non-Employee Director Stock Compensation Plan” (collectively the “Plans”) were adopted and approved by the Board and the Company’s stockholders. Under the Plans, the Company may grant incentive awards in the form of options to purchase shares of the Company’s common stock, restricted shares, common stock and stock appreciation rights to participants, which include non-employee directors, officers and employees of and consultants to the Company and its affiliates. On May 22, 2002, the Board approved the adoption of an amendment to the Company’s “2000 Stock Incentive Plan” to increase the number of shares of common stock authorized for issuance from 16,500,000 to 19,000,000 shares.

This plan amendment did not affect any other terms of the “2000 Stock Incentive Plan.” On May 29, 2003, the Board approved the adoption of an amendment to the Company’s “2000 Non-Employee Director Compensation Plan” to increase the number of shares of common stock authorized for issuance from 570,000 to 800,000, which was approved by the Company’s stockholders on July 15, 2003 at the Company’s Annual Meeting of Stockholders. Also on May 29, 2003, the Board approved the adoption of a second amendment to the Company’s “2000 Stock Incentive Plan” so that options granted to employees under the “2000 Stock Incentive Plan” will qualify as performance-based compensation under Internal Revenue Code Section 162(m) and thereby not be subject to a deduction limitation. Particularly, the amendment to the “2000 Stock Incentive Plan” provides that no employee or prospective employee shall be granted one or more options within any fiscal year which in the aggregate are for the purchase of more than 3,000,000 shares. On June 1, 2006, the Company’s Board of Directors approved the adoption of an amendment to

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

8. STOCKHOLDERS’ EQUITY (Continued)

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

On May 23, 2001, the Company’s 2001 Employee Stock Incentive Plan was adopted and approved by the Board and the Company’s stockholders. Under the “2001 Employee Stock Incentive Plan”, the Company may grant 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 “2001 Employee Stock Incentive Plan” is 2,000,000 shares. Shares subject to award under the “2001 Employee Stock Incentive 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.

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

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

STOCK-BASED COMPENSATION

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the Company’s expected stock price volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

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

8. STOCKHOLDERS’ EQUITY (Continued)

The Company estimates the expected term of options granted by reviewing annual historical employee exercise behavior of option grants with similar vesting periods and the expected life assumptions of semiconductor peer companies. The Company’s estimate of pre-vesting option forfeitures is based on historical pre-vest termination rates and those of semiconductor peer companies and it records stock-based compensation expense only for those awards that are expected to vest. The Company considered (along with its own actual experience) the forfeiture rates of semiconductor peer companies due to its lack of extensive history. The Company’s volatility assumption is forecasted based on its historical volatility over the expected term. The Company bases the risk-free interest rate that it uses in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option pricing model. The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. All share based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

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

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

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

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

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

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

8. STOCKHOLDERS’ EQUITY (Continued)

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

The following table illustrates the effect for periods prior to the adoption of SFAS 123 on net loss 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” (in thousands except per share amounts):

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

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

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

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

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

8. STOCKHOLDERS’ EQUITY (Continued)

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

The total intrinsic value of options exercised during 2006, 2005 and 2004 was $682,000, $777,000 and $2.0 million respectively.

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

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

The following table summarizes information concerning currently outstanding and exercisable options at December 31, 2006:

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

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

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

8. STOCKHOLDERS’ EQUITY (Continued)

remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards to employees or assumes unvested equity awards in connection with acquisitions.

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

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

The total intrinsic value of restricted stock vested during the year ended December 31, 2006 was $681,000 based on the vest date intrinsic value.

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

EMPLOYEE STOCK PURCHASE PLAN (“ESPP”)—In May 2001, the Company’s stockholders approved the adoption of the Company’s 2001 Employee Stock Purchase Plan (the “Purchase Plan”). Up to 1,500,000 shares of Common Stock may be issued under the Purchase Plan. 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. The plan imposes certain limitations upon an employee’s right to acquire common stock, such as no employee may be granted rights to purchase more than $25,000 worth of common stock for each calendar year in which such rights are at any time outstanding. On June 1, 2006, the Company’s Board of Directors approved the adoption of an amendment to the Company’s Purchase Plan to increase the number of shares of common stock authorized for issuance from 1,500,000 to 2,250,000, which was approved by the Company’s stockholders on July 20, 2006 at the Company’s Annual Meeting of Stockholders.

