10-Q

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Period Ended September 30, 2004

or

¨ Transition Report Pursuant to Section 10 or 15(d) of the Securities Exchange Act of 1934

For The Transition Period from                      to                     

Commission File Number 0-15449

CALIFORNIA MICRO DEVICES

CORPORATION

(Exact name of registrant as specified in its charter)

California	94-2672609
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
430 N. McCarthy Boulevard #100 Milpitas, California	95035
(Address of principal executive offices)	(Zip Code)

(408) 263-3214

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address, and former fiscal year if changed since last report)

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

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

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

The number of shares of the registrant’s Common Stock outstanding as of October 29, 2004 was 21,459,286.

California Micro Devices Corporation

Form 10-Q for the Quarter ended September 30,2004

INDEX

		Page
Item 1.	Financial Statements (Unaudited)
	Condensed Statements of Operations for the three and six months ended September 30, 2004 and 2003	3
	Condensed Balance Sheets as of September 30, 2004 and March 31, 2004	4
	Condensed Statements of Cash Flows for the six months ended September 30, 2004 and 2003	5
	Notes to Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32
Item 4.	Controls and Procedures	32
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 3.	Defaults Upon Senior Securities	33
Item 4.	Submission of Matters to a Vote of Security Holders	33
Item 5.	Other Information	34
Item 6.	Exhibits	34
	Signature	35

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

California Micro Devices Corporation

CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,				Six Months Ended September 30,
	2004		2003		2004		2003
Net sales	$	17,060	$	14,857	$	33,532	$	26,766
Cost and expenses:
Cost of sales		10,273		9,986		20,179		19,142
Research and development		1,207		991		2,413		2,043
Selling, general and administrative		3,254		2,990		6,480		5,668
Total costs and expenses		14,734		13,967		29,072		26,853
Operating income (loss)		2,326		890		4,460		(87	)
Other expense, net		76		208		191		451
Income (loss) before income taxes		2,250		682		4,269		(538	)
Income taxes		67		—		128		—
Net income (loss)	$	2,183	$	682	$	4,141	$	(538	)
Net income (loss) per share–basic	$	0.10	$	0.04	$	0.20	$	(0.03	)
Weighted average common shares outstanding–basic		21,452		17,642		21,112		16,764
Net income (loss) per share–diluted	$	0.10	$	0.04	$	0.18	$	(0.03	)
Weighted average common shares and share equivalents outstanding–diluted		22,384		17,967		22,713		16,764

See Notes to Financial Statements.

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California Micro Devices Corporation

CONDENSED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

	September 30, 2004			March 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	11,819		$	20,325
Short-term investments		18,862			—
Accounts receivable, less allowance for doubtful accounts of $76 and $76, respectively		9,765			6,134
Inventories		7,570			6,521
Prepaid expenses and other current assets		531			911
Total current assets		48,547			33,891
Property, plant and equipment, net		7,376			6,985
Other long-term assets		175			229
TOTAL ASSETS	$	56,098		$	41,105
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,727		$	4,498
Accrued liabilities		2,495			4,560
Deferred margin on shipments to distributors		2,293			2,459
Current maturities of long-term debt and capital lease obligations		163			2,568
Total current liabilities		9,678			14,085
Long-term debt and capital leases, less current maturities		181			4,684
Other long-term liabilities		27			33
Total liabilities		9,886			18,802
Commitments and contingencies
Shareholders’ equity:
Common stock—no par value; 50,000,000 and 25,000,000 shares authorized as of September 30, 2004 and March 31, 2004, respectively; shares issued and outstanding: 21,456,786 as of September 30, 2004 and 19,788,088 as of March 31, 2004		104,760			84,991
Accumulated other comprehensive loss		(1	)		—
Accumulated deficit		(58,547	)		(62,688	)
Total shareholders’ equity		46,212			22,303
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	56,098		$	41,105

See Notes to Financial Statements.

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California Micro Devices Corporation

CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended September 30,
	2004			2003
Cash flows from operating activities:
Net income (loss)	$	4,141		$	(538	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization		830			1,288
Amortization of investment purchase discounts		(64	)		—
Provision for discontinued inventory		534			853
Write-down of fixed assets		166			233
Stock-based compensation		17			94
Loss (gain) on the sale of fixed assets		30			(16	)
Changes in assets and liabilities:
Accounts receivable		(3,631	)		(714	)
Inventories		(1,583	)		(1,637	)
Prepaid expenses and other current assets		380			428
Other long-term assets		—			(18	)
Accounts payable and other current liabilities		(1,836	)		1,754
Deferred margin on shipments to distributors		(166	)		(516	)
Other long-term liabilities		(6	)		38
Net cash (used in) provided by operating activities		(1,188	)		1,249
Cash flows from investing activities:
Purchases of short-term investments		(52,499	)		—
Sales of short-term investments		33,700			—
Proceeds from sale of fixed assets		8			20
Capital expenditures		(1,207	)		(106	)
Net change in restricted cash		—			(100	)
Net cash used in investing activities		(19,998	)		(186	)
Cash flows from financing activities:
Repayments of capital lease obligations		(11	)		(9	)
Repayments of long-term debt		(7,061	)		(708	)
Net proceeds from issuance of common stock		19,752			5,569
Net cash provided by financing activities		12,680			4,852
Net increase (decrease) in cash and cash equivalents		(8,506	)		5,915
Cash and cash equivalents at beginning of period		20,325			4,513
Cash and cash equivalents at end of period	$	11,819		$	10,428
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	78		$	703
Income taxes	$	92		$	1

See Notes to Financial Statements.

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California Micro Devices Corporation

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying unaudited condensed financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of California Micro Devices Corporation (the “Company”, “we”, “us” or “our”) as of September 30, 2004, results of operations for the three and six month periods ended September 30, 2004 and 2003, and cash flows for the six month periods ended September 30, 2004 and 2003. Results for the three and six month periods are not necessarily indicative of fiscal year results.

The condensed balance sheet at March 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The condensed financial statements should be read in conjunction with the financial statements included with our annual report on Form 10-K for the fiscal year ended March 31, 2004.

2. Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates are based on historical experience, input from sources outside of the Company, and other relevant facts and circumstances. Actual results could differ from these estimates, and such differences could be material.

3. Stock Based Compensation

As allowed under Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock Based Compensation,” we account for our employee stock plans in accordance with the provisions of Accounting Principles Board’s Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and have adopted the disclosure only provisions of SFAS 123. Stock based awards to non-employees are accounted for in accordance with SFAS 123 and EITF 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Fair value for these awards is calculated using the Black-Scholes option pricing model, which requires that we estimate the volatility of our stock, an appropriate risk-free interest rate, estimated time until exercise of the option, and our dividend yield. The Black-Scholes model was developed for use in estimating the fair value of traded options that do not have specific vesting schedules and are ordinarily transferable. The calculation of fair value is highly sensitive to the expected life of the stock based award and the volatility of our stock, both of which we estimate based primarily on historical experience. As a result, the pro forma disclosures are not necessarily indicative of pro forma effects on reported financial results for future years.

We generally recognize no compensation expense with respect to employee stock grants. Had we recognized compensation for the grant date fair value of employee stock grants in accordance with SFAS 123, our net income and net income per share would have been revised to the pro forma amounts shown below. For pro forma purposes, the estimated fair value of our stock based grants is amortized over the options’ vesting period for stock options granted under our stock option plans, and the purchase period for stock purchases under our stock purchase plan.

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	Three Months Ended September 30,						Six Months Ended September 30,
	2004			2003			2004			2003
	(in thousands, except per share amounts)
Net income (loss)
As reported	$	2,183		$	682		$	4,141		$	(538	)
Add: Stock-based employee compensation expense included in reported results		—			74			17			94
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		(861	)		(590	)		(1,543	)		(890	)
Pro forma net income (loss)	$	1,322		$	166		$	2,615		$	(1,334	)
Basic net income (loss) per share
As reported	$	0.10		$	0.04		$	0.20		$	(0.03	)
Pro forma	$	0.06		$	0.01		$	0.12		$	(0.08	)
Diluted net income (loss) per share
As reported	$	0.10		$	0.04		$	0.18		$	(0.03	)
Pro forma	$	0.06		$	0.01		$	0.12		$	(0.08	)

The fair value of our stock based grants was estimated assuming no expected dividends and the following weighted average assumptions:

	Three Months Ended September 30,				Six Months Ended September 30,
	2004		2003		2004		2003
Employee Stock Options
Expected life in years	4.05		3.21		4.05		3.39
Volatility	0.87		0.97		0.87		0.97
Risk-free interest rate	3.24	%	2.71	%	3.23	%	2.60	%
Employee Stock Purchase Plan
Expected life in years	0.50		0.38		0.49		0.39
Volatility	0.61		0.75		0.67		0.74
Risk-free interest rate	1.78	%	1.54	%	1.51	%	1.57	%

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4. Net Income (Loss) Per Share

The following table sets forth the computation of basic and diluted income (loss) per share:

	Three Months Ended September 30,				Six Months Ended September 30,
	2004		2003		2004		2003
	(in thousands, except per share amounts)
Net income (loss)	$	2,183	$	682	$	4,141	$	(538	)
Weighted average common shares outstanding used in calculation of net income (loss) per share:
Basic shares		21,452		17,642		21,112		16,764
Effect of dilutive securities:
Employee stock options		822		200		1,393		—
Warrants		110		125		208		—
Effect of dilutive securities		932		325		1,601		—
Diluted shares		22,384		17,967		22,713		16,764
Net income (loss) per share:
Basic	$	0.10	$	0.04	$	0.20	$	(0.03	)
Diluted	$	0.10	$	0.04	$	0.18	$	(0.03	)

Options to purchase 756,027 and 461,321 shares of common stock were outstanding during the three and six month periods ended September 30, 2004, respectively, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average closing share trading price reported by Nasdaq (“Average Trading Price”) of the common shares during the three and six month periods ended September 30, 2004. For the three and six months ended September 30, 2004, all outstanding warrants were included in the computation of diluted earnings per share, because the exercise prices of the warrants were less than the Average Trading Price of the common shares during the periods.

Options to purchase 2,218,895 and 3,411,985 shares of common stock were outstanding during the three- and six- month periods ended September 30, 2003, respectively, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the Average Trading Price of the common shares during the three month period ended September 30, 2003, and because we had a loss for the six month period ended September 30, 2003, and, therefore, the effect would have been anti-dilutive. Warrants to purchase 483,667 and 1,290,266 shares of common stock outstanding during the three and six month periods ended September 30, 2003, were not included in the diluted earnings per share computation, because the exercise price of the warrants was greater than the Average Trading Price of the common shares during the three month period ended September 30, 2003 and because we had a loss for the six month period ended September 30, 2003 and, therefore, the effect would have been anti-dilutive.

5. Inventories

The components of inventory consist of the following (amounts in thousands):

	September 30, 2004		March 31, 2004
Raw materials	$	37	$	92
Work in process		3,600		3,345
Finished goods		3,933		3,084
	$	7,570	$	6,521

Inventory balances by stage at March 31, 2004 have been reclassified from amounts shown in our 10-K for the year ended March 31, 2004, to apportion inventory reserves in the same manner as presented for September 30, 2004.

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6. Litigation

We are a party to lawsuits, claims, investigations and proceedings, including commercial and employment matters, which are being handled and defended in the ordinary course of business. We review the current status of any pending or threatened proceedings with our outside counsel on a regular basis and, considering all the other known relevant facts and circumstances, recognize any loss that we consider probable and estimable as of the balance sheet date. For these purposes, we consider settlement offers we may make to be indicative of such a loss under certain circumstances.

During the three month period ended June 30, 2004 we settled pending cases with former employees Chan Desaigoudar and Tarsaim L. Batra. The settlements did not affect our results for the three or six month periods ended September 30, 2004, as our settlement costs had previously been accrued.

7. Comprehensive Income (Loss)

Comprehensive income (loss) is principally comprised of net income (loss) and unrealized gains or losses on our available for sale securities. We reported an unrealized loss of $1,000 on available for sale securities during the three months ended June 30, 2004, and as a result our comprehensive income for the three and six month periods ended September 30, 2004 was $2,183,000 and $4,140,000, respectively. Comprehensive income for the three month period ended September 30, 2003 was $682,000 and equaled net income, and comprehensive loss for the six month period ended September 30, 2003 was $538,000 and equaled net loss.

8. Income Taxes

For the three and six month periods ended September 30, 2004 we recorded income tax provisions of $67,000 and $128,000, respectively, for federal and state income taxes. Our effective tax rate benefited from our ability to utilize loss carry forwards and other credits; however, the benefit was limited by alternative minimum tax provisions. For the three and six month periods ended September 30, 2003, there was no income tax provision due to a net loss for the six month period.

9. Long-term Debt

In June 2002, we entered into a Loan and Security Agreement (“Agreement”) with Silicon Valley Bank that allowed us to borrow up to a total of $5.0 million under an equipment line of credit and a revolving line of credit. The amount available under the Agreement was based on the amount of eligible equipment and accounts receivable. Borrowings under the equipment line and the revolving line bear interest at an annual rate of prime plus 3.0% and prime plus 0.75%, respectively. As of March 31, 2004, the equipment line of credit rate was 7.25%. Principal, in equal installments, and interest were due monthly for the term of 36 months for all borrowings made under the equipment line. Borrowings under the revolving credit line had a term of 12 months, with principal due at maturity and interest due in monthly installments. On May 4, 2004, we used $6.6 million of the $18.0 million net proceeds from our May 3, 2004 public offering to repay our debt with Silicon Valley Bank. In the first quarter of fiscal 2005 we took a charge of $123,000 associated with the debt repayment. As of September 30, 2004 there was no balance outstanding.

On September 30, 2004, we entered into an amended and restated loan and security agreement with Silicon Valley Bank. Under this one year agreement, the bank will provide a $15 million credit line, which is subject to financial and other covenants contained in the agreement. We granted the bank a security interest in all of our assets other than our intellectual property. Borrowings under the Agreement bear interest at an annual rate equal to the prime rate; the interest rate increases or decreases when the prime rate changes. The agreement includes a loan fee of $50,000 plus bank expenses to execute the agreement. Accrued interest is payable monthly. The agreement expires on September 28, 2005, at which time any amounts borrowed must be paid in full. The bank may withdraw the commitment if we fail to comply with the covenants, if there is a material adverse change in our business, operations or condition, if we become insolvent or if other specified events or conditions occur.

In March 2001, we entered into an equipment financing agreement with Epic Funding Corporation which allowed us to finance $975,000 of equipment over a term of 4 years with interest at 9.6% payable in 48 installments of approximately $25,000 per month. The total outstanding obligation as of September 30, 2004 was approximately $143,000.

During fiscal 2003, we entered into capital leases to finance some equipment.

In September 2004 we entered into a three year software lease with Synopsys. We accounted for the agreement as a capital lease. Under the agreement, we will make three annual payments of $104,000, with the first payment due in October 2004. The amount capitalized is $246,000.

As of September 30, 2004, total capital lease obligations were $201,000, due in monthly or annual installments with interest rates ranging from 5% to 12.6%.

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Total fixed assets purchased under capital leases and the associated accumulated depreciation were as follows (amounts in thousands):

	September 30, 2004			March 31, 2004
Capitalized cost	$	326		$	80
Accumulated depreciation		(44	)		(33	)
Net book value	$	282		$	47

10. Short-term Investments

We invest our excess cash in high quality financial instruments. We have classified our marketable securities as available for sale securities. Our available for sale securities have contractual maturities of 90 days or less and are carried at fair value, with unrealized gains and losses reported in a separate component of shareholders’ equity. Realized gains and losses and declines in value judged to be other than temporary, if any, on available for sale securities are included in interest income. Interest on securities classified as available for sale is also included in Other Expense, Net. The cost of securities sold is based on the specific identification method.

Short-term investments were as follows (in thousands):

	September 30, 2004		March 31, 2004
Commercial paper	$	7,679	$	—
U.S. Agency notes		11,183		—
		18,862		—
Amounts classified as cash equivalents		—		—
	$	18,862	$	—

During the three and six month periods ended September 30, 2004, net unrealized holding losses of $0 and $1,000, respectively, were included in accumulated other comprehensive income. There were no gains or losses reclassified out of accumulated other comprehensive income (loss) into earnings for the period. During the three and six month periods ended September 30, 2003, we did not have any short-term investments and so there were no unrealized holding gains or losses for those periods.

11. Recent Accounting Pronouncements

At its November 2003 meeting, the Emerging Issues Task Force (“EITF”) reached a consensus on disclosure guidance previously discussed under EITF 03-01, “The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments.” The consensus provided for certain disclosure requirements that were effective for fiscal years ending after December 15, 2003. We adopted the disclosure requirements during the fiscal year ended March 31, 2004. At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other than temporary impairment and its application to investments classified as either available for sale or held to maturity under FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The recognition and measurement guidance for which the consensus was reached in the March 2004 meeting is to be applied to other than temporary impairment evaluations in reporting periods beginning after June 15, 2004. We do not believe that this consensus on the recognition and measurement guidance will have an impact on our results of operations.

