UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number 0-24758

Micro Linear Corporation

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code:

(408) 433-5200

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 par value per share

Series A Participating Preferred Stock, $.001 par value per share

(Title of Class)

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 þ          No o

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

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

      The aggregate market value of the Common Stock held by non-affiliates of the Company, as of June 25, 2004 (the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing price of $5.74 per share on the Nasdaq National Market on such date), was approximately $52,989,068. Shares of Common Stock held by each executive officer and director and shares held by each holder of more than 5% of the common stock known to the registrant (based on Schedule 13G filings), have been excluded, in that such persons may under certain circumstances be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes.

      The number of shares of the Registrant’s Common Stock outstanding as of March 1, 2005, net of shares held in treasury, was 12,461,973.

TABLE OF CONTENTS

FORWARD LOOKING STATEMENTS

      When used in this Report, the words “expects”, “anticipates”, “estimates”, “believes”, “plans”, “designed to,” “allows,” “can,” “intend,” “will,” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods, and include statements regarding the growth of markets for our digital wireless solutions, types of radios and basebands, our objective to become a leading provider of digital wireless solutions for many large global markets, our strategic initiatives to achieve that objective, including our focus on becoming a major provider of wireless semiconductors in the ISM and PCS bands, developing products based on existing intellectual property, developing customer partnerships and major strategic relationships in our target markets, increasing the number of customers and design wins by applying our digital wireless expertise to markets and applications other than digital cordless telephones, developing evaluation tools and reference designs to enable companies to quickly and efficiently implement wireless connectivity in their products using our wireless integrated circuits, using our high volume manufacturing and testing expertise to deliver cost effective products with rapid time to market and the anticipated benefits of these initiatives, our beliefs that the market for wireless consumer electronics, communications and industrial products is one of the most promising potential growth segments of the wireless semiconductor industry, the features and benefits and market acceptance of our products and technology, including our transceivers, our production-ready reference designs, silicon media conversion devices for Ethernet networks and application-specific radio solutions, the sources of our future revenue and concentration of customers, the competitive advantages of our core technologies, the advantages of our use of outside foundries, our intent to spend significant resources on new product and technology development, including wireless semiconductors in the three major ISM bands, our intent to broaden our markets into streaming applications, leverage our existing intellectual property in the development of new products and to develop customer and strategic relationships in our target markets, expected expenses, including research and development and selling, general and administrative functions, our ability to compete favorably in new product introduction, innovation, quality, reliability and performance, and the amount and timing of new product shipments, anticipated revenue from our wireless and networking products, our beliefs regarding our accounting policies, our expectation that international revenue will account for a significant percentage of our revenue for the next 12 months, our expectations regarding trends in our future gross margin, average selling prices for our wireless product and networking products, erosion in demand for our legacy networking products, our expectation that Uniden will continue to be our largest customer for the next 12 months, our belief that trade payable balances will continue to fluctuate from period to period due to variations in our production cycle and timing of other operating expenses and our beliefs as to the adequacy of our existing cash resources.

      Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those risks discussed below and our dependence on key products and customers, changes in the demand for our products and seasonal factors affecting certain of our products, our ability to attract and retain customers and distribution partners for existing and new products, our ability to develop and introduce new and enhanced products in a timely manner, our dependence on international sales and risks associated with international operations, our dependence on outside foundries and test subcontractors in the manufacturing process and other outside suppliers, our ability to recruit and retain qualified employees, and the strength of competitive offerings and the prices being charged by those competitors, and the risks set forth below under “Factors that May Affect Future Operating Results”.

      These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein, to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

      All references to “Micro Linear”, “we”, “us”, “our” or the “Company” mean Micro Linear Corporation and its subsidiary, except where it is made clear that the term means only the parent company.

PART I

General

      Micro Linear Corporation is a fabless semiconductor company specializing in wireless integrated circuit solutions, which enable a variety of wireless products, serving a global market. Our products are used in many streaming wireless consumer applications such as digital cordless phones, PHS (Personal Handyphone System) handsets, wireless home theater speakers and headphones, security cameras, video game controllers, cordless headsets, digital baby monitors, computer peripherals, and other personal electronic appliances. Industrial applications that incorporate our products include lighting controls, home automation products, heating and cooling controls, vending machine controls, automatic meter reading devices, environmental monitoring devices and mesh networking nodes.

      Our products are used in designs that replace wires to transfer information. We believe wireless connectivity offers freedom of mobility, flexibility of configuration, and significant infrastructure installation cost savings. An increasing number of products that were traditionally wired are now increasingly being designed as wireless, including telephone handsets, cell phone headsets, video game controllers, audio headphones and speakers, and computer peripherals. We believe that the benefits of these digital wireless solutions, combined with the cost-effectiveness of our products, will result in significant market growth for our products as more and more applications adopt digital wireless connections.

      Our objective is to become a leading provider of digital wireless solutions for many large global markets. To meet this objective, we have embarked upon a number of strategic initiatives:

Markets and Products

      Digital wireless connectivity requires a radio frequency, or RF, physical interface and a baseband controller, the complexity of which depends on the specific application. The RF interface typically consists of an RF front end (power amplifier, low noise amplifier and switch), RF transceiver, and modem. The baseband controller provides an interface to the digital data source, control of the radio operation, and application support. We currently provide the RF transceiver and the RF front end, with the balance of the solution provided by other vendors, who in many cases have formed strategic marketing relationships with us. We believe our transceivers provide significant benefits to our customers, including lower cost, smaller form factor, higher data rates, enhanced range of operation, and an overall lower bill of material.

      During 2004, our wireless RF transceiver products represented approximately 74% of our net revenue, compared to 64% in 2003 and 62% in 2002. We have delivered over 25 million RF transceivers that can now be found in digital cordless telephones, cordless headsets, video game controllers, and other digital wireless products.

      During 2004, we expanded our customer base for RF transceivers to include additional digital cordless telephone vendors, video game controller suppliers, wireless headset manufacturers, and computer peripherals vendors. Products intended for the U.S. market use the unlicensed 5.8GHz and 900MHz frequency band, while wireless products designed for worldwide use operate at 2.4GHz. We began shipping our 5.8GHz product in high volume in 2004. This product is used in 5.8GHz digital cordless telephones targeted at the U.S. market.

      A growing number of manufacturers have emerged who do not have the capability, or the desire, to design a wireless product starting at the component level. To achieve design wins with these emerging manufacturers, we have significantly increased our customer support tools through the creation of production-ready reference designs. Currently, we offer four distinct reference designs that customers can copy or modify to allow them to easily integrate digital wireless connectivity into their products. Two designs operate at 900MHz: a less expensive low power (0dBm output power) radio, and a higher power (18dBm) version. Two operate at 2.4GHz, again with one design intended for shorter range, lower priced sockets and the second targeting maximum range applications. All of these solutions are pre-scanned for compliance to the Federal Communications Commission rules for use in the unlicensed frequency bands. We anticipate that we will continue to expand our reference designs for our 5.8GHz and PHS transceiver products.

      Our efforts in designing and testing these reference designs have afforded our engineers a good insight into the design issues confronted by our prospective customers, which we believe should assist us in making our new products more valuable to our customers. We intend to continue to develop application-specific reference designs based on our RF transceivers and other new products to support our customers’ engineering teams and to address additional market segments and customers.

      We offer media conversion products that enable implementation of cost effective fiber to the home or FTTH systems. Two existing industry standards define Ethernet protocols over twisted pair copper media: 10Base-T for 10Mbps and 100Base-TX for 100Mbps. A low-cost silicon solution called a media converter provides the required signal conversion at each point where the twisted pair copper media interfaces to fiber media.

      We believe we have been successful in providing silicon media conversion devices for Ethernet networks. We believe our product family is one of only a few that provides full auto-negotiation on both the twisted pair and fiber optic sides, to automatically configure the highest speed mode of operation on a link and select either half or full duplex operation. Additional benefits of our devices include providing the user a small footprint package, low power dissipation, and low component cost.

Sales and Distribution

      Our focus is on engaging large original equipment manufacturer customers, or OEMs, who incorporate wireless technologies into products targeted at high volume markets. To enable us to win business at these large accounts, our direct sales force focuses on key accounts. Sales to certain of our OEM customers do not carry return privileges and we recognize revenue for these sales upon shipment.

      We address smaller customers via a network of domestic and international representatives and distributors who specialize in RF components. In 2004, our domestic sales represented approximately 6% of net revenue, compared to 9% and 11% in 2003 and 2002, respectively. We offer our domestic distributors product return privileges and, in the event we lower the prices of products sold to distributors, we guarantee price protection on unsold inventory. We defer recognition of revenue and gross margin derived from sales to our domestic distributors until the distributors resell our products to their customers. Some sales to domestic distributors are below contract pricing and are not guaranteed price protection or return privileges. On these sales, we do not defer revenue.