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

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

9. INCOME TAXES

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

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

In 2006, the Company recorded a net tax benefit of $1.4 million as the statute of limitations had expired on certain estimated state tax exposures. The tax benefit for 2005 of $120,000 resulted from the expiration of the statute of limitations on certain estimated federal tax exposures. In 2004, the Company recorded a tax benefit of $7.7 million resulting from a revision of the Company’s estimated income tax contingency liability due to the receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns.

The differences between the effective income tax rate as applied to loss from operations and the statutory federal income tax rate are as follows:

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

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

9. INCOME TAXES (Continued)

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):

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

As of December 31, 2006, the Company had $1,709,000 in federal minimum tax credit carryforwards which are available indefinitely. The Company also had federal R&D tax credit carryforwards of $5,263,000, which begin to expire in 2012. Additionally, the Company had state tax credit carryforwards of $2,835,000 of which $583,000 begin to expire in 2009 and $2,252,000 are available indefinitely.

At December 31, 2006 the Company had $59,742,000 of federal net operating loss carryforwards which will expire beginning in 2023. The Company also had state net operating loss carryforwards of $70,061,000, which begin to expire in 2013.

Current federal and state tax laws include substantial restrictions on the utilization of net operating losses and tax credits in the event of an “ownership change” of a corporation. Accordingly, the Company’s ability to utilize net operating loss and tax credit carryforwards may be limited as a result of such an ownership change. Such a limitation could result in the expiration of carry forwards before they are utilized.

10. COMMITMENTS AND CONTINGENCIES

Commitments

The Company leases its corporate headquarters and manufacturing facilities under various non-cancelable operating leases expiring through January 2011. See Note 12 for a discussion of restructuring charges recorded related to these leases.

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

10. COMMITMENTS AND CONTINGENCIES (Continued)

Minimum lease commitments as of December 31, 2006 under non-cancelable leases are as follows (in thousands):

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

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

The Company subleases to third parties approximately 31,800 square feet of its abandoned leased space under non-cancelable operating leases expiring through January 2008. This sublease income is incorporated in the restructuring charges related to our lease loss accruals.

Minimum sublease income commitments as of December 31, 2006 under non-cancelable leases are as follows (in thousands):

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

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

Environmental Remediation

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

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

10. COMMITMENTS AND CONTINGENCIES (Continued)

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

Indemnification

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

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

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

12. RESTRUCTURING CHARGES (Continued)

As of December 31, 2006, the maximum potential amount of the lease loss for this property is $9.1 million which is partially offset by $481,000 of minimum sublease income commitments under non-cancelable sublease rental agreements and $152,000 of estimated net sublease income.

The following table summarizes restructuring accrual activity recorded during the years 2004 though December 31, 2006 (in thousands):

	Q3 2001
	Restructuring																							Q4
	Plan				Q3 2002 Restructuring Plan									Q4 2002 Restructuring Plan										2006
	Lease				Workforce			Lease			Asset			Workforce				Lease			Asset			Restructuring
	Loss				Reduction			Loss			Impairment			Reduction				Loss			Impairment			Plan			Total
Balance at January 1, 2004		$	11,511			$	—	$	9,941			$	—		$	253		$	3,921			$	—		$	—	$	25,626
2004 additional charge (credit)		538				—		(377		)		—			(85		)	(3,921		)		—			—		(3,845		)
Non-cash charges		12				—		30				—			—			—				—			—		42
Cash payments		(1,003		)		—		(1,233		)		—			(168		)	—				—			—		(2,404		)
Balance at December 31, 2004		11,058				—		8,361				—			—			—				—			—		19,419
2005 additional charge (credit)		—				—		—				—			—			—				—			—		—
Non-cash charges		46				—		8				—			—			—				—			—		54
Cash payments		(1,420		)		—		(1,277		)		—			—			—				—			—		(2,697		)
Balance at December 31, 2005		9,684				—		7,092				—			—			—				—			—		16,776
2006 additional charge (credit)		—				—		—				—			—			—				—			—		—
Non-cash charges (reversals)		27				—		(487		)		—			—			—				—			174		(286		)
Cash payments		(1,291		)		—		(1,314		)		—			—			—				—			—		(2,605		)
Balance at December 31, 2006		$	8,420			$	—	$	5,291			$	—		$	—		$	—			$	—		$	174	$	13,885

