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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2003

OR

For the transition period ____________ to ____________

Commission File Number: 001-13748

ZiLOG, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (408) 558-8500

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

NONE

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

Common Stock, $0.01 per share par value

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

Indicate by check mark 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. ¨

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

The aggregate market value of Common Stock held by non-affiliates of the Registrant as of June 30, 2003, was approximately $49,113,000 based on the closing sale price for shares of the Registrant’s Common Stock as reported on the Over-the-Counter Bulletin Board. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Indicate by check mark whether the Registrant has filed all documents and reports required to be filed by section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No ¨

At March 17, 2004, 16,543,425 shares of the Registrant’s Common Stock were issued and outstanding.

The Registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 26, 2004 is incorporated by reference in Part III of this Form 10-K to the extent stated herein.

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TABLE OF CONTENTS

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FORWARD-LOOKING STATEMENTS

Some of the statements under sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance and involve known and may involve unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by forward-looking statements including, but not limited to prospects for future market growth. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “anticipates,” “believes,” “estimates,” “potential,” “continue,” or the negative terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks outlined under “Risk Factors.”

Although we believe that the expectations in the forward-looking statements contained in this Form 10-K are reasonable, we cannot guarantee future results, levels of activity, and performance achievements. These forward-looking statements are based on our current expectations, and we disclaim any obligation to update these forward-looking statements for subsequent events or to explain why actual results differ unless otherwise required by law. You should not place undue reliance on these forward-looking statements.

Period Comparisons

Our results of operations after May 1, 2002 and our consolidated balance sheets at December 31, 2003, December 31, 2002 and May 1, 2002 are not comparable to our results of operations prior to May 1, 2002 and our consolidated balance sheet at December 31, 2001, due to our adoption of “fresh-start” reporting upon our emergence from bankruptcy as prescribed by the American Institute of Certified Public Accountant’s Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” Differences in our results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, interest expense and restructuring and reorganization expenses. Additionally, these differences in our balance sheets relate to inventory, in-process research and development, property, plant and equipment, intangible assets, conversion of senior notes to common stock, and minority interest. Certain figures, such as net sales and certain expenses were not affected by our adoption of fresh-start accounting and, accordingly, we believe them to be comparable. To provide a more meaningful analysis, we have combined results of our Predecessor and Successor Company’s operations for fiscal year 2002. Our combined results for 2002 are presented for convenience of annual comparison and are not meant to be a presentation in accordance with generally accepted accounting principles.

Based in San Jose, California, we were incorporated in California in October 1981 and reincorporated in Delaware in April 1997. In this report, “ZiLOG,” “the Company,” “our,” “us,” “we,” and similar expressions refer to ZiLOG, Inc. and its subsidiaries. When these expressions are used in this report in connection with ZiLOG, Inc.’s reorganization under Chapter 11 of the U.S. bankruptcy code, however, they refer only to the parent company, ZiLOG, Inc., and not to any of its subsidiaries. ZiLOG, eZ80, Z8 Encore! and Z80 are registered trademarks of ZiLOG, Inc. and eZ80Acclaim! is a trademark of ZiLOG, Inc.

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PART I

BUSINESS

Our Business

We are a global supplier of 8-bit micrologic semiconductor devices, which are also referred to as embedded control devices. We design, develop, manufacture and market a broad portfolio of these devices for embedded control and communication applications used in our target markets: consumer electronics, home appliances, security systems, point of sale terminals, personal computer peripherals, personal health and medical products as well as industrial and automotive applications. We introduced our first micrologic device in the mid-1970’s and have since established a globally recognized brand. Many of our micrologic devices are developed in collaboration with our customers.

Our micrologic devices typically combine a microprocessor, memory, and peripheral functions on a single device. Our embedded control devices enable customers in our target markets to control the functions and performance of their products. By embedding their application software on our devices, customers can control a wide variety of products such as consumer appliances, infrared remote controls, security systems and battery chargers.

We sell our devices, either directly or through distributors, to a diverse customer base of OEMs in our target end markets. These OEMs include Echostar (Dish Satellite TV brand), Emerson, Hypercom, Philips, Samsung, Thomson Consumer Electronics (GE and RCA brands) and Tyco.

We have recently introduced our Z8 Encore! and our eZ80 Acclaim! next generation micrologic device families. These devices are designed to incorporate flexible flash memory and to meet our customers’ requirements for products incorporating advanced communications and connectivity features. Flash-based microcontrollers have been identified by Semico Research as the fastest growing segment of the 8-bit market. The eZ80 Acclaim! won the Electron D’Or award for Processor of the Year in 2003 from Electronique Magazine.

Our Industry

We compete in the micrologic device segment, sometimes called the embedded control segment, of the semiconductor industry. This segment is projected by Semico Research Corporation to grow from $9.4 billion in 2002 to $22.6 billion in 2007, a compound annual growth rate, or CAGR, of 19.3%. Our devices are specifically focused on the 8-bit segment of the micrologic device segment, which is predicted to grow from $4.0 billion in 2002 to $5.7 billion in 2007, a CAGR of 7.5%. According to Semico Research, in the 8-bit segment, flash-based microcontrollers are the fastest growing device category, expected to grow from $1.4 billion in 2002 to $3.7 billion in 2007, a CAGR of 21.5%. (References are from Semico Research Corporation Market Data Update dated June 2003.)

Micrologic devices are processor-based semiconductors that include microprocessors, microcontrollers and digital signal processors that typically process information, output data or control signals according to programmed instructions and various external inputs. Micrologic devices also include integrated peripherals, such as timers, serial communication devices, analog/digital converters, infrared data transmitters, hard disk drive controllers and display drivers, that operate in conjunction with these processor-based devices to provide systems support or to control communications, graphics and images, mass storage, voice and other user input systems.

As consumer and industrial product manufacturers seek to enhance the value of their products by increasing functionality, performance and ease of use, they are embedding more advanced control features into their

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designs. One way for manufacturers to meet these market requirements is to use micrologic devices. Micrologic devices can enable customers to:

Micrologic devices have been incorporated into a wide variety of products in markets including consumer electronics, home appliances, security systems, point of sale terminals, personal computer peripherals as well as industrial and automotive applications.

Microcontrollers typically include a central processing unit, non-volatile program memory, random access memory for data storage and various peripheral capabilities. The microcontroller is offered as a complete solution because it incorporates application-specific software provided by the customer and may include specialized peripheral device controllers and internal or external non-volatile memory components to enable the storage and access of additional program software. Microcontrollers are generally segmented by word length, which is measured in bits ranging from 4-bit through 32-bit architectures. Although 4-bit microcontrollers are relatively inexpensive, they generally lack the minimum performance and features required for product differentiation and are typically used only to produce basic functionality in products. While traditional 16 and 32-bit architectures are typically higher performance, they can be too expensive for many high-volume embedded control applications, typically costing two to four times the cost of an 8-bit microcontroller. Manufacturers will choose the appropriate microcontroller based on cost, performance and functionality. 8-bit microcontrollers are characterized as follows:

We believe that 8-bit microcontrollers are generally perceived as the most cost-effective embedded control solution for high volume requirements. High-volume microcontrollers available today are typically ROM or OTP-based, which typically require longer delays and greater costs in order to implement customer application code changes as compared to flash, generally resulting in longer lead times, for delivery of such microcontrollers. In addition to delayed product introduction, these longer lead times can result in potential inventory obsolescence and disruptions to customers’ factory production when changes in the application code are required by the customer. To address some of these issues, some suppliers offer OTP-based microcontrollers that can be configured by the customer in the customer’s manufacturing line, thus minimizing lead-time and inventory risks if the customer’s application code changes occur. Furthermore, flash memory offers the flexibility of in-product reprogrammability. While these flash-based microcontrollers were initially expensive relative to ROM and OTP-based microcontrollers, manufacturing technology has evolved over the last several years to the point where the premium for flash microcontrollers over ROM and OTP-based microcontrollers has narrowed. According to Semico Research Company flash-based microcontrollers are expected to continue to be the fastest growing segment of the 8-bit market.