      Outside the United States, our products are sold both directly to international customers and through distributors. International sales accounted for approximately 94%, 91% and 89% of our net revenue in 2004, 2003 and 2002, respectively. We expect international sales to continue to represent a significant portion of product sales for the foreseeable future, as more and more electronics manufacturing is concentrated in the Pacific Rim. On a portion of our sales to international distributors, we offer product return privileges and, if we lower the prices of our products, we guarantee price protection on unsold inventory, which is standard in the semiconductor industry. We defer revenue from this portion of shipments to international distributors until these distributors notify us of product sales to their customers. Some sales to international distributors are below contract pricing and are not guaranteed price protection or return privileges. On these sales, we do not defer revenue.

      During 2004, sales to OEMs represented 86% of our net revenue, and sales through our distribution channel represented 14% of net revenue. While sales to our largest customer pass through an international distributor, we classify these sales as OEM sales since the distributor does not fulfill a traditional distributor stocking role. However, we defer revenue until this international distributor has resold the product to the end customer.

      A relatively small number of large customers have accounted for a significant portion of our net revenue in each of the past several years. During 2004, 2003 and 2002, our top ten customers, excluding domestic distributors, together accounted for approximately 82%, 77% and 79% of net revenue, respectively. During 2004, one customer, Uniden Corporation, accounted for 55% of our total sales and sales to Giant Electronics Limited (a subcontractor for Plantronics, Inc.), our second largest customer, accounted for 10% of our total sales. Seasonal demand characterizes the consumer electronics market, including Uniden’s digital cordless telephones, which incorporate our transceivers. We expect Uniden to continue to account for a significant portion of our sales in 2005. Sales to Uniden are subject to the same seasonality of demand and to all of the inherent variability of the consumer electronics market. We expect that sales to Giant Electronics will also account for a significant portion of our sales in 2005.

      During 2004, 2003 and 2002, all of our net revenue was derived from sales of products for the wireless communications market and the computer networking market. During 2004, 2003 and 2002 wireless shipments accounted for approximately 74%, 64% and 62% of net revenue. Sales of our products to network equipment manufacturers accounted for approximately 26%, 36% and 38% of our net revenue in 2004, 2003 and 2002, respectively.

Backlog

      We do not believe that backlog is a meaningful indicator of our future business prospects, due to the significant percentage of orders received and shipped within the same quarter and the ability of our customers to cancel or reschedule orders outside a thirty-day period without significant penalty.

Technology

      We believe our success and sustainable competitive advantages depend on the acceptance and continued development of our core technologies. Technologies that we believe give us a competitive advantage include:

      We use standard process technologies available from leading semiconductor foundries. Silicon technologies currently used or being implemented in new designs include:

Manufacturing

      We utilize outside foundries for all of our silicon wafer requirements, outside suppliers for both wafer sort and final product test, and outside assembly services to package our products. After assembly, the packaged units are final tested and final inspected by subcontractors prior to shipment to customers. Extensive electrical testing is individually performed on all circuits, using advanced, automated test equipment capable of high volume production, to ensure that the circuits satisfy specified performance levels.

      We believe that using outside foundries and other manufacturing services enables us to focus on our design strengths, minimize fixed costs and capital expenditures, and access diverse manufacturing technologies. We depend on silicon foundries located in the United States, Singapore and Japan for products currently in production as well as those currently being designed. Other manufacturing processes are performed by companies in the United States, Malaysia, Korea, Hong Kong, Singapore, and the Philippines.

Research and Development

      We employ state of the art integrated circuit development software tools in order to shorten development cycles and accurately simulate the performance of our designs before committing to costly and time-consuming silicon fabrication. These tools represent a significant portion of our research and development budget. Our product development strategy focuses on highly integrated silicon solutions, employing a modular design to allow for use in a broad range of applications, enabling us to address multiple markets quickly with similar platforms.

      As silicon technology advances, new processes enable higher levels of performance while existing processes become more cost effective. We watch these trends closely in order to provide the highest performance and most cost effective solutions to our customers.

      In May 2003, we undertook a restructuring that consolidated most of our design activities into our San Jose, California headquarters. Our engineering design center in San Jose is involved in the development of advanced communications circuits and systems for wireless markets. Device validation, characterization,

reliability testing, and automatic test equipment test development activities are also located in San Jose. In addition to our San Jose engineering organization, we also have a small design group in Salt Lake City, Utah.

      Research and development expenses were $9.5 million, $10.0 million, and $15.7 million in 2004, 2003, and 2002, respectively. We reduced engineering headcount as part of our overall restructuring efforts in 2003. In planning these reductions, we carefully reviewed and focused our product roadmap. We expect to continue spending significant funds on research and development activities to deliver leading edge products that have the promise of volume shipments within a short time following their introduction.

Competition

      The semiconductor industry is characterized by price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened international and domestic competition. The market segments in which we participate are intensely competitive, and many semiconductor companies presently compete, or could compete, in one or more of our target markets. Our principal competitors are National Semiconductor, Infineon, Philips, Texas Instruments, DSP Group, Atheros, and Atmel. Many of our competitors offer broader product lines and have substantially greater financial, technical, manufacturing, marketing and other resources. In addition, many of our competitors maintain their own wafer fabrication facilities, which provide them with a competitive advantage.

      We believe that product innovation, quality, reliability, performance and the ability to introduce products rapidly are important competitive factors. We believe that, by virtue of our product application knowledge and design expertise coupled with a rigorous design methodology, we can compete favorably in the areas of rapid new product introduction, product innovation, quality, reliability and performance. However, we may be at a disadvantage in comparison to larger companies with broader product lines, greater technical and financial resources, and greater service and support capabilities.

      During 2004, we continued to expand our product development partnership with Oki Electric Industry Co., Ltd. We believe that this relationship, as well as other less formal development partnerships that we have recently engaged in, will result in more optimized and complete application-specific radio solutions. The availability of such solutions should result in greater acceptance of our digital wireless products as well as shorter development cycle times for our customers.

      The acceptance of future products will depend on their direct applicability to the intended market, their cost-effectiveness, and the availability of easily implemented systems-level solutions based on these products. Larger competitors with larger development staffs, larger research and development budgets, and access to more technologies could deliver competitive products with improved feature sets, more products with differentiated feature sets and/or complete chipsets or system solutions, thus providing them a distinct competitive advantage.

Patents and Licenses

      Our success depends, in part, on our ability to obtain patents and licenses and to preserve other intellectual property rights covering our products, procedures, development tools and testing tools. To that end, we own certain patents and intend to continue to seek patents on our inventions when appropriate. We own eight U.S. patents, and have nine U.S. patent applications. We own two foreign patents, and have thirteen foreign applications pending. Through a sale of a portion of our assets, we maintain a royalty-free license to forty-five U.S. patents, three foreign patents, seven U.S. patent applications, and three foreign patent applications. We believe that although the patents described above may have value, given the rapidly changing nature of the semiconductor industry, we depend primarily on the technical competence and creativity of our technical workforce.

      We have not currently licensed any third parties to manufacture our products. We have no current plans to grant product licenses with respect to any products; however, we may find it necessary to enter into product licenses in the future. We have granted nontransferable, limited process licenses to each of our foundries to utilize our proprietary processes to manufacture our products.

Employees

      As of December 31, 2004, we had 56 full-time employees, ten of whom were engaged in manufacturing (including test development, quality and materials functions), 29 in research and development, eight in marketing, applications and sales, and nine in finance and administration. Our employees are not represented by any collective bargaining agreements, and we have never experienced a work stoppage. We believe that our employee relations are good.

Available Information

      We are subject to the informational requirements of the Securities Exchange Act of 1934. We therefore file periodic reports, proxy statements and other information with the Securities and Exchange Commission. Such reports may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street, NW, Washington, D.C. 20549, or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

      Our Web site is http://www.microlinear.com. We make available free of charge, on or through our Web site, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission (SEC). Information contained on our Web site is not incorporated by reference unless specifically referenced herein.

      In July 2004, we sold our San Jose facilities for approximately $7.0 million. We recognized a gain on the sale of approximately $1.1 million and the sale generated cash of approximately $4.6 million, net of a $1.9 million mortgage payoff and $0.5 million of closing costs. We have entered into a one year lease agreement with the new owners to lease back a portion of the facilities as we search for a new location for our headquarters. We currently lease 32,000 square feet of space and our lease expires at the end of July 2005. Due to the high vacancy rates for commercial space in the San Jose California area, we do not foresee any difficulty in our ability to find sufficient space at the expiration of our lease.

      From time to time we receive correspondence from vendors, distributors, customers or end-users of our products regarding disputes with respect to contract rights, product performance or other matters that occur in the ordinary course of business. Some of these disputes may involve us in costly litigation or other actions, the outcome of which cannot be determined in advance and may adversely affect our business. The defense of lawsuits or other actions could divert our management’s attention away from running our business. In addition, negative developments with respect to litigation could cause the price of our common stock to decline significantly. There are no lawsuits pending at this time.

      None.

