In this discussion, "Company", "CMD," "we," "us" and "our" refer to California Micro Devices Corporation. All trademarks appearing in this discussion are the property of their respective owners. This discussion should be read in conjunction with the other financial information and financial statements and related notes contained elsewhere in this report.

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates, and projections about our industry; our beliefs and assumptions; and our goals and objectives. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," and "estimates," and variations of these words and similar expressions are intended to identify forward-looking statements. Examples of the kinds of forward-looking statements in this report include statements regarding the following: (1) our expectation that our ASP ("Average Selling Prices") for similar products, based on a constant mix of products, will decline at the rate of approximately 15% per year; (2) our having a target gross margin of 38% to 40%; (3) our expectation that our future environmental compliance costs will be minimal; (4) our anticipation that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs over the next 12 months; (5) our expectation of research and development expenses, both as a percentage of sales and in dollars, to reduce significantly starting with the third quarter of fiscal 2010 primarily as a result of discontinuance of further development of display controller products, and having a long term target for research and development expenses of 9% to 10% of sales; (6) our having a long term target for selling, general and administrative expenses of 15% to 16% of sales but expecting to exceed this target until our sales increase substantially; (7) our expectation of future interest income to continue to be at a reduced level unless interest rates increase materially or we change the instruments in which we invest; and (8) our expectation that we will not pay within one year any of our liability for uncertain tax positions or associated interest and tax penalties. These statements are only predictions, are not guarantees of future performance, and are subject to risks, uncertainties, and other factors, some of which are beyond our control, are difficult to predict, and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, whether our target markets continue to experience their forecasted growth and whether such growth continues to require the devices we supply; whether we will be able to increase our market penetration; whether our product mix changes, our unit volume decreases materially, we experience price erosion due to competitive pressures, or our contract manufacturers and assemblers raise their prices to us or we experience lower yields from them or we are unable to realize expected cost savings in certain manufacturing and assembly processes; whether there will be any changes in tax accounting rules; whether we will be successful in developing new products which our customers will design into their products and whether our bookings will translate into orders; whether we encounter any unexpected environmental clean-up issues with our former Tempe facility; whether we discover any further contamination at our former Topaz Avenue Milpitas facility; whether we will incur any large unanticipated expenses; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under Item 1A, Risk Factors. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

Executive Overview

We design and sell application specific protection devices for high volume applications in the mobile handset, High Brightness LED (HBLED), digital consumer electronics and personal computer markets. These protection devices provide Electromagnetic Interference (EMI) filtering and Electrostatic Discharge (ESD) protection. End customers for our semiconductor products are original equipment manufacturers (OEMs). We sell to some of these end customers through original design manufacturers (ODMs) and contract electronics manufacturers (CEMs). We use a direct sales force, manufacturers' representatives and distributors to sell our products. Our manufacturing is completely outsourced and we use merchant foundries to fabricate our wafers and subcontractors to do backend processing and to ship to our customers. We have one operating segment and most of our physical assets are located outside the United States. Assets located outside the United States include product inventories and manufacturing equipment consigned to our wafer foundries and backend subcontractors.

Results of Operations

The table below shows our net sales, cost of sales, gross margin, expenses and
net loss, both in dollars and as a percentage of net sales, for the three months
ended June 30, 2009 and 2008 (amounts in thousands):

                                              Three Months Ended June 30,
                                             2009                     2008
                                                    % of                     % of
                                                    Net                      Net
                                       Amount      Sales        Amount      Sales
Net sales                             $  9,348        100 %    $ 14,099        100 %
Cost of sales                            7,067         76 %       9,355         66 %
Gross margin                             2,281         24 %       4,744         34 %
Research and development                 2,117         23 %       2,284         16 %
Selling, general and administrative      3,617         39 %       3,865         28 %
Amortization of intangible assets            6          0 %          34          0 %
Operating loss                          (3,459 )      (37 %)     (1,439 )      (10 %)
Other income (expense), net                (11 )       (0 %)        294          2 %
Loss before income taxes                (3,470 )      (37 %)     (1,145 )       (8 %)
Income tax benefit                         (18 )       (0 %)       (226 )       (1 %)
Net loss                              $ (3,452 )      (37 %)   $   (919 )       (7 %)

