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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Period Ended June 30, 2004

or

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

For The Transition Period from                                  to                                 

Commission File Number 0-15449

CALIFORNIA MICRO DEVICES CORPORATION

(Exact name of registrant as specified in its charter)

(408) 263-3214

(Registrant’s telephone number, including area code)

Not applicable

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

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

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

Applicable Only to Corporate Issuers

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

The number of shares of the registrant’s Common Stock outstanding as of July 31, 2004 was 21,451,811.

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California Micro Devices Corporation

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

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

California Micro Devices Corporation

CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See Notes to Financial Statements.

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California Micro Devices Corporation

CONDENSED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

(1) Derived from audited financial statements

See Notes to Financial Statements.

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California Micro Devices Corporation

CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See Notes to Financial Statements.

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California Micro Devices Corporation

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

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

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

2. Use of Estimates

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

3. Stock-Based Compensation

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

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

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

4. Net Income (Loss) Per Share

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

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Options to purchase 166,615 and 2,922,716 shares of common stock were outstanding during the three months ended June 30, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares during the three months ended June 30, 2004, and because we had a loss for the three months ended June 30, 2003, and, therefore, the effect would have been antidilutive. Warrants to purchase 483,667 shares of common stock outstanding during the three months ended June 30, 2003, were not included in the diluted earnings per share computation, because we had a loss for that period and, therefore, the effect would have been antidilutive.

5. Inventories

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

6. Litigation

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

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

7. Comprehensive Income (Loss)

Comprehensive income (loss) is principally comprised of net income (loss) and unrealized gains or losses on our available-for-sale securities. We reported an unrealized loss of $1,000 on available-for-sale securities at June 30, 2004, and as a result our comprehensive income for the three months ended June 30, 2004 was $1,957,000. Comprehensive loss for the three months ended June 30, 2003 was $1,220,000 and equaled net loss.

8. Income Taxes

For the three-month period ended June 30, 2004 we recorded an income tax provision of $61,000 for federal and state income taxes. Our effective tax rate benefited from our ability to utilize loss carry forwards and other credits; however, the benefit was limited by alternative minimum tax provisions. For the three-month period ended June 30, 2003, there was no income tax provision due to a net loss for the period.

9. Long-term Debt

In June 2002, we entered into a Loan and Security Agreement (“Agreement”) with Silicon Valley Bank that allowed us to borrow up to a total of $5.0 million under an equipment line of credit and a revolving line of credit. The amount available under the Agreement is based on the amount of eligible equipment and accounts receivable. Under the Agreement, which includes a subjective acceleration clause related to liquidity, we are subject to certain financial covenants and restrictions and were required to maintain a compensating balance of $2.75 million with the bank in order to maintain our borrowing capability. The financial covenants relate to a required monthly minimum quick ratio and quarterly tangible net worth. Borrowings under the equipment line and the revolving line bear interest at an annual rate of prime plus 3.0% and prime plus 0.75%, respectively. As of June 30, 2004 and March 31, 2004, the equipment line of credit rate was 7.0%. Principal, in equal installments, and interest are due monthly for the term of 36 months for all borrowings made under the equipment line. Borrowings under the revolving credit line have a term of 12 months, with principal due at maturity and interest due in monthly installments. Borrowings under both lines are collateralized by substantially all of our assets. We were in not compliance with the tangible net worth ratio under our Agreement as of March 31, 2003. The Bank subsequently provided a waiver to the March 31, 2003 covenants, modified the future covenants and extended the term of the agreement to July 31, 2004. On June 26, 2003, the bank agreed to further modify the loan agreement such that if we fail in the future to comply with either of the financial covenants defined in the agreement, as amended, the credit facilities would convert to an asset based lending facility. In January 2004, we entered into an Amended and Restated Loan and Security Agreement, which increased our credit facility to include a term loan that we used to refinance our Industrial Revenue Bonds.

On May 4, 2004, we used $6.6 million of the $18.0 million net proceeds from our May 3, 2004 public offering to repay our debt with Silicon Valley Bank. In the first quarter of fiscal 2005 we took a charge of $123,000 associated with the debt repayment.

In March 2001, we entered into an equipment financing agreement with Epic Funding Corporation which allowed us to finance $975,000 of equipment over a term of 4 years with interest at 9.6% payable in 48 installments of approximately $25,000 per month. The total outstanding obligation as of June 30, 2004 was approximately $213,000.