PART II

      The following table sets forth the highest and lowest sale prices of our Common Stock over the last eight quarters, as reported in the Nasdaq National Market. Our Common Stock is listed on the Nasdaq National Market under the symbol “MLIN.”

Common Stock Prices

      We have not paid or declared cash dividends on our Common Stock within the past five years and do not anticipate paying any cash dividends in the foreseeable future. Any determination with respect to the payment of dividends will be at the discretion of our board of directors.

      The information required by this Item is included under Item 12 of Part III of this Report on Form 10-K.

      The following selected consolidated financial data for the five-year period ended December 31, 2004 should be read together with our Consolidated Financial Statements and notes thereto included in Item 8 of this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this report.

      The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes included elsewhere in this report on Form 10-K. This discussion contains forward-looking statement, including those discussed in “Forward-Looking Statements”. These statements are subject to risks and uncertainties which may cause actual results to differ materially from those discussed in these statements, including risks and uncertainties discussed under “Factors That May Affect Future Operating Results.”

Overview

      Micro Linear Corporation is a fabless semiconductor company specializing in wireless integrated circuit solutions, which enable a variety of wireless products serving a global market. These transceivers can be used in many streaming wireless applications such as cordless phones, PHS handsets, wireless speakers and headphones, security cameras, game controllers, cordless headsets and other personal electronic appliances. Headquartered in San Jose, California, Micro Linear’s products are available through its authorized representatives and distributors worldwide.

      We were founded in 1983, and until 2000 we were a supplier of advanced analog and mixed signal integrated circuits to the computer, communications, telecommunications, consumer and industrial markets. During 2000, we divested our manufacturing test operation and our non-communication product lines and focused our marketing, engineering and product development on new communications products, including some wired networking products, but most notably wireless integrated circuits. During 2001, we established

ourselves as a volume supplier of RF transceivers to the digital cordless telephone segment of the communications market. Wireless product revenue represented 74% of net revenue for 2004 compared to 64% of net revenue for 2003. We expect the revenue contribution from wireless products to continue to increase as a percentage of total revenue.

      In October 2002, we announced that in order to better align our product development activities with our revenue-producing markets, we would stop development of 802.11a broadband wireless products. The realignment process included redirecting certain engineering activities, and reorganizing sales, marketing and applications to strengthen major account support. As part of the realignment, we reduced our workforce by 39 employees. On May 19, 2003, we undertook a restructuring effort that eliminated approximately 37 additional positions in all operational segments of the Company, and consolidated some functions at our San Jose headquarters.

Opportunities and Challenges

      Our operating results are likely to continue to fluctuate as a result of many factors, including, but not limited to: the level, timing, cancellation or rescheduling of customer orders, changes in market demand, fluctuations in manufacturing yields and cost, market acceptance of our products, economic conditions specific to the networking and wireless industries and markets, and general economic conditions.

      As a result of competitive pricing pressures we may experience lower margins in our wireless products, and we expect these pricing pressures to continue. In addition, the wireless and computer networking markets have undergone a period of rapid growth and consolidation in recent years. Although sales of our legacy networking products continue to decline as expected, we are still dependent on sales to computer network equipment manufacturers to continue. As a result, our business would suffer in the event of a significant slowdown in the networking equipment market. We intend to try to offset this decline in networking revenue by continuing to introduce new wireless products.

      The wireless and computer equipment networking markets in which we compete are characterized by continuing technological advancement, changes in customer requirements, and evolving industry standards. To address these challenges, we must design, develop, manufacture and sell new or enhanced products that provide increasingly higher levels of performance and reliability, are cost effective, and brought to market in a timely manner. Sales to one wireless customer, Uniden Corporation (Uniden), represented 55% of our total revenue during 2004 and we expect will represent a significant portion of our revenue during 2005. We are dependent on our relationship with Uniden and as a result our business would also suffer in the event of a significant slowdown in Uniden’s business.

      Successful engineering development and market penetration in the product areas we have chosen require high levels of engineering and product development expense. We have sometimes experienced delays in completing the development of new products. As we do not currently manufacture our own semiconductor wafers, we are vulnerable to process technology advances competitors use to manufacture products offering higher performance and lower cost.

      To address these challenges, we intend to pursue various opportunities. For example, we intend to continue to spend significant amounts of resources on new product and technology development, predominately wireless semiconductors. We intend to broaden our markets into many streaming wireless applications such as PHS transeivers, wireless speakers and headphones, security cameras, game controllers, cordless headsets and cordless telephones. We also intend to leverage our existing intellectual property in the development of new products to reduce technical risk and development cycle time and to develop customer and strategic relationships in our target markets to strengthen our competitive position.

Critical Accounting Policies

      Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles

generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of our consolidated financial statements.

      Our critical accounting policies are as follows:

      We recognize revenue for product shipped directly to OEM customers at the time of shipment, provided that we have received a signed purchase order, the price is fixed, title has transferred, and collection of the resulting receivable is reasonably assured. Sales to our OEM customers are made without return privileges and revenue on these sales is recognized upon shipment. We defer recognition of revenue from sales of our products to distributors under agreements which allow certain rights of return and price adjustments on unsold inventory. The associated cost of product on these sales to distributors is also deferred and included in our inventory balances. Revenue and cost of product is recognized when the distributor resells the product to its customers. Some sales to distributors are below contract pricing and are not guaranteed price protection or return privileges. On these sales, we do not defer revenue.

      We record estimated reductions to revenue for expected product returns. In determining the amount of the allowance, we analyze historical returns, current economic trends and changes in customer demand and acceptance of our products. There were no allowances for returns recorded at December 31, 2004.

      The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of accrued liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period.

      We perform ongoing credit evaluations of our customers based on a number of factors, including past transaction history and the creditworthiness of the customer, as determined by an evaluation of the customer’s financial statements, credit rating, bank and credit references. We do not generally require collateral from the customer. For certain international customers, we obtain letters of credit or cash payments in advance of shipment. Allowances for potential credit losses are established based on management’s review of individual accounts. The accounts receivable balance was $2.9 million, net of allowance for doubtful accounts of $139,000, as of December 31, 2004. An unexpected change in a major customer’s ability to meet its obligation could have an adverse material effect on our financial position and results of operations.

      We value inventories at the lower of standard cost or market. Standard costs are adjusted to approximate actual costs on a first-in, first-out basis. The value of inventories is reduced by an estimated allowance for

excess and obsolete inventories. This allowance for excess and obsolete inventories is based upon our review of demand for our products in light of projected sales, current market conditions, and market trends. If a significant, unanticipated decrease in demand for our products or significant technological development occurs, we may deem it necessary to provide for additional inventory reserves, which may have a material adverse impact on our gross margin. For inventory for which a reserve is provided, we do not release the reserve until the inventory is sold or otherwise disposed of.

      As part of the process of preparing the consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that deferred tax assets will be recovered from future taxable income or tax planning strategies and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, it is reflected as an expense within the tax provision in the statement of operations.

      Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We have recorded a full valuation allowance of $15.9 million as of December 31, 2004, due to uncertainties related to the ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. The valuation allowance is based on estimates of taxable income by jurisdiction in which we operate and the period over which deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance or release existing allowances, which could materially impact our financial position and results of operations.

      We evaluate the carrying value of long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144”), which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. In the third quarter of 2003, we completed an impairment review of our land and buildings. The review was undertaken due to continued weakness in the commercial real estate markets, local vacancy rates and recent real estate transactions in our local market. Upon completion of our review, we determined that the carrying values of these assets exceeded their future undiscounted cash flows. Accordingly, we recorded an impairment loss of $1.5 million to write down the assets to their current estimated market value. In July 2004, we sold our San Jose facilities for approximately $7.0 million. We recognized a gain on the sale of approximately $1.1 million and the sale generated cash of approximately $4.6 million, net of a $1.9 million mortgage payoff and $0.5 million of closing costs. In fiscal year 2002, we wrote down $0.4 of impaired capitalized software primarily due to the discontinuation of the 802.11a broadband wireless program.

      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment,” an amendment to Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation” and Statement on Financial Accounting Standards No. 95, “Statement of Cash Flows.” The revised standard addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic

method in accordance with APB 25. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS No. 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS No. 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. Currently, we disclose the pro forma net income (loss) and related pro forma income (loss) per share information in accordance with SFAS 123 and Statement on Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation Costs — Transition and Disclosure.” We believe that adoption of the new standard will have an adverse impact on our results of operations.

      In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“SFAS No. 151”), “Inventory Costs, an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. SFAS No. 151 will be effective in fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material effect on our financial position or results of operations.

      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153 (“SFAS No. 153”), “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29”. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 will be effective for nonmonetary transactions in fiscal years beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have a material effect on our financial position or results of operations.

Results of Operations

      We recognize revenue from product shipped directly to OEM customers at the time of shipment. Sales to our OEM customers are made without return privileges. During 2004, our top ten OEM customers collectively accounted for approximately 80% of net revenue. We defer recognition of revenue and costs of our products to distributors until the distributor resells the product to its customers. However, some sales to distributors are below contract pricing and are not guaranteed price protection or return privileges. On these sales, we do not defer revenue.