Net sales

Net sales by market during the three months ended June 30, 2009 and 2008 were as follows (amounts in millions):

                                                  Three Months Ended June 30,
                                                 2009                       2008
                                                       As % of                   As % of
                                                        Total                     Total          $             %
                                        Amount          Sales       Amount        Sales       Change       Change
Mobile handset                         $    4.7              50 %   $   8.1            58 %   $  (3.4 )        (42 %)
Digital consumer electronics and
personal computers                          3.6              39 %       4.7            33 %      (1.1 )        (23 %)
HBLED                                       1.0              11 %       1.3             9 %      (0.3 )        (23 %)
  Total                                $    9.3             100 %   $  14.1           100 %   $  (4.8 )        (34 %)

Net sales during the three months ended June 30, 2009 were $9.3 million, a decrease of $4.8 million or 34% from $14.1 million of net sales in the same period a year ago. Lower sales were experienced across all product lines largely as a result of the sustained weak global economy. Sales from products for the mobile handset market decreased by $3.4 million or 42% during the three months ended June 30, 2009 as compared to the same period a year ago. Sales from products for the digital consumer electronics and personal computer market decreased to $3.6 million during the three months ended June 30, 2009 from $4.7 million in the same period a year ago, down $1.1 million or 23%. Sales from products for HBLED market decreased to $1.0 million during the three months ended June 30, 2009 from $1.3 million in the same period a year ago, down $0.3 million or 23%. The decreases in sales for all product lines were driven by a combination of lower shipments and price declines.

Gross Margin

Gross margin decreased by $2.4 million during the three months ended June 30,
2009 to $2.3 million from $4.7 million during the same period a year ago, due to
the following reasons:

Gross margin increase (decrease) compared to prior period (in millions):
Price change of products based on a constant mix                           $ (1.7 )
Direct cost reductions of our products on a constant mix                      0.7
Volume, mix and other factors                                                (1.4 )
                                                                           $ (2.4 )

The gross margin decrease was primarily driven by price declines of our products, lower shipments and under-absorption of fixed manufacturing overhead driven by lower production volume, partially offset by product cost reductions. Our ASP declined 16% based on a constant mix of products in the first quarter of fiscal 2010 as compared to the same period a year ago. In the future we expect our ASP for similar products, based on a constant mix of products, to decline at the rate of approximately 15% per year. The cost reductions of our products were primarily driven by outsourcing with lower cost subcontractors, migrating from 6" to 8" wafer size and continued improvement in our assembly and testing processes.

As a percentage of sales, gross margin decreased to 24% for the three months ended June 30, 2009, compared to 34% for the same period a year ago. Our long-range gross margin target remains 38% to 40%. However, our gross margin could fail to achieve this target range or could decline.

Research and Development

Research and development expenses consist primarily of compensation and related
costs for employees, prototypes, masks and other expenses for the development of
new products, process technology and packages. The change in research and
development expenses for the three months ended June 30, 2009, compared to the
same period a year ago, is as follows:

Expense increase (decrease) compared to prior period (in thousands):
Outside services                                                       $ (274 )
Salaries and benefits                                                    (105 )
Product related costs                                                     147
Other costs                                                                65
                                                                       $ (167 )

Research and development expenses decreased by $167,000 or 7% during the three months ended June 30, 2009, as compared to the same period a year ago, primarily due to decreased spending for our serial interface display controller line of products.

As a percentage of sales, research and development expenses increased to 23% during the three months ended June 30, 2009 from 16% during the same period a year ago as a result of lower net sales. We expect the research and development expenses, both as a percentage of sales and in dollars, to reduce significantly starting with the third quarter of fiscal 2010 primarily as a result of discontinuance of further development of display controller products. Our long term target for research and development expenses is 9% to 10% of sales.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of compensation
and other employee related costs; sales commissions; marketing expenses; legal,
accounting, and other professional fees; and information technology expenses.
The change in selling, general, and administrative expenses for the three months
ended June 30, 2009, compared to the same period a year ago, is as follows:

Expense increase (decrease) compared to prior period (in thousands):
Sales Commissions                                                      $ (104 )
Salaries and benefits                                                     (93 )
Travel expenses                                                           (82 )
Other expenses                                                           (109 )
Contested proxy expenses                                                  140
                                                                       $ (248 )