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Our Competitive Strengths

We have over 30 years of experience in designing, manufacturing and selling micrologic semiconductor devices. As a pioneer in this industry, we believe that our brand name is respected and well recognized in our markets. We have established strong, long-standing relationships with numerous customers that are leaders in their respective markets. Our extensive experience as a supplier of micrologic devices has allowed us to develop the following key competitive strengths, which we believe differentiate us from many of our competitors:

Globally Recognized Brand Name

Our micrologic devices are known worldwide for providing versatile, highly customizable design solutions for use in a variety of consumer products and industrial equipment. We introduced our first Z80 microprocessor in 1974 and subsequently introduced our first Z8 microcontroller, each of which we continue to sell today. We were ranked as the third most recognized 8-bit microprocessor/microcontroller producer worldwide by engineers and engineering management surveyed by EDN and Electronics Business Magazine in 2000.

Extensive and Easily Customizable Product Portfolio with Substantial Base of Existing Code

In 2003, we shipped hundreds of different products, including ROM-based and field programmable microcontrollers for such consumer and industrial products as security systems, universal and multi-brand remote controls, infrared keyboards, car alarms and sunroofs. Our devices feature a variety of memory configurations, low voltage and power, small packaging and ease of use that allow electronics manufacturers to differentiate their products, add product functionality and reduce product costs. Our devices are built around a flexible core which facilitates customization. Our products are supported by an extensive set of Windows-based development tools and proven application assistance. Our proprietary library of reusable technology facilitates our ability to rapidly develop new products to meet the needs of our customers. Also, the backwards compatibility of our products allows engineers to re-use code created over the past 30 years.

Established Customer Base

Through direct sales and distributors, we have developed relationships with customers, including large OEMs and end users. Many are leaders in their respective markets. By collaborating with customers in an interactive product design and development process, we have been able to establish long-standing relationships, which help us solidify our customer base and define our next generation products. In our micrologic devices business line, we have collaborated with such customers as Echostar (Dish Satellite TV brand), Emerson, Hypercom, Philips, Samsung, Thomson Consumer Electronics (GE and RCA brands) and Tyco.

Our Strategy

Our objective is to be a key provider of micrologic devices. To implement our business strategy, we intend to:

Focus on Our Core 8-bit Micrologic Business

We are dedicating increased resources to developing new applications and relationships with previous and new customers for our existing and future 8-bit micrologic devices. Our extensive database of code and reusable application software developed over many years of service in these markets facilitates our customers’ ability to design-in our products.

Expand Our Addressable Portion of 8-bit Market

Although we have recently expanded our addressable portion of the 8-bit market by introducing flash-based devices, we do not address the entire 8-bit market. We have a product roadmap to develop new devices that

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address additional portions of the market. The roadmap includes adding devices that provide: a wider range of voltages, additional memory sizes and expanded peripheral functions such as USB and controller area network bus, or CAN bus.

Introduce Devices Targeted at Key Vertical Markets

In addition to providing a portfolio of general purpose micrologic devices, we are developing devices that are designed specifically for major vertical markets served by existing or new OEM customers. Our targeted key vertical markets include consumer electronics, home appliances, security systems, point of sale payment systems, personal computer peripherals, personal health and medical products as well as industrial and automotive systems. In each new vertical market we identify as well suited for our micrologic products, we work with leading OEMs to determine the requisite specifications. An example of this vertical strategy is our Z8 Crimzon, which we have created to address the infrared remote control end market. We plan to expand our Crimzon family of products to address additional consumer applications in the future.

Deliver Complete Solutions to Our Customers

We are focused on providing advanced semiconductor solutions that assist our customers in adding functionality and enhancing the performance of their products. Our efforts in this regard include:

Utilize Efficient Manufacturing

Our manufacturing strategy is to utilize third party wafer foundries to manufacture our devices. We believe outsourcing manufacturing enables us to access advanced process technologies and to reduce our manufacturing costs. This strategy allows us to focus greater resources on product design, systems and software development and customer support. We continue to manufacture wafers for many of our products in our MOD II five-inch wafer fabrication facility in Nampa, Idaho.

Products and Applications

We design, develop, manufacture and market a broad portfolio of micrologic semiconductor devices for embedded control and communication applications used in consumer electronics, home appliances, security systems, point of sale terminals and personal computer peripherals, as well as industrial and automotive applications. In addition, we manufacture other semiconductor devices such as serial communications

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controllers, on-screen television display controllers, violence blocking microcontrollers, modems and infrared data association transceivers, which we call IrDA. We refer to these semiconductor devices as “other devices.” Historically, we have also performed wafer fabrication foundry services for third-parties. In 2003, micrologic devices were approximately 66% of net sales, other devices were approximately 23% of net sales and foundry services were approximately 11% of net sales.

Micrologic Devices

All of our micrologic devices include our proprietary microprocessor technology. We have four families of microprocessors. The Z8 and Z80 are our legacy microprocessor architectures. The Z8 Encore! and eZ80 Acclaim! are our next-generation microprocessor architectures. In most of our micrologic devices, a microprocessor is combined with either read-only memory (ROM), one-time programmable (OTP) or flash memory to make a microcontroller. We introduced our Z8 Encore! and eZ80 Acclaim! in late 2002 and early 2003 to address the large flash-based market. The Z80 is also sold as a stand-alone microprocessor, which does not include integrated memory.

Most of our micrologic devices are general purpose semiconductors. We then offer our customers the ability to integrate peripheral functions (such as network connectivity, timers, serial communication, analog/digital conversion, infrared data transmission and display drivers) on our micrologic devices. These additional functions enhance the capabilities of the customer’s end product, which can lower their overall systems costs. These peripherals incorporate functionality that might otherwise be found in a separate chip on the printed circuit board to which the micrologic device is attached.

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We also combine different microprocessors, memories and peripheral functions to create devices specifically tailored to meet the requirements of targeted vertical markets. For example, our Crimzon family of products includes devices tailored for specific consumer applications such as universal remote controls. A summary of our major device offerings is included below.

ZiLOG, Inc.

8-Bit Micrologic Device Matrix

8-bit Microprocessor Families.    Our globally recognized microprocessors include the Z80, the Z8, the Z8 Encore! and the eZ80 Acclaim!. The Z8, Z8 Encore! and the eZ80 Acclaim! are primarily used in microcontrollers only, whereas the eZ80 is used in a microcontroller and as a stand-alone microprocessor.

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Memory modules for microcontrollers.    Various types of memory may be integrated around the microprocessor core, including ROM, OTP and flash. ROM products are the lowest-cost option for high volume products with stable software, but changes to the customer’s application code are time consuming and costly due to the need to produce a new mask. OTP products allow for custom programming by customers and enhance time to market and flexibility for frequent software updates in the customer’s design process, but the products are not programmable post-production. Flash memory offers the flexibility of in-product reprogrammability. A flash based device can be reprogrammed, even after sale to an end customer, to upgrade or add features in the end product. Due to this feature and decreasing flash memory prices, this is an increasingly important segment of the 8-bit market to our customers. It has been identified by Semico Research as the fastest growing segment of the 8-bit market. Consequently, we have focused the majority of our new product development efforts on flash-based 8-bit microcontrollers.

Peripheral Functionality.    As described above in connection with our microprocessor cores, we integrate a range of peripheral functions onto the chip. Such peripherals include timers, serial communication devices, analog/interface devices, infrared devices and display drivers.