      Sales to Uniden, our largest customer, pass through an international distributor, and are recognized as revenue upon the distributor’s resale to the end customer. However, these sales are classified as OEM in our percent of net revenue presentation, since the distributor does not fulfill a traditional distributor-stocking role for this customer. In 2004, sales through domestic distributors represented 5% of net revenue. Total international sales through international distributors, exclusive of sales to Uniden, represented 9% of net revenue.

Results of Operations

      The following table presents certain consolidated statements of operations data for the periods indicated:

      Net revenue for 2004 was $20.6 million, essentially flat with net revenue for 2003. Wireless product revenue, however, increased 15% in 2004 over 2003. The increase in wireless product revenue was mainly due to the 36% increase in our average selling prices compared to 2003, driven mainly by the higher average selling price of our high volume 5.8GHz product, the ML5800, as compared to the average selling price of our 2.4GHz product, the ML2724 that was shipping in volume throughout 2003. Also, in the third quarter of 2004, we began shipping our ML5824 transverter in volume, and demand for our 900MHz product, the ML2722, remained strong throughout 2004. The increase in wireless product revenue was achieved despite an overall decrease of 15% in the unit shipments of these products. We expect erosion in average selling prices of our wireless products over the coming year as our ML5800 and ML5824 products mature.

      Net revenue from our networking products decreased significantly, as expected, due mainly to the continuing fall off in the demand for our legacy networking products as they approach end-of-life. Unit shipments of our networking products decreased 16% during 2004 as compared to 2003, and the average selling prices of these products decreased 14% in 2004 as compared to 2003 due to a shift in product mix. We expect that the average selling prices of networking products will stabilize over the coming year but we

anticipate that the erosion in demand for our legacy networking products will continue, resulting in lower networking product revenue.

      Net revenue for 2003 decreased 28% as compared to net revenue for 2002. Wireless product revenue decreased in 2003 as compared to 2002 despite a 9% increase in unit shipments during 2003 as we experienced significant price erosion in our volume 2.4 GHz product, the ML2724. The decrease due to the price erosion experienced in 2003 was offset only slightly by an increase in volume shipments.

      International revenue for 2004 totaled $19.5 million, or 94% of net revenue, compared to $18.9 million, or 91% of net revenue, for 2003, and $25.4 million, or 89% of net revenue, for 2002. Domestic revenue was approximately 6% of net revenue for 2004, compared to 9% for 2003 and 11% for 2002. We expect that international revenue will continue to account for the substantial majority of our total revenue in 2005.

      In fiscal 2004, Uniden Corporation and Giant Electronics Limited (a subcontractor for Plantronics) accounted for 55% and 10% of net revenue, respectively. In fiscal 2003 and 2002, Uniden Corporation accounted for 56% of net revenue. Although our strategy is to engage large customers for new design wins, we expect that Uniden Corporation will continue to be our largest customer during the next twelve months.

      Gross margin is affected by the unit volume of product shipments, selling prices, product mix, manufacturing subcontract costs, manufacturing utilization, and product yields. It is also periodically affected by costs incurred in connection with start-up and installation of new process technologies at outside manufacturing foundries and test subcontractors. Gross margin is also affected by increases in inventory provisions required for excess and obsolete inventories.

      Our gross margin for 2004 increased 10% over 2003, despite being negatively impacted during the year due to $0.4 million in charges for write-downs in inventory related to excess quantities of certain of our legacy networking products and certain wireless products.

      Gross margin for wireless products was 51% for 2004 as compared to 33% for 2003 and gross margin for networking products was 68% for 2004 as compared to 72% for 2003.

      The increase in wireless product gross margin was primarily due to the 36% increase in average selling prices and a 13% decrease in direct unit product costs. The growth in our average selling prices was driven primarily by sales of our ML5800, which began shipping in volume during the second quarter of 2004. The decrease in our direct unit product cost during 2004 was primarily due to our ability to maintain high yields in the manufacture of our ML5800 product and our ability to achieve high yields on our ML5824, which we began producing in volume during the third quarter of 2004. Comparatively, during 2003, wireless product gross margin was negatively impacted by continued significant erosions in average selling prices and higher unit product costs due to the low yields on the ML2724, our 2.4GHz wireless product that was shipping in high volumes during 2003. During 2004 we incurred $0.2 million in charges due to increases in our inventory provisions for certain legacy wireless products. These charges impacted the wireless product gross margin by 1% in 2004. Sales of previously written down wireless inventories were not significant during 2004.

      The networking product gross margin percentage decreased 4 percentage points during 2004. This decrease in margin was mainly due to a decrease of 14% in the average selling prices of these products, resulting primarily from a shift in product mix. The decrease in networking product average selling prices was offset partially by a 16% decrease in direct unit product costs. During 2004 we incurred $0.2 million in charges due to increases in our inventory provisions for certain legacy networking products. These charges impacted

the networking product gross margin by 4% in 2004. Sales of previously written down networking inventories were $0.1 million in 2004. These sales increased the gross margin of networking products by 2% during 2004.

      Production overhead costs increased 26% in 2004 as compared to 2003, driven primarily by production start-up costs at two of our test subcontractors in 2004. Production overhead costs represented 12% of total product costs in 2004, up from 9% of total product costs in 2003. We expect that production overhead costs will decrease slightly as a percentage of revenue over the coming year.

      The decrease in gross margin in 2003, compared to 2002, resulted mainly from the decrease in the average selling prices of our wireless products and to a lesser extent the shift in product mix of our networking products. The margin decreases were slightly offset by decreases in manufacturing subcontract costs realized through a combination of a decrease in the costs of our silicon wafers and efficiencies realized in the costs to test our products. In addition, gross margin was negatively impacted in 2003 by low yields on our ML2724 product that was shipping in high volume, in the second and third quarters. These manufacturing problems were identified and fixed during the fourth quarter of 2003. During 2003 we incurred $0.1 million in charges due to increases in our inventory provisions for certain legacy wireless products. These charges impacted the wireless product gross margin by 1% in 2003. Sales of previously written down inventories were not significant during 2003.

      Fixed manufacturing overhead spending decreased by $0.6 million in 2003 as compared to 2002 but remained at 9% of net revenue in both of these periods due to the overall decrease in revenue in 2003 as compared to 2002.

      Research and development expenses include costs associated with the definition, design and development of new products. In addition, research and development expenses include test development and prototype costs associated with new product development.

      We expense wafers and new production mask sets related to new products as research and development costs until products based on new designs are fully characterized, support published data sheets and satisfy reliability tests.

      Research and development costs decreased 5% in 2004 as compared to 2003, a total cost reduction of $0.5 million. Employee related costs, consisting mainly of wages and benefits, decreased $0.3 million, and facility expenses decreased by approximately $0.3 million, due mainly to the action taken to reduce engineering headcount and consolidate facilities as part of our overall restructuring efforts undertaken in May 2003. In addition, costs of laboratory equipment and software design tools decreased slightly over $0.3 million in 2004 as compared to 2003, mainly due to a reduction in depreciation expense and amortization on capitalized software, also resulting from our May 2003 restructuring efforts, and a renegotiation of certain software license agreements. These cost reductions were partially offset by an increase in other costs of $0.4 million, primarily related to development of new products.

      The decrease in our 2003 expenses compared to 2002 was mainly due to our restructuring efforts implemented in May 2003. We reduced engineering headcount as part of these restructuring efforts and consolidated most of the design and testing activities in our San Jose headquarters and a small design group located in Salt Lake City, Utah.

      We expect to continue spending significant funds on research and development activities to deliver leading edge products that have a promise of high volume shipments within a short time following their introduction.

      The decrease in selling general and administrative expenses in 2004 compared to 2003 was due mainly to a $0.4 million reduction in employee related expenses resulting from the restructuring that we undertook in the second quarter of 2003 and $0.3 million in reduced marketing prototype costs in 2004 compared to 2003. The reduction in these expenses was partially offset by an increase in our bad debt expense of $0.2 million in 2004 compared to 2003, an increase in consulting expenses of $0.2 million resulting primarily from our Sarbanes-Oxley Act Section 404 implementation project, and an increase in travel expenses of $0.2 million related to the introduction of new products.

      The decrease of $1.3 million in 2003 selling, general and administrative expenses, as compared to 2002, was primarily a result of the restructuring efforts we undertook in May 2003 and the associated headcount reductions across all selling, general and administrative functions. These cost reductions were offset somewhat by the increase in costs associated with marketing prototypes for new products.

      We expect that selling, general and administrative expenses will increase over the coming year as we incur higher consulting, auditing and legal expenses related to the cost of complying with the Sarbanes-Oxley Act.

      In the third quarter of 2003, we completed an impairment review of our land and buildings. The review was undertaken due to an unsolicited offer to purchase our facilities, continued weakness in the commercial real estate markets, local vacancy rates and recent real estate transactions in our local market. Upon completion of our review, we determined that the carrying values of these assets exceeded their future undiscounted cash flows. Accordingly, we recorded an impairment loss of $1.5 million to write down the assets to their current estimated market value.