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12. Major Customers

Major customers were as follows:

	Three Months Ended September 30,		Six Months Ended September 30,
	2004	2003	2004	2003
Customers who each represented 10% or more of our net sales	Guidant LG Electronics Motorola	Guidant Motorola	Guidant Motorola	Guidant Motorola
Percentage of our total net sales comprised by customers who each represented 10% or more of our net sales	45%	39%	34%	37%
Distributors who each represented 10% or more of our net sales	Epco	Epco	Epco	Epco

13. Stock Issuances

On May 3, 2004, we closed our public offering of 1,300,000 shares of common stock at a price of $15.00 per share with net proceeds of $18.0 million, after deducting the underwriting discount of $1.1 million and offering expenses of $368,000. We also granted the underwriters the right to purchase up to an additional 195,000 shares of common stock to cover over allotments, if any, at any time on or before May 26, 2004. The over-allotment right was not exercised and expired on May 26, 2004.

On May 24, 2004 and June 7, 2004, some of the investors in prior private placements and one of our placement agents exercised some of the warrants they had been granted in such private placements or had purchased from investors in such private placements. In total, such investors and placement agent exercised 36,663 warrants at an exercise price of $3.00 per share resulting in total proceeds of approximately $110,000 and exercised 225,179 warrants with an exercise price of $4.36 per share resulting in total proceeds of approximately $982,000, respectively. These warrant exercises were effected without registration under the Federal Securities Act of 1933, as amended, in reliance upon the exemption provided by Section 4(2) of such Act and Rule 506 promulgated under such Section as the holders were accredited institutional investors.

Also during the three and six month periods ended September 30, 2004, we issued the following shares of common stock under our employee stock option and employee stock purchase plans:

	Three Months Ended September 30, 2004		Six Months Ended September 30, 2004
Shares issued		9,975		106,856
Total proceeds, in thousands	$	31	$	646

14. Infrastructure Alignment Plan

On September 29, 2003, the Board of Directors approved a plan to align our internal manufacturing operations to current business requirements. The plan provided for the termination of 61 employees for which severance costs of approximately $343,000 were recorded. During the three month period ended June 30, 2004, we terminated three employees who were included in the plan, which resulted in charges of $27,000 against the original $343,000 provision. We also reversed $68,000 of previously accrued charges for employees we chose to retain. At June 30, 2004, the remaining accrued employee severance liability was $13,000. During the three month period ended September 30, 2004 we reversed this remaining liability, as we decided to retain the remaining employees we had originally planned to terminate.

15. Contingencies

Environmental

During fiscal 2003, we closed our Milpitas wafer fabrication facility. As part of the closure process, we retained a state licensed environmental contractor familiar with this type of semiconductor manufacturing facility to prepare and implement a site closure plan and a site health and safety plan (HASP) to remove, decontaminate as necessary, and dispose of equipment and materials using approved methods and to work with the appropriate agencies to obtain certifications of closure. Upon inspection of the facility by the County of Santa Clara, one of four soil samples obtained by drilling through the floor in one room detected an elevated level of nickel. The County referred the matter to the California Department of Toxic Substances Control (“DTSC”), which in a June 23, 2003, letter requested that the Company conduct further soil and ground water investigation to assess the nature and extent of the contamination at the site from nickel and other substances. We entered into an agreement with the DTSC on February 26, 2004, and submitted a Preliminary Endangerment Assessment (“PEA”) work plan, which the DTSC approved on August 18,

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2004. Further testing identified an elevated level of chromium, in addition to nickel, on one area of the site. We have proposed a limited soil removal action in that area, which the DTSC is reviewing. The estimated cost of our proposed actions is approximately $50,000. Based on analytical data collected at the site to date, we do not anticipate that any further remediation at the site will be required. However, if the contamination is found to extend beyond the area currently delineated, additional actions may need to be taken. The cost of any such additional activities would ultimately depend on the nature and extent of contamination, if any, that is found beyond that expected and any risks posed by such contamination. In addition, our Tempe, Arizona facility is located in an area of known groundwater contamination.

16. Subsequent Events

In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter due to reduced customer demand for these products and to close our thin film manufacturing operation in Tempe, Arizona. As a result, we expect to incur $2.2 million to $3.2 million of costs related to terminating employees, selling or abandoning equipment and maintaining the Tempe facility until we sell it. We expect that approximately 60% to 70% of the costs will be charged to our results of operations during the three month period ended December 31, 2004.

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

In this discussion, “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 discussion and report contain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange 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 as to future levels of gross margin; (2) our expectation that we will have substantially lower sales of end of life products; (3) our expectation as to future levels of research and development expenses and selling, general and administrative expenses; (4) our expectations about our fiscal 2005 income tax rate and days sales outstanding; (5) our planned closure of our Tempe facility and its financial statement and cash flow implications; (6) our estimated costs to remediate environmental issues at our former facility on Topaz Avenue in Milpitas, California; and (7) our anticipation that our existing cash, cash equivalents and short term investments will be sufficient to meet our anticipated cash needs over the next 12 months after considering the anticipated costs of closing our thin film manufacturing operations in Tempe, Arizona. 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, our expectation that customers will not change their minds and order end of life products remaining in our inventory but which we have already written off; whether we will decide to invest more or less in research and development or sales and marketing due to market conditions, technology discoveries, or other circumstances; whether we will incur unexpected expenses related to our internal controls as a result of our Sarbanes-Oxley Section 404 audit; 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; whether there will be any changes in tax accounting rules; whether we receive any unexpected orders for our Medical products, whether we are able to realize what we expect for the Tempe property and equipment, and whether we encounter any unexpected environmental clean-up issues with our Tempe facility; whether we discover any further contamination at our Topaz Avenue Milpitas facility or delays which affect our former landlord’s pending sale of the building; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under the caption “Risk Factors and Other Factors That Could Affect Future Results” at the end of this discussion in this under Item 2. 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.

Overview

We design and sell application specific analog semiconductor products primarily for high volume applications in the Mobile, Computing and Digital Consumer markets. We are a leading supplier of application specific integrated passive (ASIP™) devices that provide electromagnetic interference filtering, electrostatic discharge protection and termination for high speed signals. We also offer a growing portfolio of active analog devices including power management and interface devices. Our ASIP devices, built using our proprietary silicon process technology, provide the function of multiple passive components in a single chip solution for densely populated, high performance electronic systems. Our ASIP devices are significantly smaller, offer increased performance and reliability, and cost our customers less, taking into account all of the costs of implementation, than traditional solutions based on discrete passive components. Some of our ASIP devices also integrate active analog elements to provide additional functionality. With our active analog device portfolio, we seek opportunities to design standard products that are differentiated from competitive alternatives by being optimized for specific applications. We also selectively design second source active analog devices that provide us entry to new applications, complement other products in our portfolio or enhance existing customer relationships. Our active analog device solutions use industry standard CMOS manufacturing processes for cost effectiveness.

During the past three years, we have streamlined our operations and become fabless for the semiconductor products that we supply to our customers in our core markets, using independent providers of wafer fabrication services. This decision to use independent foundries led us to close our fabrication facility in Milpitas, California and consolidate our thin film manufacturing activities in Tempe, Arizona. In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter due to lower customer demand for these products and to close our Tempe facility where we make them. The closure of our Tempe facility will complete the elimination of all of our internal manufacturing operations. See Note 16 of Notes to Financial Statements.

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During the past several years, we have also focused our marketing and sales on strategic customers in our three core markets. As a part of this process, we have reduced the number of our actively marketed products from approximately 5,000 to approximately 200 while at the same time increasing our unit shipments from less than 25 million in the quarter ended March 31, 2001 to approximately 101 million in the quarter ended September 30, 2004.

End customers for our semiconductor products are original equipment manufacturers including Dell, Hewlett-Packard, Kyocera Wireless, LG Electronics, Motorola, Samsung and Sony. We sell to some of these end customers through original design manufacturers, including Appeal, Arima, BenQ, Compal, Pantech and Quanta, and contract electronics manufacturers, including Celestica, Foxconn and Solectron. We use a direct sales force, manufacturers’ representatives and a network of distributors to sell our semiconductor products.

We operate in one operating segment and most of our assets are located in the United States. Our assets located outside the United States are comprised primarily of inventory or equipment used in manufacturing our products.

Results of Operations

Net sales. Net sales for the three month period ended September 30, 2004 were $17.1 million, a 15% increase from the three month period ended September 30, 2003. Net sales for the six month period ended September 30, 2004 were $33.5 million, a 25% increase from the six month period ended September 30, 2003. As shown in the table below, our Mobile products represented the largest component of these increases.

	Three Months Ended September 30,				Six Months Ended September 30,
(in millions)	2004		2003		2004		2003
Mobile	$	9.4	$	5.2	$	18.2	$	8.5
Computing and Digital Consumer		3.6		4.2		7.3		8.0
Medical		2.2		2.8		5.4		4.7
Other products*		1.9		2.7		2.6		5.6
	$	17.1	$	14.9	$	33.5	$	26.8

* Other products include lighting, communications, legacy and mature products.

Our growth in Mobile sales is primarily due to our focus on increasing our penetration of the Mobile phone handset market. In addition to top tier manufacturers, we also sell our products to a large number of other handset manufacturers.

Computing and Digital Consumer sales were lower due to a decline in sales of our older products, price erosion in our Computing products and slowing growth in the Computing market.

In our Medical business, the decline in revenue for the three month period is the result of lower orders from our primary Medical products customer, Guidant Corporation. For the six month period, the increase is primarily the result of improved pricing from Guidant starting in July, 2003. In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter and close our Tempe thin film manufacturing operation. See Note 16 of Notes to Financial Statements.

Our sales from Other products declined during the three and six month periods ended September 30, 2004 compared to 2003, due to a decline in end of life sales for our legacy, lighting and communications products. For the three month period ended September 30, 2004 there was a substantial increase in sales of Other products compared to the three month period ended June 30, 2004 as a result of additional one time demand from two customers for certain end of life products. We completed shipment of most end of life product orders during fiscal 2004 and expect to recognize substantially lower sales of these products starting in the third quarter of fiscal 2005.

Units shipped during the three and six month periods ended September 30, 2004 increased to approximately 101 million and 209 million units, up from approximately 72 million and 127 million units for the three and six month periods ended September 30, 2003. For the three month period ended September 30, 2004, units shipped declined by 7% from the 108 million units shipped during the three month period ended June 30, 2004, primarily due to lower shipments to our distributors.

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Our increased net sales resulted primarily from larger unit sales, due in part from increased sales of current products and in part from sales of newly introduced products, and to a lesser extent, from price increases effective July 1, 2003, on our Medical products.

Our average unit price decreased by approximately 21% during the three month period ended September 30, 2004 compared to the three month period ended September 30, 2003. This decrease was primarily the result of a change in product mix, with our core product unit volumes increasing and our Medical and Other products decreasing in proportion to total units shipped.

Major customers were as follows:

	Three Months Ended September 30,		Six Months Ended September 30,
	2004	2003	2004	2003
Customers who each represented 10% or more of our net sales	Guidant LG Electronics Motorola	Guidant Motorola	Guidant Motorola	Guidant Motorola
Percentage of our total net sales comprised by customers who each represented 10% or more of our net sales	45%	39%	34%	37%
Distributors who each represented 10% or more of our net sales	Epco	Epco	Epco	Epco

Cost of Sales, Gross Margin and Expenses

The table below shows our net sales, cost of sales, gross margin and operating expenses, both in dollars and as a percentage of net sales, for the three and six month periods ended September 30, 2004 and 2003 (in thousands):

	Three Months Ended September 30,								Six Months Ended September 30,
	2004				2003				2004				2003
	Amount		% of Net Sales		Amount		% of Net Sales		Amount		% of Net Sales		Amount			% of Net Sales
Net sales	$	17,060	100	%	$	14,857	100	%	$	33,532	100	%	$	26,766		100	%
Cost of sales		10,273	60	%		9,986	67	%		20,179	60	%		19,142		72	%
Gross margin		6,787	40	%		4,871	33	%		13,353	40	%		7,624		28	%
Research and development		1,207	7	%		991	7	%		2,413	7	%		2,043		8	%
Selling, general and administrative		3,254	19	%		2,990	20	%		6,480	19	%		5,668		21	%
Other expense, net		76	0	%		208	1	%		191	1	%		451		2	%
Income (loss) before income taxes		2,250	13	%		682	5	%		4,269	13	%		(538	)	(2	%)
Income taxes		67	0	%		—	0	%		128	0	%		—		0	%
Net income (loss)	$	2,183	13	%	$	682	5	%	$	4,141	12	%	$	(538	)	(2	%)

Cost of Sales. During fiscal 2004, we completed implementing a strategy to satisfy the production requirements for products in our core markets from external foundries, which we had previously manufactured in our own factories. As a result of outsourcing wafer fabrication, we converted our Tempe manufacturing operations to a dedicated thin film facility and reduced our manufacturing costs at that facility. During the three month period ended June 30, 2004 we took action to further reduce spending at our Tempe facility in anticipation of lower Medical product sales in future quarters. In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter and close our Tempe thin film manufacturing operation. See Note 16 of Notes to Financial Statements. Our thin film products are primarily Medical products plus a relatively small portion of our mature products, which are shown in the “Other products” category in the net sales discussion.

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Cost of sales increased by approximately $300,000 for the three month period ended September 30, 2004 compared to the three month period ended September 30, 2003 primarily due to the following reasons:

Increase in shipments	$	900
Change in product mix		900
Decrease in sales of previously reserved inventory		300
Increase in inventory reserve provision		200
Decrease in manufacturing spending		(1,800	)
Other		(200	)
	$	300

Cost of sales increased by approximately $1.0 million for the six month period ended September 30, 2004 compared to the six month period ended September 30, 2003 primarily due to the following reasons:

Increase in shipments	$	2,900
Change in product mix		1,800
Decrease in sales of previously reserved inventory		400
Decrease in manufacturing spending		(3,800	)
Decrease in inventory reserve provisions		(100	)
Other		(200	)
	$	1,000

For the three and six month periods ended September 30, 2004, increases in net sales compared to the prior year periods directly resulted in increases in costs of $0.9 million and $2.9 million. The decreases in manufacturing spending were primarily due to the realignment of and reduction in spending at our Tempe wafer fabrication facility. The increases in cost of sales due to change in product mix were due to increased sales of our Mobile products as proportions of our total net sales.

We have, during recent quarters, benefited from the sale of previously reserved inventory due primarily to the large number of products for which we have discontinued future support by placing them in an ‘end of life’ category. These products have been primarily sold through our distributors to an erratic and unpredictable demand by end customers. As a result, we have experienced the actual sale of some products previously reserved and the requirement to further write down certain other products for which we had expected to receive orders but did not. The benefits related to sales of previously reserved inventory for the three month periods ended September 30, 2004 and 2003 were approximately $200,000 and $500,000, respectively, and for the six month periods ended September 30, 2004 and 2003 were approximately $400,000 and $800,000, respectively.

Gross Margin. Gross margin is comprised of net sales less cost of sales. For the three month period ended September 30, 2004, gross margin was $6.8 million, an increase of $1.9 million from the prior year period’s $4.9 million. For the six month period ended September 30, 2004, gross margin was $13.4 million, an increase of $5.7 million from the prior year period’s $7.6 million. Gross margin as a percentage of revenues was 40% and 33% for the three month periods ended September 30, 2004 and 2003, respectively, and 40% and 28% for the six month periods ended September 30, 2004 and 2003, respectively. The gross margin dollar increase during the three month period ended September 30, 2004 compared to the prior year was primarily the result of increased sales volumes and reductions in manufacturing spending. The gross margin dollar increase during the six month period ended September 30, 2004 compared to the prior year was primarily the result of increased sales volumes, a significant price increase for our Medical products and reductions in manufacturing spending. The gross margin percentage increases were primarily the result of increased sales volumes that led to economies of scale in our manufacturing operations, a significant price increase for our Medical products in the second quarter of fiscal 2004 which improved gross margins on these products to approximately the company target, and reductions in manufacturing spending. Gross margins during fiscal 2004 and to a lesser extent fiscal 2005 benefited from sales of our Other products, a portion of which were previously reserved and as a result generated a 100% gross margin. In future periods, we expect our gross margin to be approximately 40% of net sales on average, subject to substantial quarterly variation due to changes in volume, pricing, product mix, manufacturing costs and manufacturing yields.