Other Devices

Our other devices are primarily focused on serial communications for voice and data transmission in the telecommunications market and low speed modems for a broad range of markets including point of sale and set-top box applications. Additionally, other devices include IrDA transceivers for use in PDAs, cell phones and laptop computers. We are not expending significant resources developing technologies related to these other devices. These devices are being incorporated as features in our eZ80 Acclaim! and Z8 Encore! microcontroller families.

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Foundry Services

We continue to provide wafer foundry services to third parties, such as Globespan, utilizing our MOD II facility in Nampa, Idaho. We are not investing in the business of providing foundry services, and we expect revenues from foundry services to be minimal in the future.

Development Tools

Our Developer Studio, which we call ZDS, is a stand-alone software development environment, which provides a comprehensive development solution for embedded designers and incorporates our sophisticated line of development tools. ZDS integrates a language-sensitive editor, project manager, highly optimizing ANSI C-compiler, assembler, linker and symbolic source-level debugger that support our entire portfolio of micrologic devices. ZDS provides an industry standard user interface running on Windows-based operating systems and features an integrated set of windows, document views, menus and toolbars that enable developers to create, test and refine applications in a familiar and productive environment.

ZDS II is the next generation descendent of ZDS that has been enhanced to meet the challenges of our more sophisticated developers. ZDS II supports a scripting engine for more flexible user-configuration and automated regression testing. ZDS II also supports a new communication layer allowing it to interface with third-party emulation products as well as our new ZPAK II high-speed emulation and evaluation hardware interface.

Many independent companies develop and market application development tools and systems that support our product architectures. Although we do not generate significant revenues from the sale of development tools, we believe that familiarity with, and adoption of, development systems offered by ourselves as well as third-party vendors will be an important factor when considering ZiLOG as the vendor of choice by new product developers.

Customers, Sales and Marketing

Introduction

We use a total marketing approach to build relationships with key OEMs, distributors and end users in a broad array of end markets. Our top OEM customers, determined by shipment dollars for 2003, include Echostar (Dish Satellite TV brand), Emerson, Hypercom, Philips, Samsung, Thomson Consumer Electronics (GE and RCA brands) and Tyco.

To market our products, we utilize a well-trained and highly-skilled direct sales and distribution sales force, a customer-centric website, technical documentation that includes product specifications and application notes, development tools and reference designs, sales promotional materials, targeted advertising and public relations activities, and involvement in key trade shows and technical conferences in North America, Europe and Asia. Our direct sales force and our sales representatives cover various geographic locations in the Americas, Europe and Asia.

Sales Process

We work closely with our customers in identifying opportunities for the customer to pursue end product designs using our devices. The customer’s decision to design an end product using our devices is based upon several technical and financial factors, including microprocessor performance, memory, peripheral options, pre-existing customer relationships, financial stability and pricing. Typically, a customer’s product architects and design engineers will then use our proprietary development tools over a period of many months or longer to design an end product and test the design using our devices before making a decision.

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We classify a design win as the point at which the customer has purchased at least $1,000 of product. Once we have achieved a design win we deliver a limited production of the device to our customer. Product prototypes are then created and tested. If the decision is made to produce the product for sale, we will receive a full production order. The entire cycle from design win to full production typically takes between 12 and 18 months, although it may take up to 36 months. After a design win, our sales are generally made pursuant to short-term cancellable purchase orders that can be cancelled upon 30 to 60 days notice. As a result, design wins are not necessarily an accurate or reliable indication of future net sales.

Direct Sales Force

Our direct sales force of 43 people as of December 31, 2003 focuses on four geographic areas: the Americas, Europe, Asia and Japan. We have sales offices located in the metropolitan areas of Irvine, Philadelphia, San Jose, Seattle, Hong Kong, London, Munich, Seoul, Shanghai, Shenzhen (China), Singapore, Taipei and Toronto. During 2003, we derived approximately 53% of our net sales from direct sales to OEMs, compared to 56% in 2002 and 61% in 2001. During 2003, we engaged 27 independent sales representative firms to further augment our own direct sales force.

We provide direct customer support through our field application engineers, who are located in our sales offices around the world and work directly with local customers in close consultation with our factory-based technical specialists. Field application engineers typically develop technology expertise in a market segment that is most prominent in their geographic areas. These engineers provide significant aid to the customer throughout the design process. Customer support in the Americas is being provided by our North American-based personnel. Our local area sales offices handle customer service functions for Asia and Europe.

Distribution Partners

In 2000, we announced an exclusive full-service distribution agreement with Pioneer-Standard in North America, and we terminated our existing relationships with our three then-largest distributors in North America: Arrow Electronics, Future Electronics and Unique Technologies. Our distribution agreement with Pioneer permitted either party to terminate without cause upon thirty days’ prior notice. By letter dated September 19, 2002, we notified Pioneer of our intent to terminate the distribution, and the termination became effective as of October 23, 2002. Pioneer-Standard accounted for none and approximately 12.9% and 12.6% of our net sales during 2003, 2002 and 2001, respectively.

We then entered into a distributor agreement with Future Electronics, effective October 23, 2002. This agreement provides that Future Electronics will be our exclusive full-service distributor within North America and will also serve as a non-exclusive distributor for the rest of the world. Until April 2004, we can only terminate the agreement or the exclusivity for cause; after April 2004, we may terminate the exclusive nature of the relationship upon 30 days’ prior written notice. Future Electronics may terminate the agreement without cause upon 30 days’ written notice at any time. Either party may terminate for cause if a breach is not cured within the required cure period. In connection with the agreement, we issued a warrant to Future Electronics to purchase up to 60,000 shares of common stock upon the attainment of certain performance goals, at an exercise price of $6.40 per share. This warrant expired, unexercised, on December 31, 2003. Future Electronics is a private Canadian-based company with an extensive and well-integrated international distribution infrastructure. Their ability to cover a broad spectrum of market opportunities, especially in embedded flash-based products, is expected to provide significant value and opportunities to our new flash portfolio. Future Electronics’ value-add services to us are not expected to increase our costs, but will include a significant number of sales representatives focused on our business, co-operative trade advertising, seminars and workshops to train design engineers about our products, direct mail advertising, collateral materials and web site pages dedicated to our products. For these reasons, among others, we replaced Pioneer-Standard with Future Electronics as our exclusive North American distributor. Net sales through our distribution channel represented 47%, 44% and 39% of our net sales in 2003, 2002 and 2001, respectively. In 2003, Future Electronics accounted for 18% of net sales.

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Manufacturing and Sourcing

Our manufacturing strategy is to utilize third-party wafer foundries to manufacture our devices. We believe outsourcing manufacturing enables us to access advanced process technology, reduce our research and development costs and reduce our manufacturing costs. We also operate one five-inch semiconductor wafer fabrication facility (MOD II) in Nampa, Idaho. Currently our five-inch wafer fabrication facility is primarily producing wafers with circuit geometries of 0.65, 0.8 and 1.2 microns. Our products that have circuit sizes below 0.65 microns are currently manufactured at outside foundries in Taiwan where we use a number of different suppliers. The percentage of our net sales derived from devices manufactured at our outside wafer foundry partners increased during 2003 compared to 2002. Based on our strategy of outsourcing production of our new products, we expect the proportion of our net sales derived from products produced in outside wafer foundries will continue to increase in the future. We conduct most of our test operations at our facility in the Philippines, and outsource our assembly operations to subcontractors located throughout Asia including Indonesia, Thailand and the Philippines.

The National Standards Authority of Ireland granted ISO 9001 certifications to our facilities in Idaho. The SGS International Certification Services AG of Zurich, Switzerland granted an ISO 9001 certification to our Philippines test facility. ISO certifications reflect the stringent quality standards to which all of our products are manufactured. We believe that these certifications enhance the reputation and quality of our products.

Research and Development

Our research and development expenditures have been focused largely on our next generation of flash-based microcontrollers, including our Z8 Encore! and eZ80 Acclaim! families of products. Our focus in the future is to broaden our capabilities by adding new and improved features such as enhanced memory and optimized power consumption and developing products for targeted consumer, automotive and industrial verticals.