      In July 2004, we sold our San Jose facilities for approximately $7.0 million. We recognized a gain on the sale of approximately $1.1 million and the sale generated cash of approximately $4.6 million, net of a $1.9 million mortgage payoff and $0.5 million of closing costs.

      In the second quarter of 2003, we announced a restructuring plan to better align our organizational structure with current business conditions. This realignment process included workforce reductions across all functions of the Company’s operations and a consolidation of our design centers into our San Jose facility. The activity in our restructuring reserve, consisting of restructuring charges and related utilization, for the fiscal year ended December 31, 2004 is shown in the table below. In 2004 we provided $0.2 million for our remaining lease obligations, net of expected sublease payments, on our Utah facility which we vacated in the first quarter of 2004. When these facilities were vacated, the related accrued rent was reclassified to our restructuring reserves. The remaining balance of the reserve relates to our continuing charges for rent and leased equipment obligations.

      We recorded restructuring charges in 2003 of approximately $1.0 million, consisting primarily of employee severance and related termination costs of $0.6 million and a fixed asset impairment charge of $0.4 million for assets to be disposed of due to headcount reductions and vacating facilities. We did not maintain any restructuring reserves at the beginning of 2003 but had a $26,000 ending reserve balance to provide for employee severance costs that had been incurred but not paid during 2003.

      During 2002 we recognized $0.4 million in asset impairment charges relating to capitalized software that was purchased specifically for our 802.11a development project that was cancelled in October 2002.

      The decrease in interest and other income from 2003 to 2004 and from 2002 to 2003 was primarily due to the reduction in interest income affected by changes in our cash balances. The decrease in interest and other expense from 2004 to 2003 is mainly due to the repayment of the mortgage on our San Jose facility, which was repaid in July 2004 when the property was sold.

      Our effective tax rate was 0.6% for 2004, 0.8% for 2003 and a 64% tax benefit for 2002. The provision for the twelve months ended December 31, 2004 consists mainly of minimum state tax obligations and minor taxes incurred by our subsidiary in the United Kingdom. The 0.8% effective tax rate for 2003 is primarily due to the recording of a valuation allowance against our deferred tax asset as of December 31, 2003 and taxes

associated with our UK operations. The 64% effective rate for 2002 is primarily due to tax refunds resulting from a tax law change in 2002 that allowed us to carryback net operating losses to prior years.

Liquidity and Capital Resources

      Cash used by operating activities during 2004 was due mainly to our net operating loss of $4.1 million, which was net of a gain of $1.1 million from the sale of our San Jose facilities in July 2004. Excluding this gain our net operating loss was $5.2 million. Our major uses of cash are operating expenses and cost of product manufactured. During 2004 the major additional uses of cash were an increase of accounts receivable of $2.0 million, due primarily to higher sales in December 2004 as compared to 2003, and a decrease of $1.1 million in our trade payables at December 31, 2004 as compared to 2003. We expect trade payable balances to continue to fluctuate from period to period due to variations in our production cycle and timing of other operating expenses. These uses were partially offset by non-cash depreciation and amortization charges of $0.6 million, and the inventory provision charge of $0.4 million.

      Cash used in operating activities during 2003 was primarily due to our $10.4 million net loss, offset by a non-recurring non-cash charge of $1.5 million recorded for impairment in the value of our San Jose facilities, non-cash restructuring charges of $0.4 million, and non-cash depreciation and amortization charges of $0.9 million. In addition, during 2003 we collected $1.4 million in income tax refunds due to net operating loss carrybacks that were recorded in 2002. Cash used in operating activities during 2003 also included cash provided by an increase in our accounts payable balances of $0.6 million, $0.4 million of which related to a customer refund due for products which were returned in December. These favorable cash items were offset by a decrease in deferred revenue of $1.4 million due primarily to lower stocking levels at our largest distributor and a $0.4 million decrease in accrued liabilities due in large part to a decrease in a legal accrual related to the successful outcome of the Pioneer Magnetics litigation.

      Cash used in operating activities during 2002 was primarily due to our net loss of $2.8 million. The net loss included a $5.1 million tax benefit primarily due to the carryback of net operating losses to profitable years, $3.7 million of which was received in tax refunds in 2002.

      Other components of operating cash flows for 2004, 2003 and 2002 are set forth in detail in our Consolidated Statements of Cash Flows.

      Net cash provided during 2004 included net proceeds from the sale of our San Jose facilities. The net sales price for the facilities was $7.0 million and we recognized a gain on the sale of approximately $1.1 million. The sale generated cash of approximately $4.6 million after the payoff of the remaining balance on the mortgage of $1.9 million and payment of sales commission and sales transaction costs of $0.5 million. We also generated cash from the net proceeds from sales of short-term investments of $4.3 million, and used $0.6 million to purchase capital equipment consisting mainly of engineering equipment and software design tools used in research and development projects. Capital expenditures for this type of equipment are expected to stay near 2004 levels in the coming year and we anticipate that we will be able to provide for these expenditures without any additional sources of financing.

      Net cash provided by (used in) investing activities during 2003 and 2002 consisted primarily of net proceeds from sales (purchases) of short-term investments. In 2003, cash used for capital expenditures increased to $0.5 million compared to $0.3 million in 2002.

      Net cash used in financing activities for 2004, 2003 and 2002 consists primarily of principal payments on our real estate mortgage of $2.0 million, $0.3 million and $0.2 million, respectively, offset partially by proceeds from the issuance of common stock in connection with the exercise of employee stock options of $0.6 million, $0.2 million, and $0.3 million, respectively. The mortgage on our San Jose facilities was paid off when the buildings were sold during 2004.

      Working capital was $16.3 million at December 31, 2004, including cash and cash equivalents of $10.9 million and short-term investments of $4.7 million.

      We anticipate that existing cash resources will fund any anticipated operating losses, purchases of capital equipment, and provide adequate working capital for at least the next 12 months. Our liquidity is affected by many factors, including, among others, the extent to which we pursue additional wafer fabrication capacity from existing foundry suppliers or new suppliers, capital expenditures, the level of our product development efforts, and other factors related to the uncertainties of the industry and global economies. Accordingly, there can be no assurance that events in the future will not require us to seek additional capital sooner or, if so required, that such capital will be available on terms acceptable to us.

Factors That May Affect Future Operating Results

      The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occurs, our business, financial condition or results of operations could be materially and adversely affected:

      Our operating results are difficult to predict and have fluctuated significantly in the past. They are likely to continue to fluctuate in the future as a result of many factors, some of which are outside of our control. Some of the factors that may cause these fluctuations include:

      We believe that period-to-period comparisons of our operating results will not necessarily be meaningful. You should not rely on these comparisons as an indication of our future performance. If our operating results in one or more future periods fail to meet or exceed the expectations of securities analysts or investors, the trading price of our common stock may fluctuate, possibly by a significant amount.

      Intense international and domestic competition, decreasing selling prices, rapid technological change, short product life cycles and cyclical patterns characterize the markets for our products. Competitors include significantly larger corporations. New entrants in these markets could provide additional competition. Most of our competitors are substantially larger and have greater financial, technical, marketing and other resources than we do. Many of these large organizations are in a better position to withstand any significant reduction in spending by customers in these markets. They often have broader product lines and market focus, and will therefore not be as susceptible to downturns in a particular market. In addition, many competitors have focused on the wireless market for longer than we have, and therefore have more long-standing and established relationships with domestic and foreign customers.

      The computer networking equipment and wireless markets have undergone a period of rapid growth and consolidation in recent years. We expect our dependence on sales to digital cordless phone and network equipment manufacturers to continue. Our business and results of operations would be harmed in the event of a significant slowdown in the digital cordless phone or computer networking equipment market. In addition, as a result of competitive pricing pressures, we have experienced lower margins on some of our products. Such pricing pressures will continue to have an adverse effect on our results of operations, and our business could suffer unless they can be offset by higher margins on other products or lower operating expenses.

      We do not currently manufacture our own semiconductor wafers. As a result, we are vulnerable to process technology advances competitors use to manufacture products offering higher performance and lower cost. Larger companies with wafer manufacturing facilities, broader product lines, greater technical and financial resources and greater service and support capabilities have an advantage in this market.

      In addition, our products are generally sole-sourced to our customers. If our customers were to develop other sources for our products, our operating results would be harmed.

      Rapidly changing technology, frequent product introductions and evolving industry standards make it difficult to accurately predict the market’s future growth rate, size or technological direction. In view of the evolving nature of this market, suppliers of wireless products may decide to adopt alternative standards or

technologies that are incompatible with our products. If we are unable to design, develop, manufacture and sell products that are compatible with these new standards or technologies, our business and operating results would be harmed.