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

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

Of the accrued restructuring charge at December 31, 2006, the Company expects $3.2 million of the lease loss to be paid out over the next twelve months. As such, this amount is recorded as a current liability and the remaining $10.7 million to be paid out over the remaining life of the lease of approximately four years is recorded as a long-term liability.

13. BUSINESS SEGMENT REPORTING

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

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

13. BUSINESS SEGMENT REPORTING (Continued)

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

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

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

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

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

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

14. LOSS PER SHARE CALCULATION

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

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

For the years ended December 31, 2006, 2005 and 2004, the incremental shares from the assumed exercise of 8,888,280, 9,366,759 and 13,727,396 stock options, respectively, and 64,648, 65,936 and 158,601

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

14. LOSS PER SHARE CALCULATION (Continued)

shares for the years ended December 31, 2006, 2005 and 2004, respectively, related to contributions under the Employee Stock Purchase Plan for pending purchases were not included in computing the dilutive per share amounts because operations resulted in a loss and the effect of such assumed exercise would be anti-dilutive.

15. RELATED PARTY TRANSACTIONS

On January 31, 2000, the Company entered into a management agreement with Fox Paine & Company, LLC (“Fox Paine”). Fox Paine was the majority stockholder in the Company at that time. Under that agreement, the Company would pay Fox Paine a management 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. Due to the Company’s loss incurred in 2005, 2004 and 2003, no management fee was paid to Fox Paine for the years ended December 31, 2006, 2005 and 2004, respectively. 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 $29,000, $29,000 and $108,000 for the reimbursement of expenses incurred by Fox Paine in 2006, 2005 and 2004, respectively. The Company also paid Fox Paine $700,000 in July of 2004 for investment banking services rendered in connection with the EiC Acquisition that was completed on June 18, 2004 (see Note 4).

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

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

16. QUARTERLY FINANCIAL DATA—UNAUDITED (Continued)

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

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

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

16. QUARTERLY FINANCIAL DATA—UNAUDITED (Continued)

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

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

2) During the first quarter of 2005, $3.4 million of the purchase price for the acquisition of Telenexus, Inc. was allocated to acquired in-process research and development expense (see Note 4 to the consolidated financial statements).

3) The second quarter of 2005 includes a $1.2 million charge for separation expenses related to the Company’s former CEO.

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

PART IV

Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

1. Financial Statements

The consolidated financial statements, and related notes thereto, of the Company, and the Report of Independent Registered Public Accounting Firm listed in the accompanying Index to Consolidated Financial Statements on page 3 are filed as part of this Form 10-K.

2. Financial Statement Schedules

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

Schedule II—Valuation and Qualifying Accounts

3. Exhibits

The exhibits listed on the following index to exhibits are filed as part of, or hereby incorporated by reference into, this Form 10-K.

Incorporated by Reference

Exhibit

Filing

Filed

Number

Exhibit Description

Form

File No

Exhibit

Date

Herewith

2.1

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

8-K

1-5631

2.1

10/28/99

3.1

Certificate of Incorporation of the Registrant

S-1/A

333-38518

3.1

7/12/00

3.2

By-Laws of the Registrant

S-1/A

333-38518

3.2

7/12/00

4.1

Specimen of Common Stock Certificate

8-A

000-31337

4.1

8/14/00

4.2*

Shareholders’ Agreement, dated as of January 31, 2000, by and among the Registrant, the Parties listed on the signature pages thereto and certain stockholders of the Registrant