Research and development expenditures were $18.0 million, $17.9 million and $28.7 million in 2003, 2002 and 2001, respectively, representing 17%, 13% and 17% of net sales, respectively, in each of those annual periods. In 2003 and 2002, our research and development expenditures were focused largely on new product development of our Z8 Encore! and eZ80 Acclaim! product families within our micrologic devices group and our Crimzon family of products. During 2001, our research and development activities were focused largely on communications product development relating to our eZ80 and Cartezian products. In January 2002, we announced the discontinuation of our Cartezian product development efforts and the closure of our Austin, Texas design center. As a result of these actions, our research and development spending in 2002 declined compared to 2001 levels.

Competition

The semiconductor industry is characterized by price erosion, rapid technological change and heightened competition in many markets. The industry consists of major domestic and international semiconductor companies, many of which have substantially greater resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. Emerging companies are also expected to increase their participation in the semiconductor market.

We compete with other micrologic device manufacturers who target the same specific market segment. We believe the primary bases for competition in this market include: price, technological sophistication, customer relationships, support tools, familiarity with micrologic architecture, and existing customer investment in system software based on a particular architecture. In many instances our competitors have similar competitive strengths to us, and they have significantly more resources than we do. Many of our competitors are much larger than we are, with broad product offerings in many sectors.

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Our current and future products compete with, or may compete with, products offered by Atmel, Cypress Semiconductor, Intel, Microchip, Motorola, National Semiconductor, Renasas, STMicroelectronics and Texas Instruments, among others.

Backlog

Our total backlog of cancellable customer orders was $10.0 million at December 31, 2003, $10.6 million at December 31, 2002 and $23.4 million as of December 31, 2001. Our sales are generally made pursuant to short-term cancellable purchase orders that are cancellable upon 30 to 60 days notice rather than long-term contracts. As a result, our backlog may not be an accurate measure of net sales or operating results for any period. Additionally, during times of economic downturn there tends to be excess capacity in the marketplace, driving shorter lead time expectations, which often results in a higher percentage of book-ship (or turns) business in the quarter.

Patents and Licenses

We employ a combination of patents, copyrights, maskwork rights, trademarks and trade secrets, as well as contractual restrictions, to protect the proprietary aspects of our business and devices. In addition to our own intellectual property, we license technologies and products from others as necessary to provide second sources for standard products or to obtain rights to cores, cells or other technology. We often enter into agreements to incorporate into our designs the intellectual property of third parties. Such agreements may impose certain obligations or limitations on our use or disclosure of such intellectual property or the enforcement of our own intellectual property. We hold numerous U.S. and foreign patents and have additional U.S. and foreign patent applications pending. We also hold numerous mask work registrations, registered copyrights to protect proprietary software employed in our devices, and trademarks. We intend to continue investing in the protection of our intellectual property through the filing of patent applications and, if appropriate, the registration of copyrights, maskworks and trademarks. Nevertheless, we believe that our continued success depends primarily on the technological skills and innovative abilities of our personnel and our ability to rapidly commercialize product developments. Thus, we believe that the loss of any one of our patents or trade secrets would not materially affect our core business.

The extent and value of our intellectual property is necessarily uncertain. While we intend to protect our intellectual property rights vigorously, our efforts may not be successful. Despite our precautions, a third party may copy or otherwise obtain our devices or technology without authorization, requiring patent litigation to enforce our rights. Patent litigation is, by its nature, expensive and unpredictable. If litigated, one or more of our patents may be found invalid or unenforceable or to have claims of such narrow scope as to be of little economic value. Third parties may design around our patents. Third parties may independently develop technology similar to our trade secrets. In addition, the laws of some foreign countries where we have patent and trademark rights may not protect our intellectual property rights to the same extent as the laws of the United States.

Additionally, our pending and future patent applications should not be relied upon as they may not issue as patents, and even if they do issue, such future patents may not be of sufficient scope or strength to provide meaningful economic or competitive value.

The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights, both defensive and offensive.

From time to time we have received, and may in the future receive, communications from third parties asserting that a product offered by us, or an aspect of our business, infringes a patent held by the third party and/ or requires a license thereto. With respect to those third party communications that are currently pending, we believe, after having consulted with counsel, that either (i) we have meritorious defenses, (ii) based on license terms previously offered to us or typically available in the industry, we can obtain any necessary licenses on

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commercially reasonable terms, or (iii) we can modify our products to avoid such rights, but if this is not the case, we may be sued and assessed damages for past infringement. Indeed, licenses may not be available on commercially reasonable terms, or at all. In addition, we have certain indemnification obligations to customers with respect to the infringement of third party intellectual property rights by our devices.

We recently received a letter from an electronic equipment manufacturer that makes products that are competitive to certain of our key products, asserting that the sale of certain of our key products may be infringing certain patents owned by them. After having consulted with counsel, we believe that we have meritorious defenses to the assertions set forth in the letter. However, should it become necessary to engage in litigation to defend against such assertions, such litigation could be expensive and time consuming. There can be no assurance that the ultimate resolution of this matter would not have a material adverse affect on our business.

Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we may not be successful in defending ourselves against intellectual property claims. The cost of defending against patent infringement or other intellectual property litigation, in terms of management time and attention, legal fees and product delays, could be substantial, whatever the outcome. If any patent or other intellectual property claims against us are successful, we may be prohibited from using the technologies subject to these claims, and if we are unable to obtain a license on acceptable terms, license a substitute technology, or design new technology to avoid infringement, we could be prohibited from using or selling the infringing products or technologies and be required to pay substantial damages. Such a result could have a material adverse effect on our business.

Conversely, we also enforce our intellectual property rights where appropriate, consistent with business considerations. For example, we filed a patent infringement suit against QuickLogic. While we believe we would ultimately be successful in this litigation, it is possible that QuickLogic could assert a number of defenses, such as noninfringement, or counterclaims of invalidity or unenforceability. Nonetheless, we do not currently believe that any outcomes of such defenses or counterclaims would have a material adverse effect on our business.

Employees

As of December 31, 2003, we had 661 full time employees. Of those 661 employees, approximately 424 were employed in a manufacturing capacity, 122 in engineering and 115 in a general administrative function.

Our employees are not represented by any collective bargaining organization.

Environmental

Our manufacturing processes require substantial use of various hazardous substances, and, as a result, we are subject to a variety of governmental laws and regulations related to the storage, use, emission, discharge and disposal of such substances, including the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Superfund Amendment and Reauthorization Act, the Clean Air Act and the Water Pollution Control Act. Although we cannot provide assurances, based on currently available information and our past experience, we do not believe that compliance with environmental laws will have a material impact on our business.

In February 1999, our facilities in Idaho received ISO 14001 certification from an independent auditor. We believe that ISO 14001 certification is widely recognized as the global standard for measuring the effectiveness of a company’s environmental management. To qualify, companies must implement an environmental management system, commit to prevent pollution, adopt a program of continual improvement, and submit to periodic outside audits of their environmental management system. Our environmental management system controls and monitors the ways in which we impact the environment, including air quality, water use, conservation, waste disposal and chemical handling.

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Financial Restructuring and Reorganization

We filed a pre-packaged Chapter 11 reorganization plan with the United States Bankruptcy Court for the Northern District of California on February 28, 2002. The court confirmed the plan on April 30, 2002, and it became effective on May 13, 2002.

Pursuant to our reorganization plan, we extinguished $325.7 million of liabilities, which included $280.0 million in principal amount of our former 9 ¹/2% Senior Secured Notes due 2005, $27.2 million in accrued interest due on the notes and $18.5 million of dividends payable on our former series A preferred stock. Each holder of senior notes received, in exchange for its senior notes, its pro rata share of:

Our previously outstanding common stock and preferred stock, and all related options and warrants, were also cancelled pursuant to the terms of the reorganization plan, and all accumulated dividends and any other obligations with respect to such shares were extinguished. Each holder of common stock received a pro rata share of $50,000. Each holder of preferred stock received a pro rata share of $150,000. As a result of this reorganization, we expect to save more than $26.6 million in annual interest payments on the extinguished senior notes.