      Continuing technological advancement, changes in customer requirements and evolving industry standards characterize the wireless and computer equipment networking markets. To compete successfully, we must design, develop, manufacture and sell new or enhanced products that:

      The development of these new circuits is highly complex. We have sometimes experienced delays in completing the development of new products. Successful product development and introduction depends on many factors, including:

      We must be able to adjust to changing market conditions quickly and cost-effectively to compete successfully. Furthermore, we must introduce new products in a timely manner, and achieve market acceptance for these products. In addition, our customers’ products which incorporate our products must be introduced in a timely manner and achieve market acceptance. If we, or our customers, fail to develop and introduce new products successfully, our business and operating results would suffer.

      To successfully develop and market certain of our planned products, we may need to enter into technology development or licensing agreements with third parties. If we cannot enter into such agreements on acceptable terms, our ability to develop and market new products could suffer, and our business and operating results would be adversely affected.

      Customers typically take a long time to evaluate our new products. It takes three to six months or more for customers to test new products, and at least an additional three to 12 months until customers begin significant production of products incorporating our products. We may therefore experience a lengthy delay between product development and the generation of revenue from new products. Delays inherent in such a long sales cycle raise additional risks that customers may decide to cancel or change their product plans. Such changes could result in the loss of anticipated sales. Our business, financial condition, and results of operations would suffer if customers reduce or delay orders, or choose not to release products incorporating our products.

      We have incurred quarterly net losses from June 2000 through December 2004, except for a profit in the third quarter of 2002 which was attributable to an income tax refund, and a profit in the third quarter of 2004

which occurred from the sale of our land and buildings. Because of those losses, we had an accumulated deficit of $24.3 million as of December 31, 2004.

      Successful engineering development and market penetration in the product areas we have chosen to compete in require high levels of engineering and product development expense. We intend to continue to spend significant amounts on new product and technology development. Our networking products are reaching maturity, and revenue from this product line has declined and is expected to decline further over the next 12 months. We anticipate that our existing cash will fund any anticipated operating losses, purchases of capital equipment, and provide adequate working capital for at least the next 12 months. We expect to incur losses in the future and may not achieve our goals of positive net income and cash flow.

      We believe that our existing capital resources and cash generated from operations will enable us to maintain our operations for at least the next 12 months. However, if our capital requirements or results of operations vary materially from those currently planned, we may require additional financing sooner than anticipated. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to our common stock, and the terms of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. We cannot be certain that additional financing will be available in amounts or on terms acceptable to us, if at all. If adequate funds are not available to us on acceptable terms, our ability to hire, train or retain employees, to fund our operations and sales and marketing efforts, take advantage of unanticipated opportunities, develop or enhance services or products, or respond to competitive pressures would be significantly limited, which could harm our business, financial condition and operating results.

      Demand for our products in the future will depend on the amount and timing of spending by network providers, manufacturers of wireless consumer products, and telecommunications equipment suppliers. Spending in these areas depends upon a variety of factors, including competitive pressures, discretionary consumer spending patterns, and general economic conditions.

      During 2002 and 2003 new orders slowed, customers cancelled or placed holds on existing orders, and orders dropped from prior periods, due to developments in the general economy and capital markets. This situation could recur in the future. Because the majority of our revenue comes from sales to a few customers, a delay in orders from one customer could have a significant negative effect on future revenue.

      Relatively short product life cycles characterize the computer network equipment and digital cordless telephone markets. If one or more of our significant customers were to select circuits manufactured by a competitor for future products, our business would suffer. The loss of one or more of our current customers, failure to attract new customers, or disruption of our sales and distribution channels could harm our business and operating results.

      A significant majority of our revenue comes from sales to relatively few customers. Sales to the ten largest customers, excluding domestic distributors, in 2004, 2003, and 2002 accounted for approximately 82%, 77%, and 79% of net revenue, respectively. Sales to domestic distributors in 2004, 2003, and 2002 accounted for approximately 5%, 5%, and 7% of net revenue. We anticipate that a limited number of key customers and distributors will continue to provide a significant portion of our net revenue for the foreseeable future. During

2004, two customers each accounted for more than 10% of our net revenues, Uniden Corporation accounted for 55% of our total sales and Giant Electronics Limited (a subcontractor for Plantronics) accounted for 10% of our total sales. Our future success depends on our ability to retain our current customers and attract new customers. A reduction, delay or cancellation of orders from one or more significant customers could materially harm our operating results. In addition, our operating results could be adversely affected if one or more of our major customers were to develop other sources for the products we now supply them.

      Generally, customers may cancel or reschedule orders to purchase standard products without significant penalty until 30 days prior to requested shipment. Customers frequently revise delivery schedules, and the quantities of products to be delivered, to reflect changes in their needs. Since backlog can be canceled or rescheduled, our backlog at any time is not necessarily indicative of future revenue.

      Sales to customers outside of the United States in 2004, 2003, and 2002 represented 94%, 91%, and 89% of net revenue, respectively. We expect that international sales will continue to generate a substantial proportion of net revenue for the foreseeable future. Our international operations are subject to a number of risks, including:

      Substantially all of our international sales must be licensed by the Office of Export Administration of the U.S. Department of Commerce. To date, we have not experienced any material difficulties in obtaining export licenses.

      Our international sales are typically denominated in U.S. dollars. Fluctuations in currency exchange rates could cause our products to become relatively more expensive to customers in a particular country, while competitors’ products denominated in local currencies become less expensive. This may lead to a reduction in sales or profitability in that country, which could adversely affect our business.

      Gains and losses on the conversion to U.S. dollars of accounts receivable, accounts payable and other international assets and liabilities may contribute to fluctuations in operating results. In addition, international customers typically take longer to pay for purchases than customers in the United States. If foreign markets do not continue to develop, or foreign sales cycles prove unpredictable, our revenue and business would be adversely affected.

      Average selling prices for products in the wireless markets have rapidly declined due to many factors, including:

      The decline in the average selling prices of our products may cause substantial fluctuations in our operating results. We continue to develop and market new products that incorporate valued new features and sell at higher prices. Failure to deliver new products offering increased value would result in a decline in both revenue and margins, harming our business, financial condition, and results of operations.

      Complex products such as ours frequently contain errors, defects, and bugs upon release. Despite thorough testing by Micro Linear, our test houses and customers, these errors, defects and bugs are sometimes discovered after we begin to ship products. We expend significant resources to remedy these problems, but occasionally have faced legal claims by customers and others. Product defects can also cause interruptions, delays or cancellations of sales to customers, in addition to claims against us, all of which could adversely affect our operating results.

      The semiconductor industry experiences significant downturns and wide fluctuations in supply and demand. The industry also experiences significant fluctuations in anticipation of changes in general economic conditions. This causes significant variances in product demand and production capacity, and aggravates both our manufacturing costs and product selling prices. These cyclical patterns, which we expect to continue, may substantially harm our business, financial condition, and results of operations.

      We regularly request indications from customers as to their future plans and requirements, to ensure that we will be prepared to meet production demand for our products. However, we may not receive anticipated purchase orders for our products. We must be able to effectively manage the expenses and inventory risks associated with meeting potential demand. If we fail to meet customers’ supply expectations, we may lose business from such customers. If we expend resources and purchase materials, or enter into commitments to acquire materials and manufacture products, and customers do not purchase these products, our business and operating results would suffer.

      Design wins, which require significant expenditures, often precede the generation of volume sales by a year or more. The value of any design win will largely depend upon the commercial success of the customer’s product, and on the extent to which the design of the customer’s product accommodates components manufactured by our competitors. We cannot assure that we will achieve design wins, or that any design win will result in significant future revenue.

      We utilize outside foundries for all wafer production. We believe that utilizing outside foundries enable us to focus on our design strengths, minimize fixed costs and capital expenditures and access diverse manufacturing technologies. We currently intend to continue to rely exclusively upon our outside foundries for our wafer fabrication requirements. However, there are significant risks associated with the reliance on outside foundries, including the lack of assured wafer supply and control over delivery schedules, delays in obtaining access to key process technologies, and limited control over manufacturing yields and production costs.

      The manufacture of integrated circuits is a highly complex and technically demanding process. We have diversified our sources of wafer supply and have worked closely with our foundries to minimize the likelihood of reduced manufacturing yields. However, our foundries have sometimes experienced lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new processes. Reduced yields have, at times, negatively affected our operating results, a situation which may recur in the future.

      Dependence on foundries located outside of the United States subjects us to numerous risks, including exchange rate fluctuations, export and import restrictions, trade sanctions, political instability and tariff increases. One of our main foundries is located in Singapore, which presents specific risks due to political instability in that region.

      We purchase wafers from outside foundries pursuant to customers’ purchase orders. We generally do not have a guaranteed level of wafer capacity or wafer costs at our foundries. Our wafer suppliers could prioritize capacity for other uses, or reduce or eliminate deliveries to us on short notice. In addition, we depend upon a limited number of foundries for our wafer requirements. Any sudden demand for an increased amount of wafers, or sudden reduction or elimination of any source of wafers, could result in a material delay in the shipment of products. Disruptions in supply, which have occurred in the past, may occur in the future. If such a disruption occurred, and we were unable to qualify alternative manufacturing sources for our products in a timely manner, or if such sources were unable to produce wafers with acceptable manufacturing yields, our business and operating results would be materially and adversely affected.