S-1/A

333-38518

4.2

7/26/00

10.1*

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

S-1/A

333-38518

10.4

7/12/00

10.2*

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

S-1/A

333-38518

10.6

7/12/00

10.3*

WJ Communications, Inc. 2000 Stock Incentive Plan

S-1/A

333-38518

10.8

7/12/00

10.4

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

S-1/A

333-38518

10.9

7/12/00

10.5

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

S-1/A

333-38518

10.10

7/12/00

100

10.6

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

S-1/A

333-38518

10.17

7/12/00

10.7

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

S-8

333-52408

99.2

12/21/00

10.8*

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

8-K

000-31337

10.1

11/15/04

10.9

Amended and Restated WJ Communications, Inc. 2002 Non-Employee Director Stock Compensation Plan

10-Q

000-31337

10.1 and 10.2

8/12/03

10.10*

Second Amendment to WJ Communications, Inc. 2000 Stock Incentive Plan

10-Q

000-31337

10.1 and 10.2

8/12/03

10.11

Amended and Restated Loan and Security Agreement, dated September 29, 2003, by and among the Registrant and Comerica Bank

10-Q

000-31337

10.1 and 10.2

10/30/03

10.12

Intellectual Property Security Agreement, dated September 29, 2003, by and among the Registrant and Comerica Bank

10-Q

000-31337

10.1 and 10.2

10/30/03

10.13

Acquisition related agreements by and between WJ Communications, Inc., EiC Corporation and EiC Enterprises Limited dated June 18, 2004

8-K

000-31337

2.1, 2.2, 4.1,
4.2 and 10.1

7/2/04

10.14

Acquisition related agreements by and among WJ Communications, Inc., WJ Newco, LLC, Telenexus, Inc. and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton dated January 28, 2005

8-K

000-31337

2.1 and 4.1

2/3/05

10.15††

Employment Agreement by and between WJ Communications, Inc. and Richard J. Swanson dated January 28, 2005

8-K

000-31337

10.1

2/3/05

10.16††

Employment Agreement by and between WJ Communications, Inc. and Wilfred K. Lau dated January 28, 2005

8-K

000-31337

10.2

2/3/05

10.17

Employment agreement between the Registrant and Javed S. Patel

10-Q

000-31337

10.1

5/18/05

10.18*

Employment agreement between the Registrant and Neil Morris, Ph.D.

10-Q

000-31337

10.2

5/18/05

10.19*

Employment agreement between the Registrant and Robert J. Bayruns

10-Q

000-31337

10.3

5/18/05

101

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

102

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

* Indicates a contract, compensatory plan or arrangement in which directors or executive officers are eligible to participate.

† Confidential treatment has been requested with respect to the redacted portions of the referenced exhibit.

†† Confidential treatment has previously been granted by the SEC for certain portions of the referenced exhibit pursuant to Rule 406 under the Securities Act.

103

SCHEDULE II

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
(in thousands)

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

105

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

DELAWARE		94-1402710
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
401 River Oaks Parkway, San Jose, California		95134
(Address of principal executive offices)		(Zip Code)

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

	High		Low
First Quarter (through April 3, 2005)	$	3.68	$	2.18
Second Quarter (through July 3, 2005)	$	2.45	$	1.68
Third Quarter (through October 2, 2005)	$	1.87	$	1.18
Fourth Quarter (through December 31, 2005)	$	1.95	$	0.88
First Quarter (through April 2, 2006)	$	2.57	$	1.58
Second Quarter (through July 2, 2006)	$	3.10	$	1.40
Third Quarter (through October 1, 2006)	$	2.17	$	1.29
Fourth Quarter (through December 31, 2006)	$	2.43	$	1.38

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

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

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

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

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

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

Name of Entity				State or Other Jurisdiction of Incorporation or Organization
WJ Newco, LLC				Delaware

March 28, 2007

/s/ BRUCE W. DIAMOND

Bruce W. Diamond

President and Chief Executive Officer

(principal executive officer)