Historical Background to the Plan of Reorganization

We issued our senior secured notes in connection with our going-private transaction in 1998. From 1998 through 2002, our business and financial growth were negatively affected by the extremely difficult business climate in which we operated.

In March 2001, we retained Lazard Frères & Co., LLC as our independent financial advisor to assist us in exploring a number of strategic alternatives. Also in March 2001, Lazard began the process of soliciting bids for the sale of all or parts of our business. While we received a number of proposals, each of these contained significant financing or due diligence contingencies. After consultation with our financial advisor, we determined that these contingencies could seriously jeopardize the likelihood that a strategic transaction could be consummated.

In July 2001, holders of senior notes who collectively held or managed approximately $165.0 million in principal amount of our senior notes formed an informal group to discuss and negotiate the terms of a possible restructuring with us. All members of this group executed confidentiality agreements, and on July 13, 2001, members of our management met with these holders and their counsel to discuss a possible restructuring.

Discussions continued over the course of the summer and fall of 2001. During the course of these discussions, we concluded that the best vehicle to achieve a restructuring of our senior notes was through

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consummation of a voluntary pre-packaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code. On November 27, 2001, we reached a non-binding agreement regarding the terms of the reorganization plan with this informal group of our noteholders.

On January 28, 2002, we commenced solicitation of acceptances of the plan of reorganization from the holders of our senior notes and preferred stock. As permitted by bankruptcy court rules, we did not solicit votes from holders of our old common stock. In connection with this solicitation, we entered into lock-up agreements with members of the informal group. Under the lock-up agreements, the members of the informal group agreed, among other things and subject to certain conditions, to vote to accept the plan of reorganization.

The voting period for the solicitation ended on February 26, 2002. Holders of approximately $221.0 million of our senior notes accepted the plan of reorganization. None of the holders rejected the plan. All of the holders of preferred stock who voted also accepted the plan of reorganization.

On February 28, 2002, MOD III, Inc. and we filed voluntary petitions with the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11. The bankruptcy court confirmed the reorganization plan by its order entered on April 30, 2002, and the reorganization plan became effective on May 13, 2002.

Our corporate headquarters are located in a 41,000 square foot facility in San Jose, California, which we have leased through January 31, 2007. We currently own and perform wafer fabrication at our 118,000 square foot building located on a 53-acre site in Nampa, Idaho, which we call MOD II.

A majority of our product testing, inventory warehousing and logistics resides in a 64,000 square foot facility located in the Philippines. In October 2003, we executed a new lease agreement for the Philippines facility through March 2009. In addition, we have short-term leases for sales offices located in the U.S., Canada, England, Germany, Korea, Malaysia, the People’s Republic of China (including Hong Kong), Singapore and Taiwan. We believe that our properties currently are adequate to meet our needs.

In January 2002, we closed our MOD III facility, which is approximately 158,000 square feet. In connection with our plan of reorganization, we transferred the assets of the MOD III facility to MOD III, Inc. MOD III, Inc. is holding this facility for sale. The holders of our former senior notes will receive the first $30 million of net proceeds (plus dividends accruing on $30 million of preferred stock at a rate of 9.5% per annum) from the sale of the assets, and the proceeds above this amount are split evenly between them and us.

We are participating in litigation and responding to claims arising in the ordinary course of business. We intend to defend ourselves vigorously in these matters. Our management believes that it is unlikely that the outcome of these matters will have a material adverse effect on our financial statements, although there can be no assurance in this regard. In August 2003, we filed suit against QuickLogic Corporation in the U.S. District Court for the Northern District of California alleging that QuickLogic’s FPGA and ESP products infringe claims of ZiLOG’s U.S. patent number 4,607,749 and seeking to recover monetary damages resulting from the alleged infringement.

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(a) Stockholders Meeting

On February 12, 2004, at a special meeting, the Company’s stockholders approved the following:

Each of the foregoing was accomplished via amendment of our Certificate of Incorporation.

(b) Stock Split

On February 18, 2004, the Board of Directors approved a reverse stock split in which every two shares of common stock was converted into one share of common stock, effective March 1, 2004. All Successor Company common shares and per share figures have been retroactively restated to reflect this one-for-two reverse stock split. In addition, the Company reclassified $200,000 and $200,000 from “common stock” to “Additional paid-in capital” in the Company’s balance sheet at December 31, 2003 and 2002, respectively.

(c) 2004 Omnibus Stock Incentive Plan

On December 17, 2003, the Company’s Compensation Committee approved the 2004 Omnibus Stock Incentive Plan. The Company’s stockholders approved the 2004 Omnibus Plan at a special meeting held on February 12, 2004. The Company has reserved 1,500,000 shares of common stock for issuance under the 2004 Omnibus Plan.

(d) 2004 Employee Stock Purchase Plan

On December 17, 2003, the Company’s Compensation Committee approved the 2004 Employee Stock Plan. The Company’s stockholders approved the adoption of the 2004 ESPP at a special meeting held on February 12, 2004. The total of 1,250,000 shares of the Company’s common stock has been reserved for purchase by eligible employees under the 2004 ESPP, subject to certain adjustments.

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PART II

As of December 31, 2003, we had issued 931,233 restricted shares and 1,487,292 options pursuant to our 2002 Omnibus Stock Option Plan, which plan was approved by the Bankruptcy Court. We believe that the transactions were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), under Rule 701 or Section 4(2) of the Securities Act.

On January 20, 2003, we issued a warrant to Future Electronics, Inc. to purchase up to 120,000 shares of the Company’s common stock, for $3.20 per share. The vesting of the warrant is based on the attainment of certain performance goals during calendar year 2003, pursuant to a related distribution agreement. We believe the issuance of this warrant was exempt from registration under the Securities Act pursuant to Section 4(2) on the basis that the transaction did not involve a public offering. This warrant expired unexercised on December 31, 2003.

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PRICE RANGE OF COMMON STOCK

Our Common Stock

Our common stock commenced trading on the Nasdaq National Market on March 12, 2004 under the symbol “ZILG.” Previously, our common stock traded on the Over-the-Counter Bulletin Board. For the period between May 13, 2002, the effective date of our plan of reorganization, and May 16, 2002, our common stock was quoted through the Pink Sheets Electronic Quotation Service. Between January 1, 2001 and May 13, 2002, there was no market for our common stock. The following table sets forth the high and low last trading prices by quarter on the Over-the-Counter Bulletin Board or the Nasdaq National Market (as adjusted to give effect to our reverse stock split), as applicable.

EQUITY COMPENSATION PLAN INFORMATION

The following is a summary of the shares reserved for issuance pursuant to outstanding options, rights or warrants granted under our equity compensation plans as of December 31, 2003:

See Note 17 to the consolidated financial statements for a discussion of related party transactions.