      We rely on four outside test service subcontractors to test our products. The same risks described in the paragraphs above, concerning guaranteed capacity, dependence upon a limited number of test service subcontractors, and disruptions in service, also apply to our test and assembly subcontractors.

      Rapid technological change and frequent new product introductions characterize the markets for our products. To remain competitive, we must develop or obtain access to new semiconductor process technologies in order to reduce die size, increase die performance and functional complexity, and improve manufacturing yields. If we are unable to obtain access to advanced wafer processing technologies, limiting our ability to introduce competitive products on a timely basis, our future operating results would be harmed.

      Minute levels of contaminants in the semiconductor manufacturing environment, defects in the masks used to print circuits on a wafer, difficulties in the fabrication process and other factors can cause a substantial percentage of wafers to be rejected or a significant number of die on each wafer to be nonfunctional. Many of these manufacturing problems are difficult to diagnose and time consuming and expensive to remedy. Our foundries have, at times, experienced lower than anticipated yields, which have adversely affected production and operating results.

      The manufacturing processes utilized by our foundries are continuously being improved in order to increase yield and product performance. Process changes can, however, result in interruptions in production or significantly reduced yields. New process technologies and new products are especially susceptible to wide variations in manufacturing yields and efficiency. Irregularities, adverse yield fluctuations or other manufacturing problems at our foundries could result in production interruption or delivery delays, which would harm our business and results of operations.

      We have granted nontransferable, limited process licenses to some of our foundries to utilize our processes to manufacture and sell wafers to other customers. We protect our proprietary technology, particularly our design methodology, but may not be able to prevent its misappropriation by our foundries or others.

      Our wafer suppliers and test and assembly subcontractors are subject to a variety of U.S. and foreign government regulations related to the discharge or disposal of toxic, volatile or otherwise hazardous chemicals used in their manufacturing processes. Failure by our suppliers or subcontractors to comply with environmental regulations could result in fines, suspension of production or cessation of operations. Environmental regulations could also require our suppliers or subcontractors to acquire equipment or incur other expenses to comply with environmental regulations. If our suppliers or subcontractors incur substantial additional expenses, product costs could significantly increase, adversely affecting our results of operations.

      We are also subject to a variety of environmental regulations relating to our operations. If we fail to comply with present and future regulations, the government could impose fines on us, or compel us to suspend or cease operations. If we or our suppliers or subcontractors fail to control the use or discharge of hazardous substances, we could be subject to civil or criminal liabilities, which could harm our business and operating results.

      Our future success will depend to a significant extent on our ability to attract, retain and motivate qualified personnel, especially those with engineering design experience and expertise. We may not be successful in attracting and retaining such qualified personnel.

      Competitors may attempt to recruit our employees. While employees are required to sign standard agreements concerning confidentiality and ownership of inventions, we do not have employment contracts or non-competition agreements with most of our personnel. The loss of the services of key employees, the inability to attract or retain qualified personnel, or delays in hiring personnel, particularly engineers and other technical personnel could negatively affect our business and prevent us from achieving our business goals.

      We own eight U.S. patents, and have nine U.S. patent applications. We own two foreign patents, and have 13 foreign applications pending. Through a sale of a portion of our assets, we maintain a royalty-free license to several U.S. patents, foreign patents, U.S. patent applications, and foreign patent applications.

      We attempt to protect our intellectual property rights through patents, trademarks, copyrights, licensing arrangements, maintaining certain technology as trade secrets and other measures. However, any patent, trademark, copyright or other intellectual property rights we own may be invalidated, circumvented or challenged. We cannot be certain that our intellectual property rights will provide competitive advantages, or that any pending or future patent applications will be issued with the scope of the claims sought by us. Competitors may develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents that we own. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries in which we do business.

      We believe that the future success of our business will depend on our ability to translate technological expertise and innovation into new and enhanced products. We enter into confidentiality or license agreements with our employees, consultants, vendors and customers, and limit access to and distribution of our proprietary information. Nevertheless, we may not be able to prevent the misappropriation of our technology.

      In addition, we have taken legal action to enforce our patents and other intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others, and defend against claims of infringement or invalidity. If a third party makes a valid claim, and we cannot obtain a license to the technology on reasonable terms, our operations could be harmed.

      We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the proprietary rights and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming, and could divert our management’s attention away from running our business.

      From time to time we have received correspondence from vendors, distributors, customers or end-users of our products regarding disputes with respect to contract rights, product performance or other matters that occur in the ordinary course of business. Some of these disputes may involve us in costly litigation or other actions, the outcome of which cannot be determined in advance and may adversely affect our business. The defense of lawsuits or other actions could divert our management’s attention away from running our business. In addition, negative developments with respect to litigation could cause the price of our common stock to decline significantly.

      Our stock price has been and is likely to continue to be highly volatile. Between January 1, 2004 and December 31, 2004, our stock price has traded as high as $7.95 on January 28, 2004, and as low as $4.09 on December 7, 2004. Our stock price could fluctuate significantly due to a number of factors, including:

      Many of these factors are beyond our control. In addition, the stock markets in general, and the NASDAQ National Market and the market for technology companies in particular, have experienced extreme price and volume fluctuations recently. These fluctuations often have been unrelated or disproportionate to the operating performance of these companies. These broad market and industry factors may decrease the market price of our common stock, regardless of our actual operating performance. In the past, companies that have experienced volatility in the market prices of their stock have been the objects of securities class action litigation. If we were the objects of securities class action litigation, it could result in substantial costs and a diversion of management’s attention and resources, which could harm our business.

      Provisions of our Amended and Restated Certificate of Incorporation, Bylaws, the 1998 Shareholder Rights Plan, our stock option plans and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

      Under the Shareholder Rights Plan, adopted in August 1998, each share of our outstanding common stock carries one Right to purchase 1/1000 of a share of Series A Participating Preferred Stock at an exercise price of $30.00 per Right. If someone acquires 15% or more of our common stock, each Right not owned by a holder of 15% or more of our common stock entitles the holder, upon payment of the $30.00 exercise price, to receive common stock having a current market value of $60.00. This issuance of additional common stock would significantly reduce the percentage of common stock held by a potential acquirer. The Rights expire in August 2008.

      In addition, Section 203 of the Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control of Micro Linear. Specifically, Section 203 prohibits a Delaware corporation from engaging in any business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder unless specific conditions are met. Also, in the event outstanding options granted pursuant to certain of our stock option plans are not assumed by an acquiring corporation, the unvested portion of such options may be accelerated upon a change of control. In addition, some individual stock option grants provide for the partial or complete acceleration of vesting upon a change of control.

      Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by the SEC and NASDAQ, could cause us to incur increased costs as we evaluate the implications of new rules and respond to new requirements. The new rules could make it more difficult 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, or as executive officers. We are presently evaluating and monitoring developments with respect to these new and proposed rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

      We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, accounting policies affecting many aspects of our business, including rules relating to employee stock option grants, have recently been revised or are under review. The Financial Accounting Standards Board and other agencies have finalized changes to U.S. generally accepted accounting principles that will require us, starting in our third quarter of 2005, to record a charge to earnings for employee stock option grants and other equity incentives. We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could reduce our overall net income. In addition, since we historically have used equity-related compensation as a component of our total employee compensation program, the accounting change could

make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain employees.

      Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. This legislation is relatively new and neither companies nor accounting firms have significant experience in complying with its requirements. As a result, we expect to incur increased expense and to devote additional management resources to Section 404 compliance. In the event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and could cause a decline in the market price of our stock.

Interest Rate Risk

      As of December 31, 2004 our investment portfolio consisted of U.S. government obligations, commercial paper and money market funds, typically with maturities of less than 12 months (see Note 1 to the Consolidated Financial Statements). Some of these securities are subject to interest rate risk, and will decline in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2004 and December 31, 2003, the fair market value of these investments would decline by an immaterial amount.

Foreign Currency Exchange Risk

      Our international sales are significant in relation to our total sales; however, substantially all of our sales are in United States dollars. We do maintain small amounts of foreign currencies to fund our international operations, but to date, our exposure related to exchange rate volatility has not been significant.

INDEX TO FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

      To the Board of Directors and Stockholders of Micro Linear Corporation:

      In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Micro Linear Corporation and its subsidiary at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

March 25, 2005

MICRO LINEAR CORPORATION

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

MICRO LINEAR CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements.

MICRO LINEAR CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

The accompanying notes are an integral part of these consolidated financial statements.

MICRO LINEAR CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements.