Selling, general and administrative expenses decreased by $248,000 or 6% during the three months ended June 30, 2009, respectively, as compared to the same period a year ago primarily due to decreases in sales commissions, salaries and benefits, as well as travel expenses. Decrease in sales commission was due to reduced sales during the first quarter of fiscal 2010 as compared with the same period a year ago, decrease in salaries and benefits was primarily the result of no target bonus payouts during the first quarter of fiscal 2010 and mandatory time off for all employees of the Company, and decrease in travel expenses was the result of cost cutting measures taken by the Company to reduce discretionary spending. The other expenses decreased primarily due to the reduction in stock based compensation expense. During the three months ended June 30, 2009, we incurred additional proxy expenses due to the contested solicitation for election of directors in the 2009 annual meeting of shareholders of approximately $140,000.

As a percentage of sales, selling, general and administrative expenses increased to 39% during the three months ended June 30, 2009 from 28% during the same period a year ago, primarily as a result of lower sales. Our long term target for selling, general and administrative expenses is 15% to 16% of sales. However, selling, general and administrative expenses will continue to exceed our target range and represent more than 16% of sales until our sales increase substantially.

Amortization of Intangible Assets

Amortization of intangible assets was $6,000 during the three months ended June 30, 2009 as compared to $34,000 during the same period a year ago. The decrease in amortization expense during the three months ended June 30, 2009 as compared to a year ago was due to the intervening sale of certain intangible assets and partial impairment of others. For additional information regarding intangible assets, see Note 6 of notes to condensed consolidated financial statements in this Form 10-Q.

Other Income (Expense), Net

Other income (expense), net, mainly includes interest income, interest expense and other non-operating income and expense.

Interest income decreased by $0.3 million during the three months ended June 30, 2009, as compared to the same period a year ago primarily as a result of the overall decline in interest rates and our moving our short-term investments into money market funds and to a lesser extent due to our reduced total amount of cash, cash equivalents and short-term investments. We expect interest income, in the near future, to remain at this reduced level unless interest rates increase materially or we change the instruments in which we invest.

Income Taxes

During the three months ended June 30, 2009 and 2008, income tax benefit was $18,000 and $226,000 respectively. Our income tax benefit decreased during the three months ended June 30, 2009 compared to the same period a year ago, primarily as a result of our changed estimates of our ability to utilize loss carryforwards and the increased valuation allowance against our deferred tax assets. See Note 14 in the notes to condensed consolidated financial statements of this Form 10-Q for further discussion.

Critical Accounting Policies and Estimates

The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes. We base our estimates on historical experience and the known facts and circumstances that we believe are relevant. We have not made any material changes in the accounting methodology used to establish our estimates and assumptions during the first quarter of fiscal 2010. We do not believe there is a reasonable likelihood that there will be a material change in the accounting methodology used to establish our estimates or assumptions. However, actual results may differ materially from our estimates. Our significant accounting policies are described in Note 2 of notes to consolidated financial statements in our annual report on Form 10-K for fiscal year ended March 31, 2009. The significant accounting policies that we believe are critical, either because they relate to financial line items that are key indicators of our financial performance such as revenue or because their application requires significant management judgment, are described in the following paragraphs:

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery or customer acceptance, where applicable, has occurred, the fee is fixed or determinable, and collection is reasonably assured.

Revenue from product sales to end user customers, or to distributors that do not receive price concessions and do not have return rights, is recognized upon shipment and transfer of risk of loss, if we believe collection is reasonably assured and all other revenue recognition criteria are met. We assess the probability of collection based on a number of factors, including past transaction history and customer credit worthiness. If we determine that collection of a receivable is not probable, we defer recognition of revenue until the collection becomes probable, which is generally upon receipt of cash. Reserves for sales returns and allowances from end user customers are estimated based on historical experience and management judgment, and are provided for at the time of shipment. The sufficiency of the reserves for sales return and allowances is assessed at the end of each reporting period.

Revenue from sales of our standard products to distributors, for which we provide price concessions or product return rights, is recognized when the distributor sells the product to an end customer. When we sell such products to distributors, we defer our gross selling price of the product shipped and its related cost and reflect such net amounts on our balance sheet as a current liability entitled "deferred margin on shipments to distributors". We receive periodic reports from our distributors of their inventory of our products and when we test our inventory in order to determine the extent, if any, to which we have excess or obsolete inventory, we also test the inventory held by our distributors. For our custom products and end of life products, if we believe that collection is probable, we recognize revenue upon shipment to the distributor, because our contractual arrangements provide for no right of return or price concessions for those products.