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Research and Development. Research and development expenses consist primarily of compensation and related costs for employees and prototypes, masks and other expenses for the development of new products, process technology and new packages. The increases in research and development expenses for the three and six month periods ended September 30, 2004 compared to the same period in 2003 were due to the following:

Expense increase (decrease) compared to prior year periods:	Three Months Ended September 30, 2004			Six Months Ended September 30, 2004
Increase in salaries and benefits due to increased staffing	$	210		$	290
Increase in supplies and tooling		60			80
Decrease in other expenses		(54	)		—
	$	216		$	370

In the future we expect to incur increased research and development expenses and to represent 8% to 9% of sales. However, if our sales were to decline in future periods, research and development could represent more than 9% of sales.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of compensation and related costs for employees, sales commissions, marketing and promotional expenses, and legal and other professional fees. The increases in selling, general, and administrative expenses for the three and six month periods ended September 30, 2004 compared to the same period in 2003 were due to the following:

Expense increase compared to prior year periods:	Three Months Ended September 30, 2004		Six Months Ended September 30, 2004
Increase in salaries and benefits due to increased staffing, primarily in Sales and Marketing	$	70	$	420
Product samples		110		230
Increase in outside services and other		84		162
	$	264	$	812

The percentage of net sales comprised by selling, general and administrative expenses decreased during the same periods due to our increased net sales. These expenses are expected to increase in dollar terms in the future, but at a slower rate than our anticipated sales growth. As a result, we expect a gradual reduction in selling, general and administrative expenses as a percentage of sales; however, if our sales were to decline in future periods, these expenses could increase as a percentage of sales.

Income Taxes. For the three and six month periods ended September 30, 2004 we recorded income tax provisions of $67,000 and $128,000 for federal and state income taxes. Our effective tax rate benefited from our ability to utilize loss carry forwards and other credits; however, the benefit was limited by alternative minimum tax provisions. For fiscal 2005 we currently expect our effective income tax rate to be 3% of profit before taxes. For the three and six month periods ended September 30, 2003 there were no income tax provisions due to a net loss for the six month period.

Net Income. For the reasons explained above, we realized a net income of approximately $2.2 million and $682,000 for the three month periods ended September 30, 2004 and 2003, respectively, and a net income of $4.1 million and a net loss of $538,000 for the six month periods ended September 30, 2004 and 2003, respectively.

Recent Accounting Pronouncements

At its November 2003 meeting, the Emerging Issues Task Force (“EITF”) reached a consensus on disclosure guidance previously discussed under EITF 03-01, “The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments.” The consensus provided for certain disclosure requirements that were effective for fiscal years ending after December 15, 2003. We adopted the disclosure requirements during the fiscal year ended March 31, 2004. At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other than temporary impairment and its

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application to investments classified as either available for sale or held to maturity under FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The recognition and measurement guidance for which the consensus was reached in the March 2004 meeting is to be applied to other than temporary impairment evaluations in reporting periods beginning after June 15, 2004. We do not believe that this consensus on the recognition and measurement guidance will have an impact on our results of operations.

Critical Accounting Policies and Estimates

We described our critical accounting policies and estimates in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the year ended March 31, 2004. Our critical accounting policies and estimates are related to financial line items that are key indicators of our financial performance or that require significant management judgment. Our critical accounting policies, which have not changed materially since March 31, 2004, include those regarding (1) revenue recognition; (2) inventory and related reserves; (3) impairment of long lived assets; (4) litigation, including environmental issues; and (5) income taxes. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We believe that we have consistently applied judgments and estimates that fairly depict our financial condition and results of operations for all periods presented. Below, we discuss further the critical estimates we make.

With respect to revenue recognition, we make estimates in relation to sales returns and allowances and to bad debt. To estimate sales returns and allowances, we analyze recent sales returns trends and open return material authorizations to evaluate the likelihood of future returns. Also, we consult with our sales, marketing and quality management personnel to identify any specific issues that may require a sales returns and allowances reserve provision. To estimate bad debt, we analyze our current aged accounts receivable to evaluate the likelihood of our not being able to collect payment from customers whose payments are overdue. Our policy is to partially or fully reserve receivables that are 90 days old or more, while at the same time continuing efforts to collect payment from the customer. We also maintain a general bad debt reserve to provide for collection risks involving customers with whom we do less business and as a consequence have less experience in evaluating their credit risk.

With respect to inventory and related reserves, the primary area of estimation and judgement is in the evaluation of products that we may have produced in excess of expected demand. Each period, we review current demand expectations in comparison to our inventory quantities for each product. In cases where the inventory quantity exceeds expected demand for the next 12 months for a product, we establish financial reserves against the excess inventory quantity. If demand occurs at a future date for inventory that has been reserved, we release the reserve during the period when revenue is recognized.

With respect to the impairment of long lived assets, we evaluate two separate measures of fair value to assess whether the carrying value of our equipment is appropriate. First, we forecast future cash flows to determine whether we believe that our future cash flows will be sufficient to recover the carrying value of those assets. Second, in cases where we have identified surplus assets that we have removed from service and are making available for sale, we estimate the net proceeds that we expect to realize upon sale. If expected net proceeds are less than the current net book value for a particular asset, we write down the value of the asset to the expected net sales proceeds. If we have strong evidence that we will be unable to sell the asset, we fully write off the value of the asset and take a charge in the period during which we have performed the assessment.

With respect to litigation, the potential exposure for legal disputes is very uncertain. We are a party to lawsuits, claims, investigations and proceedings, including commercial and employment matters, which are being handled and defended in the ordinary course of business. We review the current status of any pending or threatened proceedings with our outside counsel on a regular basis and, considering all the other known relevant facts and circumstances, recognize any loss that we consider probable and estimable as of the balance sheet date. For these purposes, we consider settlement offers we may make to be indicative of such a loss under certain circumstances.

With respect to environmental issues, we have a financial exposure related to our former site in Milpitas, California. The State of California’s Department of Toxic Substances Control is currently considering our proposed plan to remediate the site, for which the estimated cost of our proposed remediation is approximately $50,000; however, the cost will ultimately depend on the nature and extent of contamination that is found during the cleanup and any risks posed by such contamination. See Note 15 of Notes to Financial Statements.

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With respect to income taxes, we have provided a valuation allowance against our total deferred tax assets due to the uncertainties surrounding our ability to generate sufficient taxable income in future periods to realize the tax benefits of our loss carry forwards. See Note 11 of Notes to Financial Statements in our annual report on Form 10-K for the fiscal year ended March 31, 2004. We have experienced quarterly taxable income beginning with the second quarter of fiscal 2004. If we continue to produce taxable income in future periods, we may reverse a portion of our valuation allowance. This would generate income rather than expense from income taxes on our financial statements. We will continue to evaluate our ability to realize the deferred tax asset.

Liquidity and Capital Resources

We have historically financed our operations through a combination of debt and equity financing and cash generated from operations. Total cash, cash equivalents and short-term investments as of September 30, 2004 were $30.7 million compared to $20.3 million as of March 31, 2004. Receivables increased $3.6 million to $9.8 million as of September 30, 2004 compared to $6.1 million as of March 31, 2004. Receivables days sales outstanding were 52 and 35 days as of September 30, 2004 and March 31, 2004, respectively, with the increase due primarily to our having shipped a higher percentage of our revenues late in the three month period ended September 30, 2004 compared to the three month period ended March 31, 2004. We expect days sales outstanding to range from 45 to 50 days in the future, depending on the linearity of our shipments. Inventories increased by approximately $440,000 and inventory reserves decreased by approximately $610,000 due to scrapping and sales of previously reserved inventory. Net inventory increased by approximately $1.1 million, resulting in a net inventory balance of $7.6 million as of September 30, 2004 compared to $6.5 million as of March 31, 2004. The increase in net inventory was the result of increased production to support our expected growth in shipments. Accounts payable and other accrued liabilities decreased by $1.8 million during the six month period ending September 30, 2004 to a balance of $7.2 million, due to payment of accrued employee bonuses and the acceleration of payments to suppliers just prior to the October 2004 start-up of our new Oracle business system in order to ease our transition.

Operating activities used approximately $1.2 million of cash during the six month period ended September 30, 2004, compared to $1.2 million of positive cash flow from operations for the six month period ended September 30, 2003. The decrease was primarily due to a decrease in accounts payable and other current liabilities and an increase in accounts receivable, offset by a swing to net income from a net loss. Investing activities used $20.2 million of cash during the six month period ended September 30, 2004, which was the result of net purchases of $18.8 million of short-term investments and $1.4 million of capital expenditures.

Net cash provided by financing activities for the six month period ended September 30, 2004 was $12.8 million and was the result of $18.0 net proceeds from our public offering of common stock, $1.1 million of proceeds from the exercise of common stock warrants and $646,000 of proceeds from sales of stock in employee stock plans, offset by $7.1 million of repayment of long-term debt. The $7.1 million of debt repayment was comprised of approximately $400,000 of regularly scheduled debt payments and the early retirement of $6.6 million of debt to Silicon Valley Bank using proceeds from our May 2004 public stock offering.

The following table summarizes our contractual obligations as of September 30, 2004:

	Payments due by period (in thousands)
	1 year		2-3 years		4-5 years		More than 5 years		TOTAL
Long-term debt obligations	$	143	$	—	$	—	$	—	$	143
Capital lease obligations		11		190		—		—		201
Operating lease obligations		282		291		—		—		573
Purchase obligations		788		177		44		—		1,009
TOTAL	$	1,224	$	658	$	44	$	—	$	1,926

In the future, it is possible that our liquidity could be impacted in order to resolve an environmental issue arising out of the closure of our Milpitas wafer fabrication facility. As described in Note 15 of Notes to Condensed Financial Statements, we currently estimate that the cost to remediate the site will be approximately $50,000; however, the cost will ultimately depend on the nature and extent of contamination that is found during the cleanup and any risks posed by such contamination.

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In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter due to reduced customer requirements and to close our thin film manufacturing operation in Tempe, Arizona. As a result, we expect to use approximately $1.5 million of cash related to terminating employees and preparing the Tempe facility for sale. Of the $1.5 million, we expect to use approximately $600,000 during the three month period ended December 31, 2004, and $450,000 during the three month period ended March 31, 2005. After the sale of assets we expect the full exit and closure activity to be cash neutral or positive.

We currently anticipate that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for the next twelve months. However, we may need to raise additional funds through public or private equity or debt financing in order to expand our operations to the level we desire. The funds may not be available to us, or if available, we may not be able to obtain them on terms favorable to us.

RISK FACTORS AND OTHER FACTORS THAT COULD AFFECT FUTURE RESULTS

Our operating results may fluctuate significantly because of a number of factors, many of which are beyond our control and are difficult to predict. These fluctuations may cause our stock price to decline.

Our operating results may fluctuate significantly for a variety of reasons, including some of those described in the risk factors below, many of which are difficult to control or predict. While we believe that quarter to quarter and year to year comparisons of our revenue and operating results are not necessarily meaningful or accurate indicators of future performance, our stock price historically has been susceptible to large swings in response to short-term fluctuations in our operating results. Should our future operating results fall below our guidance or the expectations of securities analysts or investors, the likelihood of which is increased by the fluctuations in our operating results, the market price of our common stock may decline.

We incurred quarterly losses for ten consecutive quarters beginning with the quarter ended March 31, 2001 and ending with the quarter ended June 30, 2003, and we may be unable to sustain profitability.

Prior to achieving profitability in the second quarter of fiscal 2004, we had been unprofitable for ten consecutive quarters, incurring an average loss of $3.8 million per quarter and doubling our accumulated deficit from $31.3 million to $67.7 million. Many factors will affect our ability to sustain profitability including the health of the Mobile, Computing and Digital Consumer markets in which we focus, continued demand for our products by our key customers, lack of price erosion, availability of capacity from our manufacturing subcontractors, continued product innovation and design wins, and our continued ability to manage our operating expenses. In addition, our planned exit of the Medical business and closure of our Tempe facility (see Note 16 of Notes to Financial Statements) in the next six months will not only result in a material decrease in revenue starting in our fourth fiscal quarter of 2005 and beyond, as Medical has typically been between 15% and 20% of our revenues over the past several quarters with margins approximating our company gross margins, it will also lead to one-time expenses estimated between $2.2 million and $3.2 million, most of which will be incurred during the second half of fiscal 2005. Therefore, the likelihood of our incurring losses in the near term is significantly increased. The semiconductor industry has historically been cyclical, and we may be subject to such cyclicality, which could lead to our incurring losses again.

Our revenues could fall below cash breakeven causing us to cut our expenses which could result in our reducing our investment in research and development and marketing.

We have restructured our company to better focus our business and to transition to a fabless model by outsourcing our manufacturing, except for our thin film products. We have taken these steps in an effort to reduce the level of revenues we need to generate to achieve operating cash flow breakeven and at the same time to increase our revenues in key markets. However, if our net sales do not continue to satisfy our cash needs, then we may have to cut additional expenses in order to conserve our cash, or raise additional financing, of which there can be no assurance of success. Even if we are successful in reducing our cash usage, we may raise additional equity financing to finance growth, for strategic acquisitions, and/or to provide us with cash reserves should we operate at a loss in the future. We plan to discontinue our Medical thin film products in March 2005 (see Note 16 of Notes to Financial Statements). In the three months ended September 30, 2004 our Medical products revenue was $2.2 million. By the first quarter of fiscal 2006, we will no longer be generating revenue from Medical products. If we are unable to replace revenues from our Medical business with revenues from our core business, then we could operate at a loss and unless we believed that we would ultimately be able to increase our core business revenues, we may need to reduce expenses.

In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter and to close our thin film manufacturing operation in Tempe, Arizona. We could be unfavorably impacted if we are unable to sell the site or sell it for less substantially less than we have estimated.

We expect to incur $2.2 million to $3.2 million of costs related to terminating employees, selling or abandoning equipment and maintaining the Tempe facility until we sell it. If we are unable to sell the site or sell it for substantially less than we have estimated, we will incur higher closure costs than we have estimated, which would negatively impact our results and cash position, most likely during the remainder of fiscal 2005.

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We currently rely heavily upon a few customers for a large percentage of our net sales. Our revenue would suffer materially were we to lose any one of these customers.

Our sales strategy has been to focus on customers with large market shares in their respective markets. As a result, we have several large customers. During the quarter ended September 30, 2004, Motorola and LG Electronics, customers in the Mobile market, and Guidant, a customer in the Medical market, together represented approximately 45% of our net sales.

Guidant has determined that it will not require a sufficient level of products from us going forward for us to earn a reasonable margin on our sales of these products, and as a result, in October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter and close our Tempe thin film manufacturing operation. See Note 16 of Notes to Financial Statements. As described above, this could result in significantly decreased revenue unless and until the revenue from our core business grows enough to replace our Medical products revenue, of which there can be no assurance.

Also, in the quarter ended September 30, 2004, Motorola and LG Electronics together represented approximately 50% of our sales in the Mobile market. We may become increasingly dependent upon Motorola over the next twelve months as we believe that we have more penetration of their planned new products than their current products. There can be no assurance that Motorola and LG Electronics will continue to purchase our products in the quantities forecasted, or at all.

During the quarter ended September 30, 2004, one of our distributors, Epco Technology, represented 14% of our net sales. If we were to lose Epco as a distributor, we might not be able to obtain another distributor to represent us or a new distributor might not have the same relationships with the current end customers to maintain our current level of net sales. Additionally the time and resources involved with the changeover and training could have potentially adverse impacts on our business.

We currently rely heavily upon a few core markets for the bulk of our sales. If we are unable to further penetrate the Mobile, Computing and Digital Consumer markets, our revenues could stop growing and might decline.

Most of our revenues in recent periods have been derived from sales to manufacturers of Mobile, Computing and Digital Consumer, and Medical devices. We will discontinue our Medical devices in the March 2005 quarter due to our Medical customer no longer requiring enough product from us to make our Tempe operations economically viable. In order for us to be successful, we must continue to penetrate the Mobile, Computing and Digital Consumer markets, both by obtaining more business from our current customers and by obtaining new customers. Due to our narrow market focus, we are susceptible to materially lower revenues due to material adverse changes to one of these markets. For example, should the Mobile phone demand in China prove to be a bubble, or should growth not occur in the markets we have penetrated the most, our future revenues would be adversely impacted.

Our fastest growing market has been the Mobile market. A slowdown in the adoption of ASIPs by cellular handset manufacturers would reduce our future growth.

Much of our revenue growth over the past two years has been in the Mobile market where more complex cellular handsets have meant increased adoption of and demand for ASIP solutions. Should the rate of ASIP adoption decelerate in the Mobile market, our planned rate of increase in Mobile market penetration would decrease, thereby reducing our future growth.

The markets in which we participate are intensely competitive and our products are not sold pursuant to long-term contracts, enabling our customers to replace us with our larger competitors if they choose.

Our core markets are intensely competitive. Our ability to compete successfully in our core markets depends upon our being able to offer attractive high quality products to our customers that are properly priced and dependably supplied. Our customer relationships do not generally involve long-term binding commitments making it easier for customers to change suppliers and making us more vulnerable to competitors. Our customer relationships instead depend upon our past performance for the customer, their perception of our ability to meet their future need, including price and delivery and the timely development of new devices, the lead time to qualify a new supplier for a particular product, and interpersonal relationships and trust.