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During fiscal 2003, we entered into capital leases to finance some equipment purchases. The total capital lease obligations were $43,000 as of June 30, 2004, due in monthly installments with interest rates ranging from 10.4% to 12.6%. Fixed assets purchased under capital leases and the associated accumulated depreciation were not material as of June 30, 2004 and March 31, 2004.

10. Short-term Investments

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

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

During the three months ended June 30, 2004, a net unrealized holding loss of $1,000 has been included in accumulated other comprehensive income (loss). There were no gains or losses reclassified out of accumulated other comprehensive income (loss) into earnings for the period. During the three months ended June 30, 2003, we did not have any short-term investments and so there were no unrealized holding gains or losses for that period.

All available-for-sale securities have contractual maturities of 90 days or less.

11. Recent Accounting Pronouncements

In December 2003, the FASB issued FIN 46R, “Consolidation of Variable Interest Entities”. FIN 46R requires us to consolidate a variable interest entity if we are subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. Application of this Interpretation is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities (other than small business issuers) for all other types of entities is required in financial statements for periods ending after March 15, 2004. We currently have no contractual relationships or other business relationships with variable interest entities and do not have any such plans, and therefore our adoption of the interpretive guidance in FIN 46R had no effect on our financial position, results of operations or cash flows.

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

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12. Major Customers

Major customers were as follows:

13. Stock Issuances

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

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

Also during the three months ended June 30, 2004, we issued 96,881 shares of common stock under our employee stock option and employee stock purchase plans, resulting in total proceeds of approximately $615,000.

14. Infrastructure Alignment Plan

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

15. Contingencies

Environmental

During fiscal 2003, we closed our Milpitas wafer fabrication facility. As part of the closure process, we retained a state-licensed environmental contractor familiar with this type of semiconductor manufacturing facility to prepare and implement a site closure plan and a site health and safety plan (HASP) to remove, decontaminate as necessary, and dispose of equipment and materials using approved methods and to work with the appropriate agencies to obtain certifications of closure. Upon inspection of the facility by the County of Santa Clara, one of four soil samples obtained by drilling through the floor in one room detected an elevated level of nickel. The County referred the matter to the California Department of Toxic Substances Control (“DTSC”), which in a June 23, 2003, letter requested that the Company conduct further soil and ground water investigation to assess the nature and extent of the contamination at the site from nickel and other substances. We entered into an agreement with the DTSC on February 26, 2004, and we have submitted a Preliminary Endangerment Assessment (“PEA”) work plan that we will be working with the DTSC to finalize in response to DTSC comments. The results of the PEA will determine whether further investigation and remediation, if any, will be required. The cost of any required remediation will depend upon the nature and extent of contamination that is ultimately found and any risks posed by such contamination. In addition, our Tempe, Arizona facility is located in an area of known groundwater contamination.

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

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

Forward-Looking Statements

This discussion and report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates, and projections about our industry; our beliefs and assumptions; and our goals and objectives. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” and “estimates,” and variations of these words and similar expressions are intended to identify forward-looking statements. Examples of the kinds of forward-looking statements in this report include statements regarding the following: (1) our expectation as to future levels of gross margin; (2) our expectation that we will have substantially lower sales of end of life products and that we will not have material further sales of lighting products; (3) our expectation as to future levels of research and development expenses and selling, general and administrative expenses; (4) our expectation about our fiscal 2005 income tax rate; and (5) our anticipation that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs over the next 12 months. These statements are only predictions, are not guarantees of future performance, and are subject to risks, uncertainties, and other factors, some of which are beyond our control, are difficult to predict, and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, our expectation that customers will not change their minds and order end-of life products remaining in our inventory but which we have already written off; whether we will decide to invest differently in research and development or sales and marketing due to market conditions, technology discoveries, or other circumstances; whether we will incur unexpected internal control expenses due to the results of our Sarbanes-Oxley Section 404 audit; whether our product mix changes, our unit volume decreases materially, we experience price erosion due to competitive pressures, or our contract manufacturers and assemblers raise their prices to us or we experience lower yields from them; whether there will be any changes in tax accounting rules; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under the caption “Risk Factors and Other Factors That Could Affect Future Results” at the end of this discussion in this under Item 2. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

Overview

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

During the past three years, we have streamlined our operations and become fabless for the semiconductor products that we supply to our customers in our core markets, using independent providers of wafer fabrication services. This decision to use independent foundries led us to close our fabrication facility in Milpitas, California and consolidate our thin film manufacturing activities in Tempe, Arizona.