We typically have written agreements with our distributors which provide that
(1) if we lower our distributor list price, our distributors may request for a limited time period a credit for the differential of eligible product in the distributor's inventory and (2) periodically, our distributors have the right to return eligible product to us, provided that the amount returned must be limited to a certain agreed percentage of the value of our shipments to them during such period. Product over a certain age may not be returned and there is a restocking charge if the distributor has not placed a recent commensurate replacement stocking order.

Inventories

Forecasting customer demand is the factor in our inventory policy that involves significant judgments and estimates. We estimate excess and obsolete inventory based on a comparison of the quantity and cost of inventory on hand to management's forecast of customer demand for the next twelve months. In forecasting customer demand, we make estimates as to, among other things, the timing of sales, the mix of products sold to customers, the timing of design wins and related volume purchases by new and existing customers, and the timing of existing customers' transition to new products. We also use historical trends as a factor in forecasting customer demand, especially that from our distributors. We review our excess and obsolete inventory on a quarterly basis considering the known facts. Once inventory is written down, it is valued as such until it is sold or otherwise disposed of. To the extent that our forecast of customer demand materially differs from actual demand, our cost of sales and gross margin could be impacted.

Impairment of long lived assets

Long lived assets are reviewed for impairment whenever events indicate that their carrying value may not be recoverable. An impairment loss is recognized if the sum of the expected undiscounted cash flows from the use of the asset is less than the carrying value of the asset. The amount of impairment loss is measured as the difference between the carrying value of the assets and their estimated fair value.

We account for our intangible assets in accordance with Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). In accordance with SFAS 142, a recognized intangible asset shall be amortized over its useful life to the reporting entity unless that life is determined to be indefinite. If an intangible asset has a finite useful life, but the precise length of that life is not known, that intangible asset shall be amortized over the best estimate of its useful life. SFAS 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment at the reporting unit level at least annually and more frequently if there are indicators of impairment. The amount of impairment loss is measured as the difference between the carrying value of the assets and their estimated fair value. An impairment loss for an intangible asset is recognized if the sum of the expected undiscounted cash flows from the use of the asset is less than the carrying value of the asset. Significant judgment required to estimate the fair value of an intangible asset includes estimating future cash flows and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value.

An intangible asset that is subject to amortization shall be reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". An impairment loss shall be recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. Subsequent reversal of a previously recognized impairment loss is prohibited.

Stock-based Compensation

In accordance with the fair value recognition provisions of SFAS 123(R), we estimate the stock-based compensation cost at the grant date based on the fair value of the award and recognize it as an expense on a graded vesting schedule over the requisite service period of the award.

We estimate the value of employee stock options on the date of grant using the Black-Scholes model. The determination of 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 as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. The use of the Black-Scholes model requires the use of extensive actual employee exercise behavior data and a number of complex assumptions including expected volatility, risk-free interest rate and expected dividends.

Our computation of expected volatility is based on a combination of historical and market-based implied volatility. Our computation of expected life is based on a combination of historical exercise patterns and certain assumptions regarding the exercise life of unexercised options adjusted for job level and demographics. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on our history and expectation of dividend payouts.

As stock-based compensation expense recognized in the condensed consolidated statements of operations for the three months ended June 30, 2009 and 2008 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on an average of historical forfeitures. The expense that we recognize in future periods could differ significantly from the current period and/or our forecasts due to adjustments in assumed forfeiture rates or change in our assumptions.

Income Taxes

We account for income taxes under the asset and liability method; which requires significant judgments in making estimates for determining certain tax liabilities and recoverability of certain deferred tax assets, including the tax effects attributable to net operating loss carryforwards and temporary differences between the tax and financial statement recognition of revenue and expenses, as well as the interest and penalties relating to these uncertain tax positions.

On a quarterly basis, we evaluate our ability to recover our deferred tax assets, including but not limited to our past operating results, the existence of cumulative losses in the most recent fiscal years, and our forecast of future taxable income on a jurisdiction by jurisdiction basis. In the event that actual . . .