Because we operate in different semiconductor product markets, we generally encounter different competitors in our various market areas. Competitors with respect to our integrated passive products include ON Semiconductor, Philips

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Electronics, Semtech and STMicroelectronics. Our integrated passive products also compete with ceramic devices from competitors such as Murata, TDK and Innochips Technology, and discrete passives from competitors such as Murata, Samsung and Vishay. For our other semiconductor products, our competitors include Fairchild Semiconductor, Linear Technology, Maxim Integrated Products, Micrel, National Semiconductor, ON Semiconductor, RichTek, Semtech, STMicroelectronics and Texas Instruments. Many of our competitors are larger than we are, have substantially greater financial, technical, marketing, distribution and other resources than we do and have their own facilities for the production of semiconductor components.

Deficiencies in our internal controls could cause us to have material errors in our financial statements, which could cause us to have to restate them. Such a restatement could cause continued drain on our resources to address and correct internal control deficiencies and could have adverse consequences on our stock price, potentially limiting our access to financial markets.

We have in the past had deficiencies in certain of our internal control processes. We are vulnerable to difficulties as many of our recordkeeping processes are manual or involve software that has not been upgraded and for which we have no adequate backup if the software were to fail. We have also experienced in the past, high turnover in our finance department, due in part to the relocation of several functions from Tempe to Milpitas and the employees performing those functions being unwilling to relocate. While preparing our financial statements for the 2003 fiscal year, both our internal staff and prior outside accountants found errors in certain primary financial processes, which they corrected during such preparation. However, these errors caused inaccuracies in the fiscal 2003 interim results for the three, six and nine month periods that required these interim period results to be restated. As a result, our prior outside accountants informed us that they had noted a combination of reportable conditions that, taken together, constituted a material weakness in our internal controls. The material weakness included issues with our inventory costing systems and procedures, accounts payable cutoff, information systems user administration and finance organization. We have instituted additional processes and procedures to mitigate the conditions identified and to provide reasonable assurance that our internal control objectives are met. During fiscal 2004, we recruited an almost entirely new finance department and we have instituted backup procedures for our manual processes as we automate them, although some key controls remain manual and are consequently inefficient. We have devoted substantial effort and resources to improving our internal controls. We expect that the design and operation of our new Oracle business system will help us improve our internal control over our business and financial processes; however, there can be no assurance that we will nonetheless not have a material error in our financial statements.

In October 2004 we started to use new Oracle business system software. Should we encounter significant difficulties with the software or with our revised business processes, our or our independent accountants’ assessment of our internal control over financial reporting may indicate significant deficiencies or a material weakness in such internal control. Such assessments, if they were to occur, would appear in our Form 10-Q for the period ended December 31, 2004 or in our Form 10-K for the year ended March 31, 2005. Any such material weakness may need to be corrected before our outside accountants would be able to issue an audit report with an unqualified opinion.

In October 2004 we began live use of portions of our new enterprise resource planning (“ERP”) software, which has been a complex task to install, requiring large amounts of time and effort from our employees, consultants, and management. It is not uncommon for companies implementing ERP software to encounter delays and system start-up difficulties. As part of our implementation we have made significant changes to some of our business processes. We will be relying on our new ERP software to automate our inventory control and costing systems. Should we encounter difficulties with these or other features or with our revised business processes, we may not have time to fully test our ERP software prior to March 31, 2005. As a result, we would have to rely on manual checks and balances for inventory costing to avoid errors in our financial reporting of our year-end results, as we have done in the past. These checks and balances, while adequate in the past for such purposes, may lead us, or our outside accountants, to assess our internal control over financial reporting as having significant deficiencies. If we had other significant deficiencies as well, it is possible that we or our independent accountants assessing our internal control over financial reporting as part of our fiscal 2005 report on Form 10-K could determine that we have a material weakness in such control. Any such material weakness may need to be corrected before our outside accountants would be able to issue an audit report with an unqualified opinion.

While we believe we currently have adequate internal control over financial reporting, we are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404), beginning with our Annual Report on Form 10-K for the fiscal year ending March 31, 2005, we will be required to furnish a report by our management on our internal control over financial reporting. Such report will contain, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Such report must also contain a statement that our auditors have issued an attestation report on management’s assessment of such internal controls.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) provides a framework for us to assess and improve our internal control systems. Auditing Standard No. 2 provides the professional standards and related performance guidance for auditors to attest to, and report on, management’s assessment of the effectiveness of internal

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control over financial reporting under Section 404. Management’s assessment of internal controls over financial reporting requires management to make subjective judgments and, particularly because Section 404 and Auditing Standard No. 2 are newly effective, some of the judgments will be in areas that may be open to interpretation and therefore the report may be uniquely difficult to prepare and our auditors may not agree with our assessments.

While we currently believe our internal control over financial reporting is effective, we are still performing the system and process documentation and evaluation needed to comply with Section 404, which is both costly and challenging. During this process, if we identify one or more material weaknesses in our internal control over financial reporting, we may be unable to assert such internal control is effective. If we are unable to assert that our internal control over financial reporting is effective as of March 31, 2005 (or if our auditors are unable to attest that our management’s report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.

While we currently anticipate being able to satisfy the requirements of Section 404 in a timely fashion, we cannot be certain as to the timing of completion of our evaluation, testing and any required remediation due in large part to the fact that there is no precedent available by which to measure compliance with these new requirements and that we are currently implementing a new business information system. In this regard, if we are unable to provide our results and assessments to our auditors on a timely basis, our auditors may not have sufficient staff necessary to complete their work and issue their attestation report by the required date. If we are not able to complete our assessment in a timely manner, we and our auditors may be unable to conclude that our internal control over financial reporting is effective as of March 31, 2005.

Our competitors have in the past and may in the future reverse engineer our most successful products and become second sources for our customers, which could decrease our revenues and gross margins.

Our most successful products are not covered by patents and have in the past and may in the future be reverse engineered. Thus, our competitors can become second sources of these products for our customers or our customers’ competitors, which could decrease our unit sales or our ability to increase unit sales and also could lead to price competition. This price competition could result in lower prices for our products, which would also result in lower revenues and gross margins. Certain of our competitors have announced products that are essentially copies of some of our most successful products, especially in the Mobile market, where many of our largest revenue generating products have been second sourced. To the extent that the revenue secured by these competitors has exceeded the expansion in market size resulting from the availability of second sources, this has decreased the revenue potential for our products. Furthermore, should a second source attempt to increase its market share by dramatic or predatory price cuts for large revenue products, our revenues and margins could decline materially.

In the future our revenues will become increasingly subject to macroeconomic cycles and more likely to decline if there is an economic downturn.

As ASIP penetration increases, our revenues may become increasingly susceptible to macroeconomic cycles because our revenue growth may become more dependent on growth in the overall market rather than primarily on increased penetration, as has been the case in the past.

Our reliance on foreign customers could cause fluctuations in our operating results.

International sales for the past few years have accounted for approximately two-thirds of our total net sales. International sales include sales to U.S. based customers if the product is delivered outside the United States.

In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter, and we expect that sales of our thin film Medical devices will end in March 2005. Accordingly, we expect that a higher proportion of our sales will come from our international customers as we discontinue this business, which has been all U.S. based. See Note 16 of Notes to Financial Statements.

If international sales account for an increasing portion of our revenues, this would subject us to the following risks:

• changes in regulatory requirements;

• tariffs and other barriers;

• timing and availability of export licenses;

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• political and economic instability;

• the impact of regional and global illnesses such as severe acute respiratory syndrome infections (SARS);

• difficulties in accounts receivable collections;

• difficulties in staffing and managing foreign operations;

• difficulties in managing distributors;

• difficulties in obtaining foreign governmental approvals, if those approvals should become required for any of our products;

• limited intellectual property protection;

• foreign currency exchange fluctuations;

• the burden of complying with and the risk of violating a wide variety of complex foreign laws and treaties; and

• potentially adverse tax consequences.

In addition, because sales of our products have been denominated in United States dollars, increases in the value of the U.S. dollar could increase the relative price of our products so that they become more expensive to customers in the local currency of a particular country. Furthermore, because some of our customer purchase orders and agreements are influenced, if not governed, by foreign laws, we may be limited in our ability to enforce our rights under these agreements and to collect damages, if awarded.

If our distributors or sales representatives experience financial difficulty or otherwise are unwilling to promote our products, our business could be harmed.

We sell many of our products through distributors and sales representatives. Our distributors and sales representatives could reduce or discontinue sales of our products or sell our competitors’ products. They may not devote the resources necessary to sell our products in the volumes and within the time frames that we expect. In addition, we depend upon the continued viability and financial resources of these distributors and sales representatives, some of which are small organizations with limited working capital. These distributors and sales representatives, in turn, depend substantially on general economic conditions and conditions within the electronics industry. We believe that our success will continue to depend upon these distributors and sales representatives. If our distributors and sales representatives experience financial difficulties, or otherwise become unable or unwilling to promote and sell our products, our business could be harmed.

Our current dependence on our foundry partners and a small number of assembly and test subcontractors and our planned future dependence upon a limited number of such partners and subcontractors exposes us to a risk of manufacturing disruption or uncontrolled price changes.

Given the current size of our business, we believe it is impractical for us to spread our use of foundry partners and assembly and test subcontractors over more than a few partners and subcontractors as it would lead to significant increases in our costs. Currently, in addition to our Tempe, Arizona thin film facility, we have only two foundry partners and rely on a small number of assembly and test subcontractors. (In October 2004, we decided to exit our thin film Medical device business during the March 2005 quarter and close our Tempe facility. See Note 16 of Notes to Financial Statements). Many of our products are sole sourced at one of our foundry partners near Shanghai, China or in Japan. Our intention is to add additional foundry partners to reduce our dependence and increase our flexibility, although no assurance can be given that we will be successful. One of our assembly steps is the “ball drop” process, which is a key step in the chip scale packaging used for the bulk of our Mobile products. We currently use two third party vendors for ball drop. There are only a limited number of suppliers of this service at this time. Furthermore, for many of our products, due to their relatively low volumes, we may still choose to rely on only one supplier for wafer fabrication, assembly and test. If the operations of one or more of our suppliers should be disrupted, or if they should choose not to devote capacity to our products in a timely manner, our business would be adversely impacted as we would be unable to manufacture some of our products on a timely basis. In addition, the cyclicality of the semiconductor industry has periodically resulted in shortages of wafer fabrication, assembly and test capacity and other disruption of supply. We may not be able to find sufficient suppliers 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;

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• longer lead times;

• the impact of regional and global illnesses such as SARS;

• 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.

We have outsourced our wafer fabrication, other than for thin film products, and assembly and test operations and are seeking additional foundry, assembly and test partners. We may encounter difficulties in expanding our outsourcing of capacity.

Other than for our thin film products, we have adopted a fabless manufacturing model that involves the use of foundry partners and assembly and test subcontractors to provide our production capacity. We chose this model in order to reduce our overall manufacturing costs and thereby increase our gross margin, reduce the impact of fixed cost issues when volume is light, provide us with capacity in case of short term demand increases, provide us with access to newer production facilities and equipment, and provide us with additional manufacturing sources should unforeseen problems arise in our facility. Within the past two years, we have outsourced our wafer manufacturing and assembly and test operations overseas in Asia and now we are seeking additional foundry and assembly and test capacity to provide for growth and second sources. As we add foundry capacity, we may encounter difficulties in outsourcing as the third party contract manufacturers must learn how to run our processes in their facilities. As a result, we may experience unexpected delays, technical issues or quality problems as we outsource our manufacturing to facilities that have never run our processes. If we experience manufacturing difficulties, we may not have sufficient product to fully meet the demand of our customers.

We do our own thin film wafer fabrication and do not have alternate sources for these processes.

We currently operate our own thin film wafer manufacturing facility in Tempe, Arizona, although in October 2004, we made a decision to exit our thin film Medical device business during the March 2005 quarter and close our Tempe facility. (See Note 16 of Notes to Financial Statements). Much of our equipment has been utilized for a long time, and can be subject to unscheduled downtime. Our Tempe, Arizona facility is the only fabrication facility in which we can run the thin film processes associated with our Medical products. Any disruption at our Tempe, Arizona facility would preclude our manufacturing of our Medical products, which would have a material adverse impact on our revenues and gross margin over the next two quarters. Other significant risks associated with our wafer manufacturing over the next two quarters include:

• the lack of assured supplies of wafers, chemicals or other materials, and control over delivery schedules;

• our inability to retain certain of our manufacturing personnel in light of our announced plant closure;

• our ability to meet our customers’ quality requirements;

• our ability to achieve and maintain satisfactory yields and productivity; and

• the availability of spare parts and maintenance service for aging equipment.

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Our reliance upon foreign suppliers exposes us to risks associated with international operations.

We use foundry partners and assembly and test subcontractors in Asia, primarily in China, Japan, Thailand, Malaysia, Taiwan and India, for our products. Our dependence on these foundries and subcontractors involves the following substantial risks:

• political and economic instability;

• changes in our cost structure due to changes in local currency values relative to the U.S. dollar;

• potential difficulty in enforcing agreements and recovering damages for their breach;

• inability to obtain and retain manufacturing capacity and priority for our business, especially during industry-wide times of capacity shortages;

• exposure to greater risk of misappropriation of intellectual property;

• disruption to air transportation from Asia; and

• changes in tax laws, tariffs and freight rates.

These risks may lead to delayed product delivery or increased costs, which would harm our profitability, financial results and customer relationships. In addition, we maintain significant inventory at our foreign subcontractors that could be at risk.

We also drop ship product from these foreign subcontractors directly to customers. This increases our exposure to disruptions in operations not under our direct control and may require us to enhance our computer and information systems to coordinate this remote activity.

Our markets are subject to rapid technological change. Therefore, our success depends on our ability to develop and introduce new products.

The markets for our products are characterized by:

• rapidly changing technologies;

• changing customer needs;

• evolving industry standards;

• frequent new product introductions and enhancements;

• increased integration with other functions; and

• rapid product obsolescence.

Our competitors or customers may offer new products based on new technologies, industry standards or end user or customer requirements, including products that have the potential to replace or provide lower cost or higher performance alternatives to our products. The introduction of new products by our competitors or customers could render our existing and future products obsolete or unmarketable. In addition, our competitors and customers may introduce products that eliminate the need for our products. Our customers are constantly developing new products that are more complex and miniature, increasing the pressure on us to develop products to address the increasingly complex requirements of our customers’ products in environments in which power usage, lack of interference with neighboring devices and miniaturization are increasingly important.

To develop new products for our core markets, we must develop, gain access to, and use new technologies in a cost effective and timely manner, and continue to expand our technical and design expertise. In addition, we must have our products designed into our customers’ future products and maintain close working relationships with key customers in order to develop new products that meet their changing needs.

We may not be able to identify new product opportunities, to develop or use new technologies successfully, to develop and bring to market new products, or to respond effectively to new technological changes or product announcements by our competitors. There can be no assurance even if we are able to do so that our customers will design our products

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into their products or that our customers’ products will achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense and involve engineering risk. Failure in any of these areas could harm our operating results.

We may be unable to reduce the costs associated with our products quickly enough for us to meet our margin targets, particularly in the Mobile and Computing markets.

In the Computing market, where we often have been a second source to competitors’ products, our ability to compete depends to a great extent on price. In the Mobile market our competitors have been second sourcing our products and as a result this market is becoming more price competitive. We need to be able to reduce the costs associated with our products in order to retain and increase our market share. We may attempt to achieve cost reductions, for example by obtaining reduced prices from our manufacturing subcontractors, using larger sized wafers, adopting simpler processes, and redesigning parts to require fewer pins or to make them smaller thereby increasing the number of good die per wafer. There can be no assurance that we will be successful in achieving cost reductions through any of these methods, in which case we will experience lower margins.

Our future success depends in part on the continued service of our key engineering and management personnel and our ability to identify, hire and retain additional personnel.

There is intense competition for qualified personnel in the semiconductor industry, in particular for the highly skilled design, applications and test engineers involved in the development of new analog integrated circuits. Competition is especially intense in the San Francisco Bay area, where our corporate headquarters and engineering center is located. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our employ in the future. This is especially true in the analog area where competition is fierce for qualified experienced design engineers. Growth is expected to place increased demands on our resources and will likely require the addition of management and engineering personnel, and the development of additional expertise by existing management personnel. The loss of services and/or changes in our management team or our key engineers, or the failure to recruit or retain other key technical and management personnel, could cause additional expense, potentially reduce the efficiency of our operations and could harm our business.

Due to the volatility of demand for our products, our inventory may from time to time be in excess of our needs, which could cause write-downs of our inventory or of inventory held by our distributors.