During the past several years, we have also focused our marketing and sales on strategic customers in our three core markets. As a part of this process, we have reduced the number of our actively marketed products from approximately 5,000 to

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approximately 500 while at the same time increasing our unit shipments from less than 25 million in the quarter ended March 31, 2001 to more than 108 million in the quarter ended June 30, 2004.

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

We also manufacture a limited number of thin film products in our Tempe, Arizona fabrication facility, which we sell primarily to Guidant for use in implantable defibrillators and pacemakers.

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

Results of Operations

Net sales. Net sales for the three-month period ended June 30, 2004 were $16.5 million, an increase of $4.6 million or 38% from the three-month period ended June 30, 2003. As shown in the table below, our Mobile products represented the largest component of this increase.

* Other products includes lighting, communications, legacy and mature products

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

The growth in the Medical business is primarily the result of improved pricing from our primary medical products customer, Guidant.

Computing and Digital Consumer sales were approximately flat primarily due to soft demand for notebook and desktop computers and a decline in sales of certain older products.

Our sales from Other products declined during the three-month period ended June 30, 2004 compared to 2003. We had expected a decrease in sales of our communications, legacy and mature products, as during the earlier year period we provided our customers for many of these products with end of life purchase opportunities. We completed shipment of most end of life product orders during fiscal 2004 and expect to recognize substantially lower sales of these products after the second quarter of fiscal 2005. In addition, price increases for our lighting products and other factors resulted in a substantial reduction in orders for our lighting products, and we do not expect further sales of lighting products to be significant.

Units shipped during the three-month period ended June 30, 2004 increased to approximately 108 million units, up from approximately 55 million units for the three-month period ended June 30, 2003. Our increased net sales resulted primarily from larger unit sales, due in part from increased sales of current products and in part from sales of newly introduced products, and to a lesser extent, from price increases effective July 1, 2003, on our medical products. Our average unit price decreased by approximately 24% during the three-month period ended June 30, 2004 compared to the three-month period ended June 30,

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2003. This decrease was predominately the result of faster growth in our lower priced products, which offset our medical product price increases.

Major customers were as follows:

Cost of Sales, Gross Margin and Expenses

The table below shows our net sales, cost of sales, gross margin and expenses, both in dollars and as a percentage of net sales, for the three-month periods ended June 30, 2004 and 2003.

Cost of Sales. During fiscal 2004, we completed implementing a strategy to satisfy the production requirements for products in our core markets from external foundries, which we used to manufacture in our own factory. As a result of outsourcing wafer fabrication, we converted our Tempe manufacturing operations to a dedicated thin film facility and reduced our manufacturing costs at that facility. During the three months ended June 30, 2004 we took action to further reduce spending at our Tempe facility in anticipation of lower medical product sales in future quarters. Our thin film products are primarily medical products plus a portion of our mature products, which are shown in the “Other products” category in the net sales discussion.

Cost of sales increased by approximately $700,000 for the three-month period ended June 30, 2004 compared to the three-month period ended June 30, 2003 primarily due to the following reasons:

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The increase in net sales from $11.9 million to $16.5 million directly resulted in an increase in costs of $1.9 million. The reduction in manufacturing spending was primarily due to the realignment of and reduction in spending at our Tempe wafer fabrication facility. The reduction in inventory reserve provisions was due to our having written down end-of-life inventories during the first quarter of fiscal 2004 when we issued an end-of-life notice to our customers for a group of products that we were phasing out.

We have, during recent quarters, benefited from the sale of previously reserved inventory due primarily to the large number of products for which we have discontinued future support by placing them in an ‘end of life’ category. These products have been primarily sold through our distributors to an erratic and unpredictable demand by end customers. As a result, we have experienced the actual sale of some products previously reserved and the requirement to further write-down certain other products for which we had expected to receive orders, and did not. The benefit related to sales of previously reserved inventory was approximately $200,000 and $300,000 for the three-month periods ended June 30, 2004 and June 30, 2003, respectively.