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As of December 31, 2003, we had approximately 750 holders of record of our common stock, including holders of our restricted shares of common stock granted under the 2002 Omnibus Stock Incentive Plan. We have not paid any dividends and currently intend to retain any future earnings for investment in our business. We may be restricted from paying any cash dividends on our common stock by the terms of the agreement governing our senior secured revolving credit facility, as described under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

You should read the following selected consolidated financial data set forth below in conjunction with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the notes to those statements appearing elsewhere in this Form 10-K. The consolidated statement of operations data for the year ended December 31, 2003, the eight months and four months ended December 31, 2002 and April 30, 2002, respectively, and for the year ended December 31, 2001 and the consolidated balance sheet data as of December 31, 2003 and 2002 are derived from our respective consolidated financial statements included elsewhere in this Form 10-K which have been audited by KPMG LLP, independent auditors. KPMG LLP’s report on our December 31, 2003 consolidated financial statements contains two explanatory paragraphs. The first paragraph relates to the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” and the second paragraph refers to the adoption of “fresh-start” reporting in accordance with Statement of Position 90-7 “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” The consolidated balance sheet data as of December 31, 2001 are derived from financial statements not included herein which have been audited by KPMG LLP, independent auditors. The consolidated statement of operations data for the years ended December 31, 2000 and 1999 and the consolidated balance sheet data as of December 31, 2000 and 1999 are derived from our respective consolidated financial statements not included herein which have been audited by Ernst & Young LLP, independent auditors.

Upon emergence from Chapter 11 proceedings, we adopted fresh-start reporting in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, “Financial Reporting By Entities in Reorganization Under the Bankruptcy Code,” or SOP 90-7. In connection with the adoption of fresh-start reporting, our reorganization value has been allocated to our assets and liabilities on a basis which is substantially consistent with the purchase method of accounting. Our financial statements for periods subsequent to adoption of fresh-start reporting are not comparable with those prepared before our plan was confirmed because they are, in effect, those of a new entity. Consequently, the consolidated balance sheet data at December 31, 2003, December 31, 2002 and at May 1, 2002 is labeled “Successor Company,” and reflects the effect of our reorganization plan and the associated fresh-start adjustments. Periods presented prior to May 1, 2002 have been designated “Predecessor Company.” Note 3 to our consolidated financial statements, included elsewhere in this Form 10-K, provides a reconciliation of the Predecessor Company’s consolidated balance sheet from April 30, 2002 to that of the Successor Company on May 1, 2002.

Although our plan of reorganization became effective on May 13, 2002, for financial reporting purposes, the effective date of our plan of reorganization is considered to be April 30, 2002.

A black line has been drawn between the accompanying financial statements to distinguish for accounting purposes between the Successor Company and the Predecessor Company.

We have included in-process research and development and goodwill amortization within “research and development” and “special charges and reorganization items,” respectively, of the Predecessor Company statements of operations, whereas these items are each disclosed separately in the Successor Company’s consolidated statement of operations data. The 2002 Consolidated Statement of Operations has been combined as a matter of convenience. The combined results are not meant to be a presentation in accordance with generally accepted accounting principles due to the change in basis resulting from the completion of the reorganization plan and the application of fresh-start accounting during the period.

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Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth in the section entitled “Risk Factors” and in other sections of this Form 10-K.

The following is management’s discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the years ended December 31, 2003, 2002 and 2001. This discussion and analysis should be read in conjunction with the section entitled “Selected Consolidated Financial Data” and the consolidated financial statements and notes thereto included elsewhere herein. Management’s discussion and analysis provides information concerning our business environment, consolidated results of operations and liquidity and capital resources.

We prepare and release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles or GAAP. We also disclose and discuss EBITDA as a measure of liquidity in our filings with the Securities and Exchange Commission, earnings releases and investor conference calls. We believe the disclosure of such information helps investors more meaningfully evaluate the results of our ongoing operations. However, we recommend that investors carefully review the GAAP financial information included as part of our Quarterly Reports on Form 10-Q, our Annual Reports on Form 10-K, and our quarterly earnings releases, compare GAAP financial information with the pro forma financial results disclosed in our quarterly earnings releases and investor calls, and read the associated reconciliation.

Our interim results are based on fiscal quarters of thirteen weeks in duration ending on the last Sunday of each calendar quarter. However, for ease of reading our financial reports, we have labeled our interim fiscal periods as ending on calendar month-end. The operating results for any interim period are not necessarily indicative of results for any subsequent period or the full year, which ends on December 31 of each year.

Overview

Founded in 1974, we are a global supplier of 8-bit micrologic semiconductor devices. We design, develop, manufacture and market various families of devices in this market segment. Using proprietary technology that we have developed over our 30-year operating history, we provide semiconductor integrated circuit devices that our customers design into their end products. Our devices often include related application software and typically combine a microprocessor with memory and various peripheral functions on a single device. Our products enable a broad range of consumer and industrial electronics manufacturers to control the functions and performance of their products. For example, some typical applications include devices that control the speed of a motor, infrared remote controls, security systems and battery chargers. In addition to our micrologic devices, we sell other integrated circuit devices that have a wide variety of uses including the processing and transmission of information for communications and consumer electronics products. These devices include serial communication controllers, modems, IrDA transceivers, television display controllers and personal computer peripheral controllers. Historically we have also performed wafer fabrication foundry services for third parties.

Prior to February 1998, our common stock had been publicly traded on the New York Stock Exchange. On February 27, 1998, we consummated a leveraged merger with an affiliate of Texas Pacific Group. In connection with that transaction we issued $280 million of our former 9 ¹/2% Senior Secured Notes due 2005 that required us to make semi-annual interest payments of $13.3 million, and we ceased having publicly traded equity securities. During the period that we were controlled by Texas Pacific Group a new management team was appointed that implemented a series of restructuring and other actions, including:

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2002 Financial Restructuring and Reorganization

Commencing in 2000, our business and financial growth had been negatively affected by the extremely difficult business climate brought on by the downturn in the technology industry generally and the cyclical downturn in the semiconductor industry. We explored a number of strategic alternatives with the assistance of our financial advisor, Lazard Frères & Co., LLC, and an informal group of holders of our senior notes. We concluded that the best vehicle to achieve a restructuring of our senior notes was through consummation of a voluntary pre-packaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code. On January 28, 2002, we commenced solicitation of acceptances of a joint plan of reorganization, which set forth a plan to reorganize our company and our subsidiary, ZiLOG-MOD III, Inc.

On February 28, 2002, we and our subsidiary, ZiLOG-MOD III, Inc., which we call MOD III, Inc., filed voluntary petitions with the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11. The bankruptcy court subsequently confirmed MOD III, Inc.’s and our joint reorganization plan by its order entered on April 30, 2002. The joint plan of reorganization became effective on May 13, 2002, but for financial reporting purposes we use May 1, 2002, as the date of emergence from bankruptcy. We refer to the company prior to emergence from bankruptcy as the “Predecessor Company” and to the reorganized company as the “Successor Company.”

Pursuant to the joint reorganization plan, we extinguished $325.7 million of liabilities, which included $280.0 million principal amount of our former 9 ¹/2% Senior Secured Notes due 2005, $27.2 million in accrued interest due on the notes and $18.5 million of dividends payable on our former series A preferred stock. The former noteholders received substantially all of our new common stock and a liquidation preference in the net proceeds on the sale of the assets held by MOD III, Inc. On May 1, 2002, we adopted “fresh-start” reporting proscribed by the American Institute of Certified Public Accountant’s Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” and on that date the Predecessor Company recorded a $205.7 million net gain on discharge of debt.

Please see additional detailed information regarding our reorganization in 2002 and our implementation of fresh start reporting pursuant to Statement of Position 90-7 under the captions “2002 Financial Restructuring and Reorganization” and “Critical Accounting Policies” later in our Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Like many companies in our industry, during the fourth quarter of 2000 we began to experience declining sales and this trend of depressed sales has persisted into 2003. During the first half of 2001 our previous CEO resigned and our current CEO, Jim Thorburn, was brought in to refocus our operations and product portfolio to

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return us to profitability. Under the leadership of Jim Thorburn, we implemented a three-phase turnaround plan with the objective of establishing and maintaining financial stability, reclaiming the Company’s markets and customers and investing in innovative products.

Stock Repurchase Program

On April 17, 2003, our Board of Directors approved a stock repurchase program authorizing the repurchase of up to 500,000 shares of our common stock. Purchases under the program may be made, from time-to-time, in the open market, through block trades or otherwise. Depending upon market conditions and other factors, these purchases may be commenced or suspended at any time or from time-to-time without prior notice by the Company.