Generally our products are sold pursuant to short-term releases of customer purchase orders and some orders must be filled on an expedited basis. Our backlog is subject to revisions and cancellations and anticipated demand is constantly changing. Because of the short life cycles involved with our customers’ products, the order pattern from individual customers can be erratic, with inventory accumulation and liquidation during phases of the life cycle for our customers’ products. We face the risk of inventory write-offs if we manufacture products in advance of orders. However, if we do not make products in advance of orders, we may be unable to fulfill some or all of the demand to the detriment of our customer relationships because we have insufficient inventory on hand and at our distributors to fill unexpected orders and because the time required to make the product may be longer than the time that certain customers will wait for the product.

We typically plan our production and our inventory levels, and the inventory levels of our distributors, based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Therefore, we often order materials and at least partially fabricate product in anticipation of customer requirements. To achieve efficiencies in manufacturing, we may also order and process materials in advance of anticipated customer demand. Furthermore, due to long manufacturing lead times, in order to respond in a timely manner to customer demand, we may also make products or have products made in advance of orders to keep in our inventory, and we may encourage our distributors to order and stock products in advance of orders, which is subject to their right to return them to us.

In the last few years, there has been a trend toward vendor managed inventory among some large customers. In such situations, we do not recognize revenue until the customer withdraws inventory from stock or otherwise becomes obligated to retain our product. This imposes the burden upon us of carrying additional inventory that is stored on or near our customers’ premises and is subject in many instances to return to our premises if not used by the customer.

We value our inventories on a part by part basis to appropriately consider excess inventory levels and obsolete inventory primarily based on forecasted customer demand and on backlog, and to consider reductions in sales price. For the reasons described above, we may end up carrying more inventory than we need in order to meet our customers’ orders, in which case we may incur charges when we write down the excess inventory to its net realizable value, if any, should our customers for whatever reason not order the product in our inventory.

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Our design wins may not result in customer products utilizing our devices and our backlog may not result in future shipments of our devices. During a typical quarter, a substantial portion of our shipments are not in our backlog at the start of the quarter, which limits our ability to forecast in the near term.

We count as a design win each decision by one of our customers to use one of our parts in one of their products that, based on their projected usage, will generate more than $100,000 of sales annually for us when the product is in production. Not all of the design wins that we recognize will result in revenue as a customer may cancel an end product for a variety of reasons. Even if the customer’s end product does go into production, it may not result in annual product sales by us of $100,000 and the customer’s product may have a shorter life than expected. Also, the length of time from design win to production will vary based on the customer’s development schedule. The revenue from design wins varies significantly. Therefore, the number of design wins we obtain may not correlate directly to our future sales.

Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular point in time is not necessarily indicative of actual sales for any succeeding period. A reduction of backlog during any particular period, or the failure of our backlog to result in future shipments, could harm our business. Much of our revenue is based upon orders placed with us that have short lead time until delivery or sales by our distributors to their customers (we do not recognize revenue on sales to our distributors until the distributor sells the product to its customers). As a result, our ability to forecast our future shipments and our ability to increase manufacturing capacity quickly may limit our ability to fulfill customer orders with short lead times.

The majority of our operating expenses cannot be reduced quickly in response to revenue shortfalls without impairing our ability to effectively conduct business.

The majority of our operating expenses are labor related and therefore cannot be reduced quickly without impairing our ability to effectively conduct business. Much of the remainder of our operating costs such as rent are relatively fixed. Therefore, we have limited ability to reduce expenses quickly in response to any revenue shortfalls. Consequently, our operating results will be harmed if our revenues do not meet our projections. We may experience revenue shortfalls for the following and other reasons:

• significant pricing pressures that occur because of declines in average selling prices over the life of a product;

• sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers to allocate available supplies or capacity to other customers and, in turn, harm our ability to meet our sales obligations; and

• rescheduling or cancellation of customer orders due to actions of our competitors, a softening of the demand for our customers’ products, or other reasons.

We may not be able to protect our intellectual property rights adequately.

Our ability to compete is affected by our ability to protect our intellectual property rights. We rely on a combination of patents, trademarks, copyrights, mask work registrations, trade secrets, confidentiality procedures and nondisclosure and licensing arrangements to protect our intellectual property rights. Despite these efforts, the steps we take to protect our proprietary information may not be adequate to prevent misappropriation of our technology, and our competitors may independently develop technology that is substantially similar or superior to our technology.

To the limited extent that we are able to seek patent protection for our products or processes, our pending patent applications or any future applications may not be approved. Any issued patents may not provide us with competitive advantages and may be challenged by third parties. If challenged, our patents may be found to be invalid or unenforceable, and the patents of others may have an adverse effect on our ability to do business. Furthermore, others may independently develop similar products or processes, duplicate our products or processes, or design around any patents that may be issued to us.

We could be harmed by litigation involving patents and other intellectual property rights.

As a general matter, the semiconductor and related industries are characterized by substantial litigation regarding patent and other intellectual property rights. We may be accused of infringing the intellectual property rights of third parties. Furthermore, we may have certain indemnification obligations to customers with respect to the infringement of third party intellectual property rights by our products. Infringement claims by third parties or claims for indemnification by customers or end users of our products resulting from infringement claims may be asserted in the future and such assertions, if proven to be true, may harm our business.

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Any litigation relating to the intellectual property rights of third parties, whether or not determined in our favor or settled by us, would at a minimum be costly and could divert the efforts and attention of our management and technical personnel. In the event of any adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms, or at all.

By supplying parts used in medical devices that help sustain human life, we are vulnerable to product liability claims.

We supply our thin film products predominantly to Guidant and also to Medtronic for use in implantable defibrillators and pacemakers, which help sustain human life. Should our products cause failure in their products, we may be sued and have liability, although under federal law Guidant and Medtronic would be required to defend and take responsibility in such instances until their liability was established, in which case we could be liable for that part of those damages caused by our willful misconduct and, in the case of Medtronic, our negligence.

Our failure to comply with environmental regulations could result in substantial liability to us.

We are subject to a variety of federal, state and local laws, rules and regulations relating to the protection of health and the environment. These include laws, rules and regulations governing the use, storage, discharge, release, treatment and disposal of hazardous chemicals during and after manufacturing, research and development and sales demonstrations, as well as the maintenance of healthy and environmentally sound conditions within our facilities. If we fail to comply with applicable requirements, we could be subject to substantial liability for cleanup efforts, property damage, personal injury and fines or suspension or cessation of our operations. In these regards, during the closure of our Milpitas facility, residual contaminants from our operations were detected in concrete and soil samples, and we were required by the State Department of Toxic Substances Control (“DTSC”) to conduct a further investigation of soil and groundwater conditions at the site, involving the collection of numerous additional samples and analysis for a broad range of chemicals under a Preliminary Endangerment Assessment (“PEA”) work plan approved by the DTSC. As a result of this sampling and analysis, it was determined that there is a relatively small area of shallow soil that contains elevated levels of chromium and nickel in the vicinity of a chemical storage area adjacent to the main facility. We are proposing a limited soil removal action at this area which is pending DTSC approval. The estimated cost of the removal is approximately $50,000. We have retained the construction division of our environmental engineering firm for this purpose, which will do the work under the oversight of DTSC. If further contamination beyond that anticipated based upon our sampling is found, a more comprehensive action costing more could be required, depending upon the nature, extent and magnitude of the contamination that is found and any risks posed by such contamination. The building owner has a pending purchaser for the facility and if our clean-up results in delays in obtaining environmental clearance, then the owner may attempt to hold us liable for any resulting adverse impact on the owner’s pending sale. Similarly, our Tempe facility is located in an area of documented regional groundwater contamination. While we have no reason to believe that our operations at the facility have contributed to this regional contamination, we can give no such assurance. In connection with our pending closure of this facility, we will be conducting environmental studies at the site. Although we know of no issues, if these studies identify contamination, we may be required to remediate.

Earthquakes, other natural disasters and shortages may damage our business.

Our California facilities and some of our suppliers are located near major earthquake faults that have experienced earthquakes in the past. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of our major suppliers, like the ones that occurred in Taiwan in September 1999 and in Japan in October 2004, could disrupt the operations of those suppliers, limit the supply of our products and harm our business. The October 2004 earthquake in Japan temporarily shut down operations at one of the wafer fabrication facilities at which our products are produced; however, we currently expect to be able to support our product shipments from our two other production fabs while the affected fab is out of operation. Additionally, our facility in Tempe, Arizona is located in a desert region of the southwestern United States. Disruption of water supplies or other infrastructure support could limit the supply during the next two quarters of our products and harm our business. We have occasionally experienced power interruptions at our Tempe facility and power shortages have been reported in California and Arizona. We cannot assure that if power interruptions or shortages occur in the future, they will not adversely affect our business.

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Future terrorist activity, or threat of such activity, could adversely impact our business.

The September 11, 2001 attack may have adversely affected the demand for our customers’ products, which in turn reduced their demand for our products. In addition, terrorist activity interfered with communications and transportation networks, which adversely affected us. Future terrorist activity could similarly adversely impact our business.

Issuance of new laws or accounting regulations, or reinterpretation of existing laws or regulations, could materially impact our business or stated results.

From time to time, the government, courts and financial accounting boards issue new laws or accounting regulations, or modify or reinterpret existing ones. There may be future changes in laws, interpretations or regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally. For example, proposals to account for employee stock option grants as an expense could have the result of our not using options as widely for our employees which could impact our ability to hire and retain key employees.

Our stock price may continue to be volatile, and our trading volume may continue to be relatively low and limit liquidity and market efficiency. Should significant shareholders desire to sell their shares within a short period of time, our stock price could decline.

The market price of our common stock has fluctuated significantly. In the future, the market price of our common stock could be subject to significant fluctuations due to general market conditions and in response to quarter to quarter variations in:

• our anticipated or actual operating results;

• announcements or introductions of new products by us or our competitors;

• technological innovations or setbacks by us or our competitors;

• conditions in the semiconductor and passive components markets;

• the commencement of litigation;

• changes in estimates of our performance by securities analysts;

• announcements of merger or acquisition transactions; and

• general economic and market conditions.

In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many high technology companies, particularly semiconductor companies, that have often been unrelated or disproportionate to the operating performance of the companies. These fluctuations, as well as general economic and market conditions, may harm the market price of our common stock. Furthermore, our trading volume is often small, meaning that a few trades have disproportionate influence on our stock price. In addition, someone seeking to liquidate a sizable position in our stock may have difficulty doing so except over an extended period or privately at a discount. Thus, if a shareholder were to sell or attempt to sell a large number of its shares within a short period of time, this sale or attempt could cause our stock price to decline. Our stock is followed by a relatively small number of analysts and any changes in their rating of our stock could cause significant swings in its market price.

Our shareholder rights plan, together with the anti-takeover provisions of our certificate of incorporation and of the California General Corporation Law, may delay, defer or prevent a change of control.

Our board of directors adopted a shareholder rights plan in autumn 2001 to encourage third parties interested in acquiring us to work with and obtain the support of our board of directors. The effect of the rights plan is that any person who does not obtain the support of our board of directors for its proposed acquisition of us would suffer immediate dilution upon achieving ownership of more than 15% of our stock. Under the rights plan, we have issued rights to purchase shares of our preferred stock that are redeemable by us prior to a triggering event for a nominal

30

amount at any time and that accompany each of our outstanding common shares. These rights are triggered if a third party acquires more than 15% of our stock without board of director approval. If triggered, these rights entitle our shareholders, other than the third party causing the rights to be triggered, to purchase shares of the company’s preferred stock at what is expected to be a relatively low price. In addition, these rights may be exchanged for common stock under certain circumstances if permitted by the board of directors.

In addition, our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights of those shares without any further vote or action by our shareholders. The rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of any shares of preferred stock that may be issued in the future, including the preferred shares covered by the shareholder rights plan. The issuance of preferred stock may delay, defer or prevent a change in control. The terms of the preferred stock that might be issued could potentially make more difficult or expensive our consummation of any merger, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction. California Corporation law requires an affirmative vote of all classes of stock voting independently in order to approve a change in control. In addition, the issuance of preferred stock could have a dilutive effect on our shareholders.

Further, our shareholders must give written notice delivered to our executive offices no less than 120 days before the one year anniversary of the date our proxy statement was released to shareholders in connection with the previous year’s annual meeting to nominate a candidate for director or present a proposal to our shareholders at a meeting. These notice requirements could inhibit a takeover by delaying shareholder action. The California Corporation law also restricts business combinations with some shareholders once the shareholder acquires 15% or more of our common stock.

We will incur increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance matters and public disclosure.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the SEC and by the NASDAQ National Market and new accounting pronouncements will result in increased costs to us as we evaluate the implications of these laws, regulations and standards and respond to their requirements. To maintain high standards of corporate governance and public disclosure, we intend to invest substantial resources to comply with evolving standards. This investment may result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are taking steps to comply with the recently enacted laws and regulations in accordance with the deadlines by which compliance is required, but cannot predict or estimate the amount or timing of additional costs that we may incur to respond to their requirements.

Acquisitions and strategic alliances may harm our operating results or cause us to incur debt or assume contingent liabilities.

We may in the future acquire and form strategic alliances relating to other businesses, products and technologies. Successful acquisitions and alliances in the semiconductor industry are difficult to accomplish because they require, among other things, efficient integration and aligning of product offerings and manufacturing operations and coordination of sales and marketing and research and development efforts. We have no recent experience in making such acquisitions or alliances. The difficulties of integration and alignment may be increased by the necessity of coordinating geographically separated organizations, the complexity of the technologies being integrated and aligned and the necessity of integrating personnel with disparate business backgrounds and combining different corporate cultures. The integration and alignment of operations following an acquisition or alliance requires the dedication of management resources that may distract attention from the day to day business, and may disrupt key research and development, marketing or sales efforts. We may also incur debt or assume contingent liabilities in connection with acquisitions and alliances, which could harm our operating results. Without strategic acquisitions and alliances we may have difficulty meeting future customer product and service requirements.

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A decline in our stock price could result in securities class action litigation against us. Securities class action litigation diverts management attention and could harm our business.

In the past, securities class action litigation has often been brought against public companies after periods of volatility in the market price of their securities. Due in part to our historical stock price volatility, we could in the future be a target of such litigation. Securities litigation could result in substantial costs and divert management’s attention and resources, which could harm our ability to execute our business plan.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

As of September 30, 2004 we held $18.9 million of investments in debt securities, but did not hold investments in equity securities. As of March 31, 2004 we did not hold investments in debt or equity securities. We have owned and may own financial instruments in the future that are sensitive to market risks and subject to fluctuations in interest rates as part of our investment portfolio. We do not own derivative financial instruments.

Our investment portfolio at September 30, 2004 included debt instruments that were United Stated agency bonds and commercial paper of less than 90 days in duration. These investments were subject to interest rate risk, and could decline in value if interest rates increase. Due to the short duration and conservative nature of these instruments, we do not believe that we had a material exposure to interest rate risk.

We have evaluated the estimated fair value of our financial instruments at September 30, 2004. The amounts reported as cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to their short-term maturities. Historically, the fair values of short-term investments are estimated based on quoted market prices.

At September 30, 2004 we had $344,000 of long-term debt obligations, which consisted of capital leases and equipment loans. As of March 31, 2004 we had $7,252,000 of long-term debt obligations, which consisted of bank borrowing, capital leases and equipment loans. The table below presents principal amounts and related weighted average interest rates by year of maturity for our long-term debt obligations and their fair value as of March 31, 2004. At that date, our long-term debt securities were scheduled to mature from between one and a half years and five years. The fair value of our long-term debt was based on the estimated market rate of interest for similar debt instruments with the same remaining maturities.

At March 31, 2004:

	Periods of Maturity																		Fair Value as of March 31, 2004
in thousands	2005			2006			2007			2008			Thereafter			Total
Liabilities:
Long-term debt obligations	$	2,568		$	1,560		$	1,108		$	1,100		$	916		$	7,252		$	7,255
Weighted average interest rate		7.42	%		7.22	%		7.27	%		7.25	%		7.25	%		7.31	%

ITEM 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. The Company’s principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Form 10-Q and have determined that they are reasonably effective, taking into account the totality of the circumstances.

(b) Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting during the three-month period ended September 30, 2004, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Some of our key controls are manual and are consequently inefficient. In October 2004 we began to use Oracle business system software which we plan to use in the preparation of our third quarter and year end fiscal 2005 financial statements. We expect that the new Oracle business system software will strengthen our internal controls; however, there may be additional risk to our controls during our initial implementation in the three months ended December 31, 2004 as we update our processes, train our employees and validate our setup of the software.

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PART II.

ITEM 1. Legal Proceedings

None

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

None.

ITEM 3. Defaults upon Senior Securities

None.

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

The Company’s annual meeting of shareholders was held on August 12, 2004. At the meeting the following matters were acted upon.

Matter Acted Upon:

A. Election of Directors

	Votes for	Votes Withheld
Robert V. Dickinson	18,771,750	837,309
Wade F. Meyercord	18,146,681	1,462,378
Dr. Edward C. Ross	18,683,304	925,755
Dr. David W. Sear	18,770,843	838,216
Dr. John L. Sprague	18,665,337	943,722
David L. Wittrock	18,756,717	852,342

B. To ratify the selection of the firm Grant Thornton LLP as the independent auditors for the fiscal year ending March 31, 2005.