Gross Margin. Gross margin is comprised of net sales less cost of sales. The gross margin dollar increase during the three months ended June 30, 2004 compared to the three months ended June 30, 2003 was primarily the result of increased sales volumes, a significant price increase for our medical products and a reduction in manufacturing spending variances. The gross margin percentage increase was primarily the result of increased sales volumes that led to economies of scale in our manufacturing operations, a significant price increase for our medical products and a reduction in manufacturing spending. In future periods, we expect our gross margin to be approximately 40% of net sales, subject to normal quarterly variations. The gross margin percent in future periods may deviate substantially from our expectations due to changes in volume, pricing, product mix, manufacturing costs and manufacturing yields.

Research and Development. Research and development expenses consist primarily of compensation and related costs for employees, prototypes, masks and other expenses for the development of new products, process technology and new packages. The increase in research and development expenses for the three-month period ended June 30, 2004 compared to the same period in 2003 was primarily due to costs related to closing our Austin, Texas design center and accruals for our bonus plan. In the future we would expect to incur increased research and development expenses as sales increase, and we expect research and development to represent an average of 8% to 9% of sales in future periods; however, if our sales were to decline in future periods, research and development could represent more than 9% of sales.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of compensation and related costs for employees, sales commissions, marketing and promotional expenses, and legal and other professional fees. The increases in selling, general, and administrative expenses for the three-month period ended June 30, 2004 compared to the same period in 2003 were primarily due to increases in sales and marketing staffing, accruals for our bonus plan and higher product sample expenses. The percentage of net sales comprised by selling, general and administrative expenses decreased during the same period due to our increased net sales. These expenses are expected to increase in dollar terms in the future as sales increase, but at a slower rate than the growth in sales. As a result, we expect a gradual reduction in selling, general and administrative expenses as a percentage of sales in the future; however, if our sales were to decline in future periods, these expenses could increase as a percentage of sales.

Income Taxes. For the three-month period ended June 30, 2004 we recorded an income tax provision of $61,000 for federal and state income taxes. Our effective tax rate benefited from our ability to utilize loss carry forwards and other credits; however, the benefit was limited by alternative minimum tax provisions. For fiscal 2005 we currently expect our effective income tax rate to be 3% of profit before taxes. For the three-month period ended June 30, 2003 there was no income tax provision due to a net loss for the period.

Net Income. Largely for the reasons explained above, we realized a net income of approximately $2.0 million for the three-month period ended June 30, 2004, compared to a net loss of approximately $1.2 million for the three-month period ended June 30, 2003.

Recent Accounting Pronouncements

The adoption of recent accounting pronouncements as discussed in Note 11, “Recent Accounting Pronouncements”, has had no effect on our financial position or results of operations.

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Critical Accounting Policies and Estimates

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

With respect to revenue recognition, we make estimates in relation to sales returns and allowances, and in relation to bad debt. To estimate sales returns and allowances, we analyze recent sales returns trends and open return material authorizations to evaluate the likelihood of future returns of products that we have sold to our customers. Also, we consult with our sales, marketing and quality management personnel to identify any specific issues that may require a sales returns and allowances reserve provision. To estimate bad debt, we analyze our current aged accounts receivable to evaluate the likelihood of our not being able to collect payment from customers whose payments are overdue, and we identify any customers who we have become aware of are not likely to pay amounts owed to us. Our policy is to partially or fully reserve receivables that are 90 days old or more, while at the same time continuing efforts to collect payment from the customer.

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

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

With respect to litigation, we currently have several legal disputes at various stages. The potential exposure for these disputes is very uncertain. We regularly review the current status, probability and amounts of potential outcomes with our legal counsel to determine whether a liability should be adjusted as appropriate.

With respect to environmental issues, financial exposures are difficult to assess. We are currently in the evaluation phase of environmental mitigation for our former site in Milpitas, California and have consulted with our environmental legal counsel and environmental contractors to assess the facts to determine anticipated exposure. At this time we have accrued our estimated costs for the California Department of Toxic Substances Control (“DTSC”) oversight under the agreement we are negotiating and for our environmental engineering consultants to conduct the work called for in the Preliminary Endangerment Assessment plan we have proposed to the DTSC.