On May 1, 2003, we repurchased 125,000 shares at $4.00 per share on the open market, which resulted in a net cash expenditure of $0.5 million. On May 30, 2003, our Board approved the repurchase of 50,000 shares from Michael D. Burger, our President, at a purchase price of $6.50 per share, which was the closing price on the Over-the-Counter Bulletin Board on the date of repurchase, net of the repayment of certain loans to Mr. Burger that were secured against the restricted stock. The net cash paid to repurchase these shares was approximately $664,000. As of December 31, 2003, the Company had repurchased an additional 203,250 shares of restricted common stock from former employees for approximately $571,000, which is net of repayment of the balance of the outstanding loan made by the Company to these former employees. In connection with the above repurchases of shares from employees and former employees, the Company retired approximately $684,000 of employee loans receivable. Additionally, during the third quarter, the Company repurchased 4,413 shares of common stock resulting from employee stock option exercises for approximately $34,000. All of these shares are reflected in the financial statements of the Company as treasury stock as of December 31, 2003. In February 2004, we repurchased 45,000 shares from a former employee for cash, net of loan repayment, of approximately $63,000. There were no repurchases of common stock during the eight-month period ending December 31, 2002.

Critical Accounting Policies and Estimates

We believe our critical accounting policies are as follows:

A brief description of each of these policies is set forth below.

On an on-going basis, we evaluate our estimates, including those related to sales returns, allowance for doubtful accounts, inventory write-downs and asset impairments. We base our estimates on historical trends and various other assumptions that we believe to be reasonable at the time the estimates are made. Actual results could differ from those estimates.

Fresh-Start Reporting

Upon emerging from Chapter 11 proceedings, we adopted fresh-start reporting in accordance with SOP 90-7. Accordingly, for financial reporting purposes, we valued our assets and liabilities at fair value. With the assistance of our independent financial advisor, Lazard Frères & Co., LLC, and in reliance upon various valuation methods, and other applicable ratios and economic industry information relevant to our industry and

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through negotiations with various creditor parties in interest, we estimated our equity value to be $90.0 million as of May 13, 2002. This estimate of equity value was derived from a weighted average of three separate valuations methodologies: the first based on a comparable public company analysis; the second based on precedent transaction analysis; and the third based on a discounted cash flow analysis. For the purposes of the comparable public company analysis, Lazard analyzed the trading multiples of numerous public companies in the semiconductor industry, including Semtech, Globespan and Mitel, amongst others as at May 13, 2002. The comparable public company analysis yielded a valuation range of $70-$87 million; Lazard weighted this analysis 35% in its estimated valuation. The precedent transaction analysis yielded a valuation range of $88-$109 million; Lazard weighted this analysis 30% in its estimated valuation. The discounted cash flow analysis yielded a valuation range of $82-$106 million. In determining the discounted cash flow valuation range, Lazard considered three years of financial projections based on management’s best estimates at the time, with terminal values ranging from six to eight times the final year’s cash flow, and utilizing a discount factor of 28%. Lazard weighted this analysis 35% in its estimated valuation. These valuations were based on the underlying assumptions and limitations set forth in their report. These assumptions include: the successful reorganization of our business and finances in a timely manner; the implementation of our business plan as a reorganized entity; the accuracy of information supplied by management about our cash flow projections; achievement of forecasted projections; market conditions as of December 31, 2001 continuing through an assumed effective date of March 31, 2002; and the plan of reorganization becoming effective in accordance with the estimates and assumptions upon which the valuation was based.

In connection with the overall revaluation of our assets and liabilities under fresh-start reporting, described above, we recorded a gain of $83.7 million. The increases in the carrying value of our intangible assets were based on three valuation approaches, depending on the specific intangible asset to be valued: the income approach, the cost approach and the market approach. The increases in carrying value of our tangible assets were based on physical inspections and written appraisals that included market data and cost approaches. Results would have varied under different assumptions or conditions.

Estimating Sales Returns and Allowances

Our net sales to OEM customers consist of gross product sales reduced by expected future sales returns and allowances. To estimate sales returns and price allowances, we analyze historical returns and allowance activity to establish a baseline reserve level. We then evaluate whether there are any underlying product quality or other customer specific issues that require additional specific reserves above the baseline level. Because the reserve for sales returns and allowances is based on our judgments and estimates, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net sales and accounts receivable could be adversely affected.

Our net sales to distributors that have rights of return and/or price protection allowances on unsold merchandise held by them are deferred until such products are resold by the distributors to end users of our devices. At the time that we recognize distributor sales as revenue, we record a reserve for estimated price adjustments that the distributors will reclaim from us on the merchandise they resold to end users. These reserves are recorded as a reduction to our net sales and a reduction to our accounts receivable. To estimate this distributor price adjustment reserve, we analyze our historical price adjustment payments and pending price adjustments that have been authorized by us but have not yet been claimed by our distributors. Because our distributor allowance reserve is based upon our judgments and estimates, such reserves may not be adequate to cover actual distributor price allowances. If our reserves are not adequate, our net sales and accounts receivable could be adversely affected.

Estimating Allowance for Doubtful Accounts

We maintain an allowance for losses we may incur as a result of our customers’ inability to make required payments. Any increase in the allowance results in a corresponding increase in our selling, general and administrative expenses. In establishing this allowance, and then evaluating the adequacy of the allowance for doubtful accounts, we consider the aging of our accounts receivable, historical bad debts, customer concentrations,

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customer credit-worthiness and, to a lesser extent, current economic trends and changes in our customer payment terms. Historically, we have not experienced material bad debt write-offs. If the financial condition of one or more of our customers unexpectedly deteriorates, resulting in their inability to make payments, or if we otherwise underestimate the losses we incur as a result of our customers’ inability to pay us, we could be required to increase our allowance for doubtful accounts which could adversely affect our operating results.

Estimating Write-Downs of Excess and Obsolete Inventories

Each inventory component is assessed for excess or obsolescence by using an algorithm that we established. This algorithm is based on historical trends, demand forecasts and inventory age. We review the result of this algorithm and generally write-off all work-in-process inventory more than one year old and finished goods inventory quantities in excess of our current backlog. Write-offs of excess and obsolete inventories are reflected as a reduction to inventory values in the accompanying consolidated balance sheets, and an increase in cost of sales. If actual market conditions or customer demand patterns are less favorable than, or inconsistent with our assumptions, we may be required to take further write-downs of our inventory value, which could adversely impact our cost of sales and operating results.

Asset Impairments

We apply the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, and the undiscounted cash flows estimated to be generated by those assets are less than the asset’s carrying value, the carrying value of the assets are reduced to their estimated fair value. The estimated fair value is usually determined based on an estimate of future discounted cash flows. Asset impairments are recorded as a reduction in the asset value in our consolidated balance sheets and as special charges in our consolidated statements of operations.

The intangible assets created by the adoption of fresh-start accounting on our emergence from bankruptcy consist of existing technology and brand name, as well as excess enterprise value, or goodwill. The existing technology and brand name are being amortized based on a pattern-of-use method in proportion to the discounted cash flows from such assets. The goodwill is not subject to amortization.

We evaluate existing technology and brand name whenever events and circumstances indicate that their fair value may be less than their carrying value. Additionally, goodwill is tested for impairment at least annually and more often if events and circumstances indicate that its fair value may be less than its carrying value. We performed the annual impairment test for goodwill in the third quarter of 2003, and we plan to perform this test in the third quarter of each year unless the existence of triggering events indicates that an earlier review should be performed.

Adjustments to record impairment of long-lived assets or intangible assets could have a material adverse impact on our financial condition and results of operations in the period or periods in which such impairment is identified.