For	19,479,148
Against	34,135
Abstain	95,776
Broker non-vote	—

C. To approve the adoption of the 2004 Omnibus Incentive Compensation Plan.

For	8,359,878
Against	3,364,351
Abstain	138,051
Broker non-vote	7,746,779

D. To approve a proposal to amend Registrant’s Restated Articles of Incorporation to increase the number of authorized shares of Common Stock from twenty-five million shares (25,000,000) to fifty million shares (50,000,000).

For	17,336,454
Against	2,170,191
Abstain	102,414
Broker non-vote	—

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ITEM 5. Other Information

None.

ITEM 6. Exhibits

The following documents are filed as Exhibits to this report:

10.20 Amended and Restated Loan and Security Agreement with Silicon Valley Bank dated September 30, 2004.*

31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer

31.2 Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer

32.1 Section 1350 Certification of Principal Executive Officer

32.2 Section 1350 Certification of Principal Financial Officer

* Portions submitted pursuant to a request for confidential treatment.

34

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		CALIFORNIA MICRO DEVICES CORPORATION
		(Registrant)
Date: November 8, 2004	By:	/S/ ROBERT V. DICKINSON
		Robert V. Dickinson, President and Chief Executive Officer (Principal Executive Officer)
		/S/ R. GREGORY MILLER
		R. Gregory Miller
		Vice President Finance and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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EX-10.20

Exhibit 10.20

SECOND AMENDED AND RESTATED

LOAN AND SECURITY AGREEMENT

by and between

Silicon Valley Bank

and

California Micro Devices Corporation

September 29, 2004

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

SECOND AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT

This SECOND AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT (this “Agreement”) dated September 29, 2004, between SILICON VALLEY BANK (“Bank”), whose address is 3003 Tasman Drive, Santa Clara, California 95054 and CALIFORNIA MICRO DEVICES CORPORATION, a California corporation (“Borrower”), whose address is 430 N. McCarthy Blvd., #100, Milpitas, California 95035, provides the terms on which Bank will lend to Borrower and Borrower will repay Bank. The parties agree as follows:

1. ACCOUNTING AND OTHER TERMS

Accounting terms not defined in this Agreement will be construed following GAAP. Calculations and determinations must be made following GAAP. The term “financial statements” includes the notes and schedules. The terms “including” and “includes” always mean “including (or includes) without limitation,” in this or any Loan Document.

2. LOAN AND TERMS OF PAYMENT

2.1 Promise to Pay.

Borrower promises to pay Bank the unpaid principal amount of all Credit Extensions and interest on the unpaid principal amount of the Credit Extensions.

2.1.1 Revolving Advances.

(a) Bank will make Advances not exceeding the Committed Revolving Line minus the Sublimit Utilization Amount. Amounts borrowed under this Section may be repaid (without penalty) and reborrowed during the term of this Agreement.

(b) To obtain an Advance, Borrower must notify Bank by facsimile or telephone by 12:00 p.m. Pacific time on the Business Day the Advance is to be made. Borrower must promptly confirm the notification by delivering to Bank the Payment/Advance Form attached as Exhibit B. Bank will credit Advances to Borrower’s deposit account. Bank may make Advances under this Agreement based on instructions from a Responsible Officer or his or her authorized designee or without instructions if the Advances are necessary to meet Obligations which have become due. Bank may rely on any telephone notice given by a person whom Bank reasonably believes is a Responsible Officer or designee. Borrower will indemnify Bank for any loss Bank suffers due to such reliance.

(c) The Committed Revolving Line terminates on the Revolving Maturity Date, when all Advances are immediately payable.

(d) Bank’s obligation to lend the undisbursed portion of the Obligations will terminate if, in Bank’s sole discretion, there has been a material adverse change in the general affairs, management, results of operations, condition (financial or otherwise) or the prospect of repayment of the Obligations, or there has been any material adverse deviation by Borrower from the most recent business plan of Borrower presented to and accepted by Bank prior to the execution of this Agreement.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

2.1.2 Letters of Credit Sublimit.

Bank will issue or have issued Letters of Credit for Borrower’s account not exceeding the Committed Revolving Line minus the sum of (a) all amounts for services utilized under the Cash Management Services Sublimit, (b) the FX Reserve and (c) the sum of the outstanding principal balance of the Advances. Each Letter of Credit will have an expiry date of no later than 180 days after the Revolving Maturity Date, but Borrower’s reimbursement obligation will be secured by cash on terms acceptable to Bank on or before the Revolving Maturity Date if the term of this Agreement is not extended by Bank. Borrower agrees to execute any further documentation in connection with the Letters of Credit as Bank may reasonably request.

2.1.3 Foreign Exchange Sublimit.

If there is availability under the Committed Revolving Line, then Borrower may enter in foreign exchange forward contracts with the Bank under which Borrower commits to purchase from or sell to Bank a set amount of foreign currency more than one business day after the contract date (the “FX Forward Contract”). Bank will subtract 10% of each outstanding FX Forward Contract from the foreign exchange sublimit which is a maximum of the Committed Revolving Line minus the sum of (a) all amounts for services utilized under the Cash Management Services Sublimit, (b) the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit), and (c) the sum of the outstanding principal balance of the Advances (the “FX Reserve”). The total FX Forward Contracts at any one time may not exceed 10 times the amount of the FX Reserve. Bank may terminate the FX Forward Contracts if an Event of Default occurs.

2.1.4 Cash Management Services Sublimit.

Borrower may use up to the Committed Revolving Line minus the sum of (a) the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit), (b) the FX Reserve and (c) the sum of the outstanding principal balance of the Advances (the “Cash Management Services Sublimit”) for Bank’s Cash Management Services, which may include merchant services, direct deposit of payroll, business credit card, and check cashing services identified in various cash management services agreements related to such services (the “Cash Management Services”). Such aggregate amounts utilized under the Cash Management Services Sublimit will at all times reduce the amount otherwise available to be borrowed under the Committed Revolving Line. Any amounts Bank pays on behalf of Borrower or any amounts that are not paid by Borrower for any Cash Management Services will be treated as Advances under the Committed Revolving Line and will accrue interest at the rate for Advances.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

2.2 Overadvances.

If Borrower’s Obligations under Section 2.1.1, 2.1.2, 2.1.3 and 2.1.4 exceed the Committed Revolving Line, Borrower must immediately pay Bank the excess.

2.3 Interest Rate, Payments.

(a) Interest Rate. Advances accrue interest on the outstanding principal balance at a per annum rate equal to the Prime Rate. After an Event of Default, Obligations accrue interest at 5 percent above the rate effective immediately before the Event of Default. The interest rate increases or decreases when the Prime Rate changes. Interest is computed on a 360 day year for the actual number of days elapsed.

(b) Payments. Interest due on the Committed Revolving Line is payable on the 1st day of each month. Bank may debit any of Borrower’s deposit accounts including Account Number ** for principal and interest payments owing or any amounts Borrower owes Bank. Bank will promptly notify Borrower when it debits Borrower’s accounts. These debits are not a set-off. Payments received after 12:00 noon Pacific time are considered received at the opening of business on the next Business Day. When a payment is due on a day that is not a Business Day, the payment is due the next Business Day and additional fees or interest accrue.

2.4 Fees.

Borrower will pay:

(a) Loan Fee. A fully earned, non-refundable term loan fee of $50,000; and

(b) Bank Expenses. All Bank Expenses (including reasonable attorneys’ fees and reasonable expenses) incurred through and after the date of this Agreement, are payable when due.

3. CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Credit Extension.

Bank’s obligation to make the initial Credit Extension is subject to the condition precedent that it receive the agreements, documents and fees it requires.

3.2 Conditions Precedent to all Credit Extensions.

Bank’s obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following:

(a) timely receipt of any Payment/Advance Form; and

(b) the representations and warranties in Section 5 must be true on the date of the Payment/Advance Form and on the effective date of each Credit Extension and no

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

Event of Default may have occurred and be continuing, or result from the Credit Extension. Each Credit Extension is Borrower’s representation and warranty on that date that the representations and warranties of Section 5 remain true.

4. CREATION OF SECURITY INTEREST

4.1 Grant of Security Interest.

Borrower grants Bank a continuing security interest in all presently existing and later acquired Collateral to secure all Obligations and performance of each of Borrower’s duties under the Loan Documents. Except for Permitted Liens, any security interest will be a first priority security interest in the Collateral. Bank may place a “hold” on any deposit account pledged as Collateral. If this Agreement is terminated, Bank’s lien and security interest in the Collateral will continue until Borrower fully satisfies its Obligations and all obligations of the Bank to make Credit Extensions or otherwise extend credit accommodations have terminated.

4.2 Authorization to File Financing Statements.

Borrower authorizes Bank to file financing statements without notice to Borrower, with all appropriate jurisdictions, as Bank deems appropriate, in order to perfect or protect Bank’s interest in the Collateral.

4.3 Release of Account Control Agreement.

Upon payment in full of the Obligations, provided that Bank has no further obligation to make any Credit Extension to Borrower, Bank shall terminate the account control agreements.

5. REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants that the following statements are true and correct on the date hereof and Borrower covenants that the following statements will continue to be true and correct throughout the term of this Agreement and so long as any Obligations are outstanding:

5.1 Due Organization and Authorization.

Borrower and each Subsidiary is duly existing and in good standing in its state of formation (or reincorporation) and qualified and licensed to do business in, and in good standing in, any state in which the conduct of its business or its ownership of property requires that it be qualified, except where the failure to do so could not reasonably be expected to cause a Material Adverse Change. Borrower has not changed its state of formation or its organizational structure or type or any organizational number (if any) assigned by its jurisdiction of formation.

The execution, delivery and performance of the Loan Documents have been duly authorized, and do not conflict with Borrower’s formation documents, nor constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which or by which it is bound in which the default could reasonably be expected to cause a Material Adverse Change.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

5.2 Collateral.

Borrower has good title to the Collateral, and good and marketable title to its real property, free of Liens except Permitted Liens. Borrower has no other deposit account, other than the deposit accounts described in the Schedule (which Schedule Borrower may update from time to time by written notice to Bank). Except as set forth in the Schedule (which Schedule Borrower may update from time to time by written notice to Bank), (a) the Accounts are bona fide, existing obligations, and the service or property has been performed or delivered to the account debtor or its agent for immediate shipment to and unconditional acceptance by the account debtor, and (b) the Collateral is not in the possession of any third party bailee (such as at a warehouse). In the event that Borrower, after the date hereof, intends to store or otherwise deliver the Collateral to such a bailee, then Borrower will receive the prior written consent of Bank and such bailee must acknowledge in writing that the bailee is holding such Collateral for the benefit of Bank. Except as set forth in the Schedule (which Schedule Borrower may update from time to time by written notice to Bank), Borrower has no notice of any actual or imminent Insolvency Proceeding of any account debtor. All Inventory is in all material respects of good and marketable quality, free from material defects. Borrower is the sole owner of the Intellectual Property, except for exclusive and non-exclusive licenses granted to its customers in the ordinary course of business. Each Patent is valid and enforceable and no part of the Intellectual Property has been judged invalid or unenforceable, in whole or in part, and no claim has been made that any part of the Intellectual Property violates the rights of any third party, except to the extent such invalidity, unenforceability, judgment, or claim could not reasonably be expected to cause a Material Adverse Change.

5.3 Litigation.

Except as set forth in the Schedule (which Schedule Borrower may update from time to time by written notice to Bank), there are no actions or proceedings pending or, to the knowledge of Borrower’s Responsible Officers, threatened by or against Borrower or any Subsidiary which could result in damages or costs to Borrower or any Subsidiary of $100,000 or more, or in which an adverse decision could reasonably be expected to cause a Material Adverse Change.

5.4 No Material Adverse Change in Financial Statements.

All consolidated financial statements for Borrower, and any Subsidiary, delivered to Bank fairly present in all material respects Borrower’s consolidated financial condition and Borrower’s consolidated results of operations. There has not been any material deterioration in Borrower’s consolidated financial condition since the date of the most recent financial statements submitted to Bank.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

5.5 Solvency.

The fair salable value of Borrower’s assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; the Borrower is not left with unreasonably small capital after the transactions in this Agreement; and Borrower is able to pay its debts (including trade debts) as they mature.

5.6 Regulatory Compliance.

Borrower is not an “investment company” or a company “controlled” by an “investment company” under the Investment Company Act. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Borrower has not violated any laws, ordinances or rules, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower’s or any Subsidiary’s properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower’s knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each Subsidiary has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP and which do not result in any tax lien on any of the Collateral. Borrower and each Subsidiary has obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all government authorities that are necessary to continue its business as currently conducted, except where the failure to do so could not reasonably be expected to cause a Material Adverse Change.

5.7 Subsidiaries.

Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments.

5.8 Full Disclosure.

No written representation, warranty or other statement of Borrower in any certificate or written statement given to Bank (taken together with all such written certificates and written statements to Bank) contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements not misleading. It being recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected and forecasted results.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

6. AFFIRMATIVE COVENANTS

Borrower will do all of the following for so long as Bank has an obligation to lend, or there are outstanding Obligations:

6.1 Government Compliance.

Borrower will maintain its and all Subsidiaries’ legal existence and good standing in its jurisdiction of formation (or reincorporation) and maintain qualification in each jurisdiction in which the failure to so qualify would reasonably be expected to cause a material adverse effect on Borrower’s business or operations. Borrower will comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which it or its properties is subject, noncompliance with which could have a material adverse effect on Borrower’s business or operations or would reasonably be expected to cause a Material Adverse Change.

6.2 Financial Statements, Reports, Certificates.

(a) Borrower will deliver to Bank: (i) as soon as available, but no later than within 5 days of filing with the SEC, Borrower’s Report on Form 10-Q containing consolidated financial statements prepared under GAAP, consistently applied, subject to year-end audit adjustments; (ii) as soon as available, but no later than within 5 days of filing with the SEC, Borrower’s Report on Form 10-K containing audited consolidated financial statements prepared under GAAP, consistently applied, together with an unqualified opinion on the financial statements from an independent certified public accounting firm reasonably acceptable to Bank; (iii) a prompt report of any legal actions pending or threatened against Borrower or any Subsidiary that could reasonably result in damages or costs to Borrower or any Subsidiary of $100,000 or more; and (iv) budgets, sales projections, operating plans, 8-K filings or other financial information Bank reasonably requests, including, within 45 days of the end of each fiscal year, an operating forecast for the next fiscal year.

(b) Within 30 days after the last day of each month, Borrower will deliver to Bank a report of cash holdings.

(c) Within 5 days after the date of filing with the SEC, Borrower will deliver to Bank with the financial statements required in subsection (a) above, a Compliance Certificate signed by a Responsible Officer in the form of Exhibit C.

(d) Promptly, but in any event within five days from the date Borrower has actual notice thereof, Borrower shall provide to Bank written notice of any material pending or threatened claim, action or proceeding involving any environmental law, any written communication from any governmental authority relating to any violation of environmental law, or any release, escape, dumping, spill or similar discharge or emission on or from its real property of any substance defined as hazardous under any applicable environmental law.

(e) Borrower will allow Bank to audit Borrower’s Collateral at Borrower’s reasonable expense. Such audits will be conducted no more often than every 6 months unless an Event of Default or an event which, with notice or passage of time or both would constitute an Event of Default, has occurred and is continuing.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

6.3 Inventory; Returns.

Borrower will keep all Inventory in good and marketable condition, free from material defects. Returns and allowances between Borrower and its account debtors will follow Borrower’s customary practices as they exist at execution of this Agreement. Borrower must promptly notify Bank of all returns, recoveries, disputes and claims, that involve more than $300,000, excluding distributor stock rotation.

6.4 Taxes.

Borrower will make, and cause each Subsidiary to make, timely payment of all material federal, state, and local taxes or assessments (other than taxes and assessments which Borrower is contesting in good faith, with adequate reserves maintained in accordance with GAAP and which do not result in any tax lien on any of the Collateral) and will deliver to Bank, on demand, appropriate certificates attesting to the payment.

6.5 Insurance.

Borrower will keep its business and the Collateral insured for risks and in amounts as Bank may reasonably request. Without limiting the foregoing, Borrower will keep the Tempe Property insured against loss or damage by fire or other risks on terms and in amounts that are no less favorable than insurance maintained by owners of similar properties, that are in accordance with normal industry practice and are in amounts equal to the replacement cost of the improvements on the real property. Insurance policies will be in a form and with companies that are satisfactory to Bank in Bank’s reasonable discretion. All property policies will have a lender’s loss payable endorsement showing Bank as an additional loss payee and all liability policies will show the Bank as an additional insured and provide that the insurer must give Bank at least 20 days notice before canceling its policy. At Bank’s request, Borrower will deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy will, at Bank’s reasonable option, be payable to Bank on account of the Obligations.