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

Liquidity and Capital Resources

We have historically financed our operations through a combination of debt and equity financing and cash generated from operations. Total cash, cash equivalents and short-term investments as of June 30, 2004 were $32.3 million compared to $20.3 million as of March 31, 2004. Receivables increased $2.7 million to $8.8 million as of June 30, 2004 compared to $6.1 million

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as of March 31, 2004, primarily as a result of increased sales. Receivables days sales outstanding were 48 and 35 days as of June 30, 2004 and March 31, 2004, respectively. Days sales outstanding were higher at June 30, 2004 due to a higher portion of our sales taking place later during the quarter. We expect days sales outstanding to range from 40 to 50 days in the future, depending on the linearity of our shipments. Inventories increased by approximately $500,000, offset by an inventory reserves increase of approximately $100,000, for a net increase of approximately $400,000, resulting in a net inventory balance of $6.9 million as of June 30, 2004 compared to $6.5 million as of March 31, 2004, as a result of higher manufacturing activity levels necessary to support our increased revenue. Accounts payable and other accrued liabilities were unchanged at $9.1 million as of June 30, 2004 and March 31, 2003.

Operating activities used approximately $300,000 in the three-month period ended June 30, 2004, which was an improvement from the use of $600,000 for the three-month period ended June 30, 2003. The improvement was primarily due to a swing to net income from a net loss and an increase in deferred margin on sales to distributors, offset by increases in accounts receivable and inventories.

Investing activities used $17.8 million of cash during the three-month period ended June 30, 2004, which was the result of purchasing $17.3 million of short-term investments and purchasing $500,000 of capital equipment.

Net cash provided by financing activities for the three-month period ended June 30, 2004 was $12.7 million and was the result of $18.0 net proceeds from our public offering common stock, $1.1 million of proceeds from the exercise of stock warrants and $615,000 of proceeds from sales of stock in employee stock compensation plans, offset by $7.0 million of repayment of long-term debt. The $7.0 million of debt repayment was comprised of $354,000 of regularly scheduled debt payments and a the early retirement of $6.6 million of debt to Silicon Valley Bank using proceeds from our May 2004 public stock offering.

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

In the future, it is possible that our liquidity could be impacted in order to resolve an environmental issue arising out of the closure of our Milpitas wafer fabrication facility. At present, we do not have a reasonable basis to assess the likelihood of potential future costs. As described in Note 15 of Notes to Condensed Financial Statements, we will be better positioned to evaluate whether we are reasonably likely to incur additional expenses to remediate the subject property once we obtain additional core samples and evaluate the risks associated with any contamination they may show.

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

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RISK FACTORS AND OTHER FACTORS THAT COULD AFFECT FUTURE RESULTS

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

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

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

Prior to achieving profitability in the second quarter of fiscal 2004, we had been unprofitable for ten consecutive quarters, incurring an average loss of $3.8 million per quarter and doubling our accumulated deficit from $31.3 million to $67.7 million. Many factors will affect our ability to sustain profitability including the health of the mobile, computing and digital consumer markets in which we focus, continued demand for our products by our key customers, lack of price erosion, availability of capacity from our manufacturing subcontractors, continued product innovation and design wins, and our continued ability to manage our operating expenses. The semiconductor industry has historically been cyclical, and we may be subject to such cyclicality, which could lead to our incurring losses again.

Our revenues could fall below cash breakeven causing us to cut our expenses to the detriment of our business.

We have restructured our company to better focus our business and to transition to a fabless model by outsourcing our manufacturing, except for our thin film products. We have taken these steps in an effort to reduce the level of revenues we need to generate to achieve operating cash flow breakeven and at the same time to increase our revenues in key markets. However, if our net sales do not continue to satisfy our cash needs, then we may have to cut additional expenses in order to conserve our cash, or raise additional financing, of which there can be no assurance of success. Even if we are successful in reducing our cash usage, we may raise additional equity financing to finance growth, for strategic acquisitions, and/or to provide us with cash reserves should we operate in a loss mode in the future.

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

Our sales strategy has been to focus on customers with large market shares in their respective markets. As a result, we have several large customers. During the quarter ended June 30, 2004, Motorola, a customer in the mobile market, and Guidant, a customer in the medical market, together represented approximately one-third of our net sales. Also, in the quarter ended June 30, 2004, Motorola represented more than 20% of our sales in the mobile market, with other large manufacturers becoming significant customers. If any of