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Reporting Segments

Beginning in May 2002, we have consolidated our business segments into one reportable segment to reflect the manner in which our chief operating decision-maker allocates resources and assesses the performance of our business.

Period Comparisons

Our results of operations after May 1, 2002 and our consolidated balance sheets at December 31, 2003, December 31, 2002 and May 1, 2002 are not comparable to our results of operations prior to May 1, 2002 and our consolidated balance sheet at December 31, 2001, due to our adoption of “fresh-start” reporting upon our emergence from bankruptcy. Differences in our results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, interest expense and restructuring and reorganization expenses. Additionally, these differences in our balance sheets relate to inventory, in-process research and development, property, plant and equipment, intangible assets, conversion of senior notes to common stock, and minority interest. Certain figures, such as net sales and certain expenses were not affected by our adoption of fresh-start accounting and, accordingly, we believe them to be comparable. To provide a more meaningful analysis, in the following discussion we have compared combined results of our Predecessor and Successor Company’s operations for fiscal year 2002 to the Predecessor Company’s results for fiscal year 2001. Our combined results for 2002 are presented for convenience of annual comparison and are not meant to be a presentation in accordance with generally accepted accounting principles.

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Results of Operations

Our net sales by region, by channel, and by business line are summarized in dollars and as a percentage of total net sales for each period indicated, as follows (in millions):

During the past two years, we have implemented a series of business restructuring programs aimed at refocusing on our core 8-bit micrologic device portfolio. In connection with these actions, we have eliminated a significant amount of fixed costs from our business operations. Additionally, pursuant to our plan of reorganization, which became effective on May 13, 2002, we extinguished $280.0 million in principal value of our former 9 ¹/2% Senior Secured Notes due 2005, which required $13.3 million in interest payments each March 15 and September 15.

Other key indices relevant in understanding our business and financial performance include the following metrics:

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We calculate each of these key metrics based on annual results of operations data and balance sheet data as of the end of the period indicated. Each of these key metrics is described below:

Days sales outstanding, DSO, is a common metric used to analyze how quickly our customers pay us. This metric is influenced largely by the timing of our customer billings and collections. For instance, at December 31, 2003 our DSO was 46 days which is higher than our historical levels. This reflects strong customer billings from several large OEMs during the month of December 2003 and a resulting increase in accounts receivable at year end. During 2001 and 2002 our net sales were generally declining on a sequential basis which contributed to our relatively low DSO figures at the end of those years.

Net sales to inventory ratio is a metric we use to analyze how quickly our investment in inventories is recovered by our sales. This metric may not be comparable to those other companies use to analyze inventory and is not the same as a typical inventory turns ratio. Our net sales to inventory ratio increased from 2001 to 2002 because we decreased our inventory levels more rapidly that our revenues declined. Our net sales to inventory ratio declined from 2002 to 2003 because our revenues declined more rapidly than our inventory levels over that period of time.

Weeks of inventory at distributors measures how quickly our distributors sell the inventories that we sell to them. During December 2003, our shipments to distributors increased from the prior year due to increased demand from such distributors which accounts for the increase in this metric at December 31, 2003. We do not recognize revenue on shipments to distributors until our distributors resell our products to end users.

Current ratio represents current assets divided by current liabilities and is commonly used to assess a company’s liquidity. The Company uses this ratio to make spending determinations on discretionary items.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Net Sales

Beginning in 2000 we experienced a trend of reduced demand for many of our products that has in certain market areas continued through the year ended December 31, 2003. During this time, we refocused our business on our core 8-bit micrologic portfolio of devices, and de-emphasized certain product offerings in our other devices business line and introduced new products including the Z8 Encore! and eZ80Acclaim!

Revenue from product sales to OEM customers is recognized upon title transfer, which generally occurs upon shipment, net of appropriate allowances for returns and warranty costs that are recorded at the time revenue is recognized. The Company recognizes revenue on sales to distributors who have rights of return and price protection on unsold merchandise held by them when products are resold by the distributors to end-users.

Net sales were $103.6 million in 2003 representing a decrease of 25.8% from net sales of $139.6 million in 2002. This decrease in net sales reflects lower unit shipments for both our micrologic and other devices business lines. The net sales decline for our micrologic devices business line in 2003 compared to 2002 reflects overall lower market demand partially as a result of our customers moving from our older Z80 and Z8 device applications to alternative technologies provided by our competitors, primarily microcontroller products with embedded flash technology. In November 2002 and February 2003, we released our new Z8 Encore! and eZ80Acclaim! products, respectively, that are focused on the market for flash-based microcontrollers, with a strategy of recapturing sales to these customers and entering new markets. Due in part to the length of the cycle from design win to production revenue we have not had and do not expect to have significant sales of these products until the second half of 2004.

Net sales of our other devices totaled $24.5 million in 2003, a decrease of $16.9 million or 40.8% from $41.4 million in 2002. This decrease primarily reflects:

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Net sales from our foundry services for the year ended December 31, 2003 increased by $3.2 million or 40.5% to $11.1 million as compared to the same period of 2002. Despite the increase in net sales from foundry services in 2003 compared to 2002, we are not investing in this business and we expect sales from foundry services to be minimal in the future.

Gross Margin

Our cost of sales primarily represents the cost of producing our products, including wafer fabrication, assembly and test expenditures. Cost of sales fluctuates, depending on materials and services prices from our vendors, manufacturing efficiency and productivity, product mix, equipment utilization and depreciation. Gross margin as a percent of net sales increased to 46.7% in 2003, up from 41.8% in the same period of 2002. This improvement in our gross margin percentage during 2003 reflects a $3.9 million charge for amortization of fresh-start reporting inventory adjustments during 2002. (See Note 3, “Fresh-Start Reporting,” in Notes to Consolidated Financial Statements in our 2002 Annual Report filed on Form 10-K.) Although our “gross margin as adjusted” is a non-GAAP measure, we believe it is meaningful to investors as excluding the bankruptcy-related inventory adjustment provides a more accurate reflection of comparable performance. Exclusive of this one-time amortization charge, our gross margin as adjusted was 44.6% of net sales for 2002.

We have improved our gross margin compared to the gross margin as adjusted in 2002, even though lower revenue has resulted in lower wafer production needs. The improvement in gross margin in 2003 as compared to 2002 is a result of improved production yields as well as lower manufacturing costs on a per unit basis driven by our focus on consolidating and streamlining our manufacturing activities with a continued emphasis on outsourcing wafer manufacturing activities. For example, we have continued to reduce our headcount in manufacturing activities as demand has fluctuated with reductions at our wafer manufacturing facility in Nampa, Idaho in February 2003 and in our Manila, Philippines facility in September 2003. Our gross margin was also improved by outsourcing our wafer requirements for 0.35-micron technologies to our foundry suppliers in Taiwan, including our new embedded flash-based Z8 Encore! and eZ80Acclaim! devices. Additionally, we have continued to multi-source our product assembly activities with several Asian suppliers to enhance our supply source flexibility and obtain favorable vendor pricing.

Research and Development Expenses

Research and development expenses were $18.0 million for the year ended December 31, 2003, reflecting a 0.6% increase from the $17.9 million of research and development expenses for the same period in 2002. Our research and development efforts in both 2002 and 2003 were, and will continue to be, primarily directed towards development of core micrologic devices and tool support, including our Z8 Encore! and eZ80Acclaim! families of 8-bit embedded-flash micrologic devices and our Crimzon consumer solutions family of products.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased to $27.6 million for the year ended December 31, 2003 from $33.4 million for the same period in 2002, or a 17.4% decline. This decrease was due to lower payroll-related costs as a result of lower headcount, a decline of stock-based compensation expense and reduced sales commissions as a result of the lower sales levels.

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Special Charges

Special charges for each period indicated were as follows (in millions):

The following table details special charge accrual activity and ending accrual balances for the years ended December 31, 2003 and 2002 (in millions):