6.6 Bank Accounts. Borrower will maintain its primary depository and operating accounts with Bank.

6.7 Financial Covenants. Borrower will maintain as of the last day of each quarter:

(a) Quick Ratio. A ratio of (i) unrestricted cash and cash equivalents plus short and long-term marketable securities and Accounts to (ii) Current Liabilities of at least ** to 1.00.

(b) Tangible Net Worth. A Tangible Net Worth of at least **.

6.8 Intellectual Property Rights.

At all times during the term of this Agreement, Borrower will (i) protect, defend and maintain the validity and enforceability of the Intellectual Property material to Borrower’s business and, so long as any Credit Extensions are outstanding, promptly advise Bank in writing of material infringements and (ii) not allow any Intellectual Property material to Borrower’s business to be abandoned, forfeited or dedicated to the public without Bank’s written consent.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

6.9 Further Assurances.

Borrower will execute any further instruments and take further action as Bank reasonably requests to perfect or continue Bank’s security interest in the Collateral or to effect the purposes of this Agreement.

7. NEGATIVE COVENANTS

Borrower will not do any of the following without Bank’s prior written consent, which will not be unreasonably withheld, for so long as Bank has an obligation to lend or there are any outstanding Obligations:

7.1 Dispositions.

Convey, sell, lease, transfer or otherwise dispose of (collectively “Transfer”), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, except for Transfers (a) of Inventory in the ordinary course of business; (b) of exclusive or non-exclusive licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; or (c) of worn-out or obsolete Inventory and Equipment.

7.2 Changes in Business, Non-Ordinary Course Transactions, Ownership, or Business Locations.

Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower or reasonably related thereto, or enter into any transaction outside the ordinary course of business, or permit any person or group of persons (within the meaning of Rule 13d-5 and successor rules promulgated under Section 13 of the Securities Exchange Act of 1934, as amended (the “34 Act”)) to (a) acquire beneficial ownership (within the meaning of Rule 13d-3 promulgated by the Securities Exchange Commission under the 34 Act) of thirty percent (30%) or more of the outstanding equity securities of Borrower entitled to vote for members of the board of directors, or (b) acquire all or substantially all substantially all of the assets of Borrower and its Subsidiaries taken as a whole. Borrower will not, without at least 30 days prior written notice to the Bank, relocate its chief executive office change its state of formation (including reincorporation), change its organizational number or name or add any new offices or business locations (including warehouses but excluding “hubs” maintained to hold goods for sale to Motorola, Inc.) in which Borrower maintains or stores over $500,000 in Collateral.

7.3 Mergers or Acquisitions.

Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person, or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person (collectively, “Mergers or Acquisitions”),

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

except that a Subsidiary may merge or consolidate into another Subsidiary or into Borrower; and Borrower may enter into Mergers or Acquisitions so long as no Event of Default has occurred, is continuing or would result therefrom.

7.4 Indebtedness.

Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary to do so, other than Permitted Indebtedness.

7.5 Encumbrance.

Create, incur, or allow any Lien on any of its property, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, or permit any Collateral not to be subject to the first priority security interest granted here, subject to Permitted Liens.

7.6 Distributions; Investments.

Directly or indirectly acquire or own any Person, or make any Investment in any Person, other than Permitted Investments, or permit any of its Subsidiaries to do so. Pay any cash dividends or make any distribution or payment or redeem, retire or purchase any capital stock, except for the repurchase of stock from employees, officers, and directors of Borrower pursuant to the terms of applicable repurchase agreement in an aggregate amount not to exceed $50,000 in the aggregate in any fiscal year, provided that no Event of Default has occurred or is continuing or would exist after giving effect to such repurchases.

7.7 Transactions with Affiliates.

Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the ordinary course of Borrower’s business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm’s length transaction with a nonaffiliated Person.

7.8 Subordinated Debt.

Make or permit any payment on any Subordinated Debt, except under the terms of the Subordinated Debt, or amend any provision in any document relating to the Subordinated Debt without Bank’s prior written consent.

7.9 Compliance.

Become an “investment company” or a company controlled by an “investment company,” under the Investment Company Act of 1940 or undertake as one of its important activities extending credit to purchase or carry margin stock, or use the proceeds of any Credit Extension for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation could

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

reasonably be expected to have a material adverse effect on Borrower’s business or operations or would reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so.

8. EVENTS OF DEFAULT

Any one of the following is an Event of Default:

8.1 Payment Default.

If Borrower fails to pay any of the Obligations within 3 days after their due date. During the additional period the failure to cure the default is not an Event of Default (but no Credit Extension will be made during the cure period);

8.2 Covenant Default.

If Borrower does not perform any obligation in Section 6 or violates any covenant in Section 7; or

If Borrower does not perform or observe any other material term, condition or covenant in this Agreement, any Loan Documents, or in any agreement between Borrower and Bank and as to any obligation, performance, covenant violation or default under a term, condition or covenant that can be cured, has not performed the obligation, come into compliance with the covenant or cured the default within 10 days after it occurs, or if the default cannot be cured within 10 days or cannot be cured after Borrower’s attempts within 10 day period, and the obligation may be performed, the covenant can be complied with, or the default may be cured within a reasonable time, then Borrower has an additional period (of not more than 30 days) to attempt to perform the obligation, comply with the covenant or cure the default. During the additional time, the failure to cure the default is not an Event of Default (but no Credit Extensions will be made during the cure period);

8.3 Material Adverse Change.

If there (i) occurs a material adverse change in the business, operations, or condition (financial or otherwise) of the Borrower, or (ii) is a material impairment of the prospect of repayment of any portion of the Obligations or (iii) is a material impairment of the value or priority of Bank’s security interests in the Collateral (each of (i), (ii) and (iii) above shall be referred to herein as a “Material Adverse Change”);

8.4 Attachment.

If any of Borrower’s assets having a value in the aggregate of more than $500,000 is seized, or comes into possession of a trustee or receiver, or is attached or levied on and the attachment or levy is not removed in 10 days, or if Borrower is enjoined, restrained, or prevented by court order from conducting a material part of its business or if a judgment or other claim becomes a Lien on a material portion of Borrower’s assets, or if a notice of lien, levy, or assessment is filed against any of Borrower’s assets by any government agency and not paid

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

within 10 days after Borrower receives notice. These are not Events of Default if stayed or if a bond is posted pending contest by Borrower (but no Credit Extensions will be made during the cure period);

8.5 Insolvency.

If Borrower becomes insolvent or if Borrower begins an Insolvency Proceeding or an Insolvency Proceeding is begun against Borrower and not dismissed or stayed within 30 days (but no Credit Extensions will be made before any Insolvency Proceeding is dismissed);

8.6 Other Agreements.

If there is a default in any agreement between Borrower and a third party that gives the third party the right to accelerate any Indebtedness exceeding $750,000 or that could cause a Material Adverse Change;

8.7 Judgments.

If a money judgment(s) in the aggregate of at least $750,000 is rendered against Borrower and is unsatisfied and unstayed for 10 days (but no Credit Extensions will be made before the judgment is stayed or satisfied); or

8.8 Misrepresentations.

If Borrower or any Person acting for Borrower makes any material misrepresentation or material misstatement now or later in any warranty or representation in this Agreement or in any writing delivered to Bank or to induce Bank to enter this Agreement or any Loan Document.

9. BANK’S RIGHTS AND REMEDIES

9.1 Rights and Remedies.

When an Event of Default occurs and continues Bank may, without notice or demand, do any or all of the following:

(a) Declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank);

(b) Stop advancing money or extending credit for Borrower’s benefit under this Agreement or under any other agreement between Borrower and Bank;

(c) Settle or adjust disputes and claims directly with account debtors for amounts, on terms and in any order that Bank considers advisable;

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

(d) Make any payments and do any acts it considers necessary or reasonable to protect its security interest in the Collateral. Borrower will assemble the Collateral if Bank requires and make it available as Bank designates. Bank may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Bank a license to enter and occupy any of its premises, without charge, to exercise any of Bank’s rights or remedies;

(e) Apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower;

(f) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral. Bank is granted a non-exclusive, royalty-free license or other right to use, without charge, Borrower’s labels, Patents, Copyrights, Mask Works, rights of use of any name, trade secrets, trade names, Trademarks, service marks, and advertising matter, or any similar property as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank’s exercise of its rights under this Section, Borrower’s rights under all licenses and all franchise agreements inure to Bank’s benefit;

(g) Require Borrower to provide cash collateral in the face amount of all undrawn Letters of Credit; and

(h) Dispose of the Collateral according to the Code.

Notwithstanding anything contained herein, Bank shall not exercise any remedy it may have pursuant to (c), (d), (f) or (h) above if no Obligations are then existing.

9.2 Power of Attorney.

Effective only when an Event of Default occurs and continues, Borrower irrevocably appoints Bank as its lawful attorney to: (i) endorse Borrower’s name on any checks or other forms of payment or security; (ii) sign Borrower’s name on any invoice or bill of lading for any Account or drafts against account debtors, (iii) make, settle, and adjust all claims under Borrower’s insurance policies; (iv) settle and adjust disputes and claims about the Accounts directly with account debtors, for amounts and on terms Bank determines reasonable; and (v) transfer the Collateral into the name of Bank or a third party as the Code permits. Bank may exercise the power of attorney to sign Borrower’s name on any documents necessary to perfect or continue the perfection of any security interest regardless of whether an Event of Default has occurred. Bank’s appointment as Borrower’s attorney in fact, and all of Bank’s rights and powers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and Bank’s obligation to provide Credit Extensions terminates.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

9.3 Accounts Collection.

When an Event of Default occurs and continues, Bank may notify any Person owing Borrower money of Bank’s security interest in the funds and demand payment of, and collect any Accounts, general intangibles and other Collateral, and, in connection therewith, Borrower irrevocably authorizes Bank to endorse or sign Borrower’s name on all collections, receipts, instruments and other documents, and, in Bank’s good faith business judgment, to grant extensions of time to pay, compromise claims and settle Accounts and general intangibles for less than face value. When an Event of Default occurs and continues, Borrower shall collect all payments in trust for Bank and, if requested by Bank, immediately deliver the payments to Bank in the form received from the account debtor, with proper endorsements for deposit.

9.4 Bank Expenses.

If Borrower fails to pay any amount or furnish any required proof of payment to third persons, Bank may make all or part of the payment or obtain insurance policies required in Section 6.5, and take any action under the policies Bank deems prudent. Any reasonable amounts paid by Bank are Bank Expenses and immediately due and payable, bearing interest at the then applicable rate and secured by the Collateral. No payments by Bank are deemed an agreement to make similar payments in the future or Bank’s waiver of any Event of Default.

9.5 Bank’s Liability for Collateral.

If Bank complies with reasonable banking practices and Section 9207 of the Code, it is not liable for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other person. Borrower otherwise bears all risk of loss, damage or destruction of the Collateral.

9.6 Remedies Cumulative.

Bank’s rights and remedies under this Agreement, the Loan Documents, and all other agreements are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank’s exercise of one right or remedy is not an election, and Bank’s waiver of any Event of Default is not a continuing waiver. Bank’s delay is not a waiver, election, or acquiescence. No waiver is effective unless signed by Bank and then is only effective for the specific instance and purpose for which it was given.

9.7 Demand Waiver.

Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Bank on which Borrower is liable.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

10. NOTICES

All notices or demands by any party about this Agreement or any other related agreement must be in writing and be personally delivered or sent by an overnight delivery service, by certified mail, postage prepaid, return receipt requested, or by facsimile to the addresses set forth at the beginning of this Agreement. A party may change its notice address by giving the other party written notice.

11. CHOICE OF LAW, FORUM AND JURY TRIAL WAIVER

California law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Santa Clara County, California.

BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.

12. GENERAL PROVISIONS

12.1 Successors and Assigns.

This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights under it without Bank’s prior written consent which may be granted or withheld in Bank’s discretion. Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank’s obligations, rights and benefits under this Agreement.

12.2 Indemnification.

Borrower will indemnify, defend and hold harmless Bank and its officers, employees, and agents against: (a) all obligations, demands, claims, and liabilities asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses incurred, or paid by Bank from, following, or consequential to transactions between Bank and Borrower (including reasonable attorneys fees and expenses), except for losses caused by Bank’s gross negligence or willful misconduct.

12.3 Time of Essence.

Time is of the essence for the performance of all obligations in this Agreement.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

12.4 Severability of Provision.

Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

12.5 Amendments in Writing, Integration.

All amendments to this Agreement must be in writing and signed by Borrower and Bank. This Agreement together with the other Loan Documents represents the entire agreement about this subject matter, and supersedes prior negotiations or agreements. All prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement merge into this Agreement and the Loan Documents.

12.6 Counterparts.

This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.7 Survival.

All covenants, representations and warranties made in this Agreement continue in full force while any Obligations remain outstanding. The obligations of Borrower in Section 12.2 to indemnify Bank will survive until all statutes of limitations for actions that may be brought against Bank have run.

12.8 Confidentiality.

In handling any confidential information, Bank will exercise the same degree of care that it exercises for its own proprietary information, but disclosure of information may be made (i) to Bank’s subsidiaries or affiliates in connection with their business with Borrower, (ii) to prospective transferees or purchasers of any interest in the loans (provided, however, Bank shall use commercially reasonable efforts in obtaining such prospective transferee or purchasers agreement of the terms of this provision), (iii) as required by law, regulation, subpoena, or other order, (iv) as required in connection with Bank’s examination or audit and (v) as Bank considers appropriate exercising remedies under this Agreement. Confidential information does not include information that either: (a) is in the public domain or in Bank’s possession when disclosed to Bank, or becomes part of the public domain after disclosure to Bank; or (b) is disclosed to Bank by a third party, if Bank does not know that the third party is prohibited from disclosing the information.

12.9 Attorneys’ Fees, Costs and Expenses.

In any action or proceeding between Borrower and Bank arising out of the Loan Documents, the prevailing party will be entitled to recover its reasonable attorneys’ fees and other reasonable costs and expenses incurred, in addition to any other relief to which it may be entitled.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

13. DEFINITIONS

13.1 Definitions.

In this Agreement:

“Accounts” are all existing and later arising accounts, contract rights, and other obligations owed Borrower in connection with its sale or lease of goods (including licensing software and other technology) or provision of services, all credit insurance, guaranties, other security and all merchandise returned or reclaimed by Borrower and Borrower’s Books relating to any of the foregoing.

“Advance” or “Advances” is a loan advance (or advances) under the Committed Revolving Line.

“Affiliate” of a Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person’s senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person’s managers and members.

“Bank Expenses” are all audit fees and expenses and reasonable costs and expenses (including reasonable attorneys’ fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings), or otherwise relating to Borrower or the Loan Documents, including, but not limited to, any reasonable attorneys’ fees and costs Bank incurs in order to do the following: obtain legal advice in connection with this Agreement or Borrower; enforce, or seek to enforce, any of Bank’s rights; prosecute actions against, or defend actions by, account debtors; commence, intervene in, or defend any action or proceeding; initiate any complaint to be relieved of the automatic stay in bankruptcy; file or prosecute any bankruptcy claim, third-party claim, or other claim; protect, obtain possession of, lease, dispose of, or otherwise enforce Bank’s security interest in, the Collateral; and otherwise represent Bank in any litigation relating to Borrower.

“Borrower’s Books” are all Borrower’s books and records including ledgers, records regarding Borrower’s assets or liabilities, the Collateral, business operations or financial condition and all computer programs or discs or any equipment containing the information.

“Business Day” is any day that is not a Saturday, Sunday or a day on which the Bank is closed.

“Cash Management Services” are defined in Section 2.1.4.

“Cash Management Services Sublimit” are defined in Section 2.1.4.

“Closing Date” is the date of this Agreement.

“Code” is the Uniform Commercial Code, as applicable.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

“Collateral” is the property described on Exhibit A.

“Committed Revolving Line” is Advances of up to $15,000,000 outstanding at any time.

“Contingent Obligation” is, for any Person, any direct or indirect liability, contingent or not, of that Person for (i) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (ii) any obligations for undrawn letters of credit for the account of that Person; and (iii) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but “Contingent Obligation” does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under the guarantee or other support arrangement.

“Copyrights” are all copyright rights, applications or registrations and like protections in each work or authorship or derivative work, whether published or not (whether or not it is a trade secret) now or later existing, created, acquired or held.

“Credit Extension” is each Advance, Letter of Credit, Exchange Contract, or any other extension of credit by Bank for Borrower’s benefit.

“Current Liabilities” are the aggregate amount of Borrower’s Total Liabilities which mature within one (1) year, and include the face amount of all outstanding Letters of Credit, all FX Forward Contracts and Cash Management Services.

“Equipment” is all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest.

“ERISA” is the Employment Retirement Income Security Act of 1974, and its regulations.

“FRB” means the Board of Governors of the Federal Reserve System, and any Governmental Authority succeeding to any of its principal functions.

“FX Forward Contract” is defined in Section 2.1.3.