MICRO LINEAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      Micro Linear Corporation is a fabless semiconductor company specializing in wireless integrated circuit solutions, which enable a variety of wireless products serving a global market. These transceivers can be used in many streaming wireless applications such as cordless phones, PHS handsets, wireless speakers and headphones, security cameras, game controllers, cordless headsets and other personal electronic appliances. Headquartered in San Jose, California, Micro Linear’s products are available through its authorized representatives and distributors worldwide.

      We report results of operations on the basis of fifty-two or fifty-three week periods, ending on the Sunday closest to December 31. Fiscal years 2004, 2003, and 2002 ended on January 2, 2005, December 28, 2003, and December 29, 2002 respectively. Fiscal year 2004 was comprised of fifty-three weeks, while fiscal years 2002 and 2001 were comprised of fifty-two weeks. For presentation purposes, the accompanying financial statements refer to the calendar year end of each respective year.

      The consolidated financial statements include the accounts of Micro Linear Corporation and our subsidiary in the United Kingdom. All significant inter-company accounts and transactions have been eliminated.

      The Company has designated the U.S. dollar as the functional currency for its United Kingdom subsidiary since that subsidiary is dependent on the parent company’s economic environment. The gains and losses resulting from the transactions of the United Kingdom subsidiary are recorded as other income and expense. For fiscal years 2004, 2003, and 2002 transaction gains and losses were not significant.

      The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates, and such differences may be material to the financial statements.

      Certain prior year amounts in the consolidated financial statements have been reclassified where necessary to conform to the presentation for the year ended December 31, 2004. Such reclassifications had no affect on previously reported results of operations or retained earnings.

      We recognize revenue from product shipped directly to OEM customers at the time of shipment, provided that we have received a signed purchase order, the price is fixed or determinable, title has transferred, and collection of the resulting receivable is reasonably assured. Sales to our OEM customers are made without a privilege of return and revenue on these sales is recognized upon shipment. We defer recognition of revenue from sale of our products to distributors under agreements which allow certain rights of return and price adjustments on unsold inventory. The associated cost of product on these sales to distributors is deferred to inventory. Revenue and cost of product is recognized when the distributor resells the product to its customers.

MICRO LINEAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Some sales to distributors are below contract pricing and are not guaranteed price protection or return privileges. Such sales are recognized as revenue upon shipment.

      We expense the cost of research and development as incurred. Research and development expenses principally consist of payroll and related costs and the cost of prototypes.

      Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash equivalents, short-term investments and trade accounts receivable.

      As of December 31, 2004, our investment portfolio consisted of U.S. government obligations, commercial paper and money market funds, typically with maturities of less than 12 months. Some of these securities are subject to interest rate risk, and will decline in value if market interest rates increase. Historically we have not incurred significant changes due to the impact from interest rate changes on income or cash flows.

      Our sale and purchase transactions are denominated in U.S. dollars. We primarily sell our products to original equipment manufacturers and distributors. We believe that our evaluation process, relatively short collection terms and the high level of creditworthiness of our customers substantially mitigate the concentration of credit risk in our trade accounts receivable. We perform ongoing credit evaluations of our customers’ financial condition and limit the amount of credit extended when deemed necessary, but generally require no collateral. Allowances for potential credit losses are established based on management’s review of individual accounts.

      In fiscal year 2004 two customers, Uniden and Giant Electronics Limited (a Plantronics subcontractor), accounted for 10% or more of our net revenue, comprising 55% and 10% of our net revenue, respectively. In fiscal years 2003 and 2002, one customer, Uniden Corporation, accounted for more than 10% of net revenue, comprising 56% of our net revenue in both years. Sales to foreign customers represented approximately 94%, 91%, and 89% of net revenue for fiscal years 2004, 2003 and 2002, respectively. These sales were principally to customers in Asia and Europe. We maintain reserves for potential credit losses, and historically such losses have been within management’s expectations.

      At December 31, 2004, receivables from three customers accounted for 45%, 22% and 12% of total receivables, respectively. At December 31, 2003 receivables from three customers accounted for 21%, 14% and 11% of total receivables, respectively.

      We consider all short-term, highly liquid investments with maturities of three months or less at the date of acquisition to be cash equivalents.

      We account for investments in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

      We invest in U.S. government obligations, commercial paper and money market funds that mature in one year or less. All securities are classified as available-for-sale and are recorded at fair value. Unrealized holding gains and losses are recorded as a separate component of other comprehensive income or loss within the shareholders’ equity. Unrealized gains (losses) for the years ended December 31, 2004, 2003, and 2002 amounted to ($10,000), ($22,000), and $61,000 respectively. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest and other income or

MICRO LINEAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

interest expense, as appropriate. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest and other income.

      Our financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities and certain other long-term assets, approximate their fair values due to the short maturity of these instruments. We do not hold or issue financial instruments for trading purposes.

      We value inventories at the lower of standard cost or market. Standard costs are periodically adjusted to approximate actual costs on a first-in, first-out basis. The value of inventories is reduced by an estimated allowance for excess and obsolete inventories. This allowance for excess and obsolete inventories is based upon our review of demand for products in light of projected sales, current market conditions, and market trends, and permanently reduces the cost basis of the underlying inventory.

      Property, plant and equipment are recorded at cost less accumulated depreciation. Depreciation for financial reporting purposes is provided on the straight-line basis over the estimated useful lives of the related assets, generally three to five years. Leasehold improvements are amortized over the shorter of the estimated useful life or the remaining term of the lease. Repair and maintenance costs are charged to expense as incurred.

      When property and equipment is sold or scrapped, the cost of the asset and the related accumulated depreciation or amortization is removed from the accounts and the resulting gain or loss, if any, is included in other income or expense.

      Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share exclude potential common stock if the effect is anti-dilutive. Diluted net earnings (loss) per share include the effect of all potentially dilutive common stock outstanding during the period. We compute diluted earnings (loss) per share using the treasury stock method for stock options outstanding.

      We evaluate the carrying value of long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144”), which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. In the third quarter of 2003, we completed an impairment review of our land and buildings. The review was undertaken due to continued weakness in the commercial real estate markets, local vacancy rates and recent real estate transactions in our local market. Upon completion of our review, we determined that the carrying values of these assets exceeded their future undiscounted cash flows. Accordingly, we recorded an impairment loss of $1.5 million to write down the assets to their current estimated market value. In July 2004, we sold our San Jose facilities for approximately $7.0 million. We recognized a gain on the sale of approximately $1.1 million and the sale generated cash of approximately $4.6 million, net of a $1.9 million mortgage payoff and $0.5 million of closing

MICRO LINEAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

costs. In fiscal year 2002, we wrote down $0.4 of impaired capitalized software primarily due to the discontinuation of the 802.11a broadband wireless program.

      Advertising costs are expensed as incurred. Advertising costs were not material in 2004, 2003 and 2002, respectively.

      Shipping and handling costs are included in costs of goods sold.

      We account for our employee stock option plans in accordance with Accounting Principles Board No. 25, “Accounting for Stock Issued to Employees.” Under APB No. 25, compensation cost is measured as the excess, if any, of the quoted market price of our stock at the date of grant over the exercise price of the option granted. Compensation cost for stock options, if any, is recognized ratably over the vesting period. We provide additional pro forma disclosures as required under SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure”.

      We account for stock issued to non-employees in accordance with the provisions of SFAS 123. Stock option awards issued to non-employees are accounted for at fair value using the Black-Scholes option-pricing model. The fair value of each non-employee stock award is remeasured at each period end until a commitment date is reached, which is generally the vesting date.

      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment,” an amendment to Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation” and Statement on Financial Accounting Standards No. 95, “Statement of Cash Flows.” The revised standard addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB 25. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS No. 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS No. 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. Currently, we disclose the pro forma net income (loss) and related pro forma income (loss) per share information in accordance with SFAS 123 and Statement on Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation Costs — Transition and Disclosure.” We believe that adoption of the new standard will have an adverse impact on our results of operations.

      As required by SFAS No. 123 and SFAS No. 148, we disclose our pro forma net income (loss) as if we had accounted for our employee stock purchase plan, employee stock options and director stock options subsequent to December 31, 1994 under the fair value method of SFAS No. 123. We estimate the fair value

MICRO LINEAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for these options at the date of grant using the Black-Scholes option pricing model and the multiple option approach with the following weighted-average assumptions:

      The Black-Scholes option valuation model is intended for use in estimating the fair value of publicly traded options that have no vesting restrictions and are fully transferable, which differs significantly from the terms of our stock option awards. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility and the expected life of the options before exercise, which greatly affect the calculated grant date fair value. The weighted average estimated fair values of shares issued under the Employee Stock Purchase Plan granted during 2004, 2003 and 2002 were $1.65, $0.99 and $1.09 respectively. The weighted average fair values of options granted under the employee and directors’ stock option plans during fiscal years 2004, 2003 and 2002 were $2.04, $1.26 and $1.29 respectively.

      The following table illustrates the effect on our net income (loss) and net income (loss) per share if we had recorded compensation costs based on the estimated grant date fair value as defined by SFAS No. 123 for all granted stock-based awards.