“FX Reserve” is defined in Section 2.1.3.

“GAAP” is generally accepted accounting principles.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

“Indebtedness” is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations and (d) Contingent Obligations.

“Insolvency Proceeding” are proceedings by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

“Intellectual Property” is:

(a) Copyrights, Trademarks, Patents, and Mask Works including amendments, renewals, extensions, and all licenses or other rights to use and all license fees and royalties from the use;

(b) Any trade secrets and any intellectual property rights in computer software and computer software products now or later existing, created, acquired or held;

(c) All design rights which may be available to Borrower now or later created, acquired or held;

(d) Any claims for damages (past, present or future) for infringement of any of the rights above, with the right, but not the obligation, to sue and collect damages for use or infringement of the intellectual property rights above;

All associated goodwill, and all proceeds and products of the foregoing, including all insurance, indemnity or warranty payments.

“Inventory” is present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or later owned by or in the custody or possession, actual or constructive, of Borrower, including inventory temporarily out of its custody or possession or in transit and including returns on any accounts or other proceeds (including insurance proceeds) from the sale or disposition of any of the foregoing and any documents of title.

“Investment” is any beneficial ownership of (including stock, partnership interest or other securities) any Person, or any loan, advance or capital contribution to any Person.

“Letter of Credit” is defined in Section 2.1.2.

“Lien” is a mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance, including without limitation, a leasehold or other interest.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

“Loan Documents” are, collectively, this Agreement, any note, or notes executed by Borrower, and any other present or future agreement between Borrower and, or for the benefit of, Bank in connection with this Agreement, all as amended, modified, extended or restated.

“Mask Works” are all mask works or similar rights available for the protection of semiconductor chips, now owned or later acquired.

“Material Adverse Change” is defined in Section 8.3.

“Obligations” are debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, including cash management services, letters of credit and foreign exchange contracts, if any, and including interest accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank.

“Patents” are patents, patent applications and like protections, including improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same.

“Permitted Indebtedness” is:

(a) Borrower’s indebtedness to Bank under this Agreement or any other Loan Document;

(b) Indebtedness existing on the Closing Date and shown on the Schedule;

(c) Subordinated Debt;

(d) Indebtedness to trade creditors and for payroll obligations and taxes incurred in the ordinary course of business; and

(e) Indebtedness secured by Permitted Liens.

“Permitted Investments” are:

(a) Investments shown on the Schedule and existing on the Closing Date;

(b) (i) Marketable direct obligations issued or unconditionally guaranteed by the United States or its agency or any State maturing within 1 year from its acquisition, (ii) commercial paper maturing no more than 1 year after its creation and having the highest rating from either Standard & Poor’s Corporation or Moody’s Investors Service, Inc., (iii) Bank’s certificates of deposit issued maturing no more than 1 year after issue, and (iv) investments maintained with Bank and Bank Affiliates; and

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

(c) Joint ventures and other strategic alliances entered into in the ordinary course of Borrower’s business, provided that any cash investments by Borrower shall not exceed $50,000 in the aggregate in any fiscal year.

“Permitted Liens” are:

(a) Liens existing on the Closing Date and shown on the Schedule or arising under this Agreement or other Loan Documents;

(b) Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, if they have no priority over any of Bank’s security interests;

(c) Purchase money Liens (i) on Equipment acquired or held by Borrower or its Subsidiaries incurred for financing the acquisition of the Equipment, or (ii) existing on equipment when acquired, if the Lien is confined to the property and improvements and the proceeds of the equipment;

(d) Licenses or sublicenses granted in the ordinary course of Borrower’s business and any interest or title of a licensor or under any license or sublicense, if the licenses and sublicenses permit granting Bank a security interest;

(e) Leases or subleases granted in the ordinary course of Borrower’s business, including in connection with Borrower’s leased premises or leased property;

(f) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (c), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase;

(g) Liens securing claims of materialmen, mechanics, carriers, warehousemen, landlords, repairmen, and the like incurred in the ordinary course of business which are not delinquent or remain payable without penalty;

(h) Deposits made in the ordinary course of business with respect to workers compensation insurance, unemployment insurance, and other social security legislation (other than any Lien imposed by ERISA); and

(i) Liens arising solely by virtue of any statutory or common law provision relating to banker’s liens, rights of set-off or similar rights and remedies as to deposit accounts or other funds maintained with a creditor depository institution; provided that (i) such deposit account is not a dedicated cash collateral account and is not subject to restrictions against access by the Borrower in excess of those set forth by regulations promulgated by the FRB, and (ii) such deposit account is not intended by the Borrower or any Subsidiary to provide collateral to the depository institution.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

“Person” is any individual, sole proprietorship, partnership, limited liability company, joint venture, company association, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

“Prime Rate” is Bank’s most recently announced “prime rate,” even if it is not Bank’s lowest rate.

“Responsible Officer” is each of the Chief Executive Officer, the President, the Chief Financial Officer and the Controller of Borrower.

“Revolving Maturity Date” is September 28, 2005.

“Schedule” is any attached schedule, including Schedule A hereto.

“Sublimit Utilization Amount” means the sum of (a) all amounts for services utilized under the Cash Management Services Sublimit, (b) the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) and (c) the FX Reserve.

“Subordinated Debt” is debt incurred by Borrower subordinated to Borrower’s indebtedness owed to Bank and which is reflected in a written agreement in a manner and form acceptable to Bank and approved by Bank in writing.

“Subsidiary” is for any Person, or any other business entity of which more than 50% of the voting stock or other equity interests is owned or controlled, directly or indirectly, by the Person or one or more Affiliates of the Person.

“Tangible Net Worth” is, on any date, the consolidated total assets of Borrower and its Subsidiaries minus (i) any amounts attributable to (a) goodwill, (b) intangible items such as unamortized debt discount and expense, Patents, trade and service marks and names, Copyrights and research and development expenses except prepaid expenses, (c) restricted cash, and (d) reserves not already deducted from assets, and (ii) Total Liabilities.

“Total Liabilities” is on any day, obligations that should, under GAAP, be classified as liabilities on Borrower’s consolidated balance sheet, including all Indebtedness, and the current portion of Subordinated Debt allowed to be paid, but excluding all other Subordinated Debt.

“Trademarks” are trademark and servicemark rights, registered or not, applications to register and registrations and like protections, and the entire goodwill of the business of Borrower connected with the trademarks.

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** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

BORROWER:

CALIFORNIA MICRO DEVICES CORPORATION

By:

Title:

BANK:

SILICON VALLEY BANK

By:

Title:

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

SCHEDULE A TO LOAN AND SECURITY AGREEMENT

The exact correct corporate name of Borrower is (attach a copy of the formation documents, e.g., articles, partnership agreement):             California Micro Devices Corporation            

Borrower’s State of formation:             California                                                 

Borrower has operated under only the following other names (if none, so state):                     None                                                         

All other addresses at which the Borrower does business are as follows (attach additional sheets if necessary and include all warehouse addresses): 2000 West 14^th Street, Tempe, AZ 85281; 3901 N Route 23, Suite b, Marengo, IL 60152; and Rm 2602, Sino Plaza, 255 Gloucester Road, Causeway Bay, Hong Kong

Borrower has deposit accounts and/or investment accounts located only at the following institutions:                     Silicon Valley Bank and US Bancorp through Silicon Valley Asset Management. Borrower is in process of establishing investment accounts at UBS and at Piper Jaffrey                    

List Acct. Numbers (if at institution other than Bank):                                                 

Liens existing on the Closing Date and disclosed to and accepted by Bank in writing: various leases; see “Outstanding Indebtedness” list below. In addition, US Bancorp has filed a UCC-1 covering debt owed under equipment leases which the Company treats as operating leases rather than capital leases for purposes of its financial statements. Therefore, the underlying lease obligation is not included in the “Outstanding Indebtedness” list below.

Investments existing on the Closing Date and disclosed to and accepted by Bank in writing:

See listing above                                                                                                                      

Subordinated Debt:    None.

Indebtedness on the Closing Date and disclosed to and consented to by Bank in writing:

Great Bay	$166,279
Other Leases	$38,672

Borrower is not subject to litigation which would have a material adverse effect on the Borrower’s financial condition, except the following (attach additional comments, if needed):

See disclosures in the Company’s most recent quarterly and annual filings with the SEC. In addition, the Company has pending wrongful termination litigation (** and **) arising from its Tempe Arizona facility. The Company offered to settle one case in September, 2002, for $** and the other for $**; however, neither offer has been accepted.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

See disclosures in the Company’s most recent quarterly and annual filings with the SEC.

Tax ID Number             94-2672609                                                                                                               

Organizational Number, if any:            none                                                                                                  

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

EXHIBIT A

The Collateral consists of all of Borrower’s right, title and interest in and to the following:

All goods and equipment now owned or hereafter acquired, including, without limitation, all machinery, fixtures, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions, and improvements to any of the foregoing, wherever located;

All inventory, now owned or hereafter acquired, including, without limitation, all merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products including such inventory as is temporarily out of Borrower’s custody or possession or in transit and including any returns upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above;

All contract rights and general intangibles now owned or hereafter acquired, including, without limitation, goodwill, servicemarks, trade styles, trade names, leases, license agreements, franchise agreements, blueprints, drawings, purchase orders, customer lists, route lists, infringements, claims, computer programs, computer discs, computer tapes, literature, reports, catalogs, design rights, income tax refunds, payments of insurance and rights to payment of any kind;

All now existing and hereafter arising accounts, contract rights, royalties, license rights and all other forms of obligations owing to Borrower arising out of the sale or lease of goods, the licensing of technology or the rendering of services by Borrower, whether or not earned by performance, and any and all credit insurance, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower;

All documents, cash, deposit accounts, securities, securities entitlements, securities accounts, investment property, financial assets, letters of credit, certificates of deposit, instruments and chattel paper now owned or hereafter acquired and Borrower’s Books relating to the foregoing; and

All Borrower’s Books relating to the foregoing and any and all claims, rights and interests in any of the above and all substitutions for, additions and accessions to and proceeds thereof.

Notwithstanding the foregoing, the Collateral shall not be deemed to include any copyrights, mask works, mask work applications, copyright applications, copyright or mask work registrations and like protection in each work of authorship and derivative work thereof, whether published or unpublished, now owned or hereafter acquired; any patents, patent applications and like protections including without limitation improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same, trademarks,

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

servicemarks and applications therefor, whether registered or not (collectively, the “Intellectual Property”), except that the Collateral shall include the proceeds of all the Intellectual Property that are accounts, (i.e. accounts receivable) of Borrower, or general intangibles consisting of rights to payment, if a judicial authority (including a U.S. Bankruptcy Court) holds that a security interest in the underlying Intellectual Property is necessary to have a security interest in such accounts and general intangibles of Borrower that are proceeds of the Intellectual Property, then the Collateral shall automatically, and effective as of the Closing Date, include the Intellectual Property to the extent necessary to permit perfection of Bank’s security interest in such accounts and general intangibles of Borrower that are proceeds of the Intellectual Property.

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

EXHIBIT B

LOAN PAYMENT/ADVANCE REQUEST FORM

DEADLINE FOR SAME DAY PROCESSING IS 12:00 P.T.

Fax To:	Date:
Loan Payment:
California Micro Devices Corporation (Borrower)
From Account #	To Account #
(Deposit Account #)	(Loan Account #)
Principal $	and/or Interest $
All Borrower’s representations and warranties in the Loan and Security Agreement are true, correct and complete in all material respects on the date of the telephone transfer request for an advance, but those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of the date.
Authorized Signature:	Phone Number:
LOAN ADVANCE:
Complete Outgoing Wire Request section below if all or a portion of the funds from this loan advance are for an outgoing wire.
From Account #	To Account #
(Loan Account #)	(Deposit Account #)
Amount of Advance $
All Borrower’s representations and warranties in the Loan and Security Agreement are true, correct and complete in all material respects on the date of the telephone transfer request for an advance, but those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of the date.
Authorized Signature:	Phone Number:
OUTGOING WIRE REQUEST
Complete only if all or a portion of funds from the loan advance above are to be wired.
Deadline for same day processing is 12:00pm, P.T.
Beneficiary Name:	Account of Wire: $
Beneficiary Name:	Account of Wire: $
City and Sate:
Beneficiary Bank Transit (ABA) #	Beneficiary Bank Code (Swift, Sort, Chip, etc.):
(For International Wire Only)
Intermediary Bank:	Transit (ABA) #                                                                 :
For Further Credit to:
Special Instruction:
By signing below, I (we) acknowledge and agree that my (our) funds transfer request shall be processed in accordance with and subject to the terms and conditions set forth in the agreements(s) covering funds transfer service(s), which agreements(s) were previously received and executed by me (us).
Authorized Signature:	2nd Signature (if Required):
Print Name/Title:	Print Name/Title:
Telephone:	Telephone:

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

EXHIBIT C

COMPLIANCE CERTIFICATE

TO:	SILICON VALLEY BANK
	3003 Tasman Drive
	Santa Clara, CA 95054
FROM:	California Micro Devices Corporation

The undersigned authorized officer (“Officer”) of California Micro Devices Corporation (“Borrower”) certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”), (i) Borrower is in complete compliance for the period ending                      with all required covenants except as noted below, and (ii) all representations and warranties in the Agreement are true and correct in all material respects on this date. In addition, the Officer certifies that Borrower and each Subsidiary (i) has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP and (ii) does not have any legal actions pending or threatened against Borrower or any Subsidiary of which Borrower has not notified Bank in accordance with Section 6.2 of the Agreement. Attached are the required documents supporting the certifications contained herein. The Officer certifies that these are prepared in accordance with GAAP consistently applied from one period to the next except as explained in an accompanying letter or footnotes. The Officer acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and that compliance is determined not just at the date this certificate is delivered.

Please indicate compliance status by circling Yes/No under “Complies” column.

Reporting Covenant	Required	Complies
Compliance Certificate	With 10Q, 10K	Yes	No
10Q, 10K (Audited)	Within 5 days of issuance	Yes	No
Cash Holding Report	Monthly within 30 days	Yes	No
Annual Forecast	Annually within 45 days of FYE	Yes	No
Budgets, sales projections, operating plans, or other financial information as Lender may request	Promptly after Lender requests	Yes	No

Financial Covenant	Required	Actual	Complies
Maintain (at quarter end):
Minimum Quick Ratio	**	:1.00	Yes	No
Minimum Tangible Net Worth	**	$	Yes	No
Borrower only has deposit accounts located at the following institutions:

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

Comments Regarding Exceptions: See Attached.	BANK USE ONLY
Sincerely,	Received by:
California Micro Devices Corporation	AUTHORIZED SIGNER
SIGNATURE	Date:
TITLE	Verified:
DATE	AUTHORIZED SIGNER
	Date:
	Compliance Status:	Yes        No

** CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO CERTAIN PORTIONS OF THIS AGREEMENT AND THE CONFIDENTIAL PORTION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

EX-31.1

Exhibit 31.1

California Micro Devices

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Robert V. Dickinson, certify that:

1. I have reviewed this quarterly report on Form 10-Q of California Micro Devices Corporation, a California corporation

(“registrant”);

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) designed such disclosure controls and procedures, or caused such disclosure controls or procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: November 8, 2004
By:	/S/ ROBERT V. DICKINSON
Robert V. Dickinson
President and Chief Executive Officer
(Principal Executive Officer)

EX-31.2

Exhibit 31.2

California Micro Devices

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, R. Gregory Miller, certify that:

1. I have reviewed this quarterly report on Form 10-Q of California Micro Devices Corporation, a California corporation

(“registrant”);

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) designed such disclosure controls and procedures, or caused such disclosure controls or procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: November 8, 2004
By:	/S/ R. GREGORY MILLER
R. Gregory Miller
Vice President Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)

EX-32.1

Exhibit 32.1¹

California Micro Devices

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the periodic report of California Micro Devices (the “Company) on Form 10-Q for the period ended September 30, 2004 as filed with the Securities and Exchange Commission (the “Report”), I, Robert V. Dickinson, Chief Executive Officer of the Company, hereby certify as of the date hereof, solely for purposes of title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:

(i) the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and

(ii) the information in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated.

Date: November 8, 2004	By:	/S/ ROBERT V. DICKINSON
		Robert V. Dickinson
		Chief Executive Officer

¹ The material contained in this Exhibit 32.1 is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.

EX-32.2

Exhibit 32.2¹

California Micro Devices

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the periodic report of California Micro Devices (the “Company) on Form 10-Q for the period ended September 30, 2004 as filed with the Securities and Exchange Commission (the “Report”), I, R. Gregory Miller, Chief Financial Officer of the Company, hereby certify as of the date hereof, solely for purposes of title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:

(i) the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and

(ii) the information in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated.

Date: November 8, 2004	By:	/S/ R. GREGORY MILLER
		R. Gregory Miller
		Chief Financial Officer

¹ The material contained in this Exhibit 32.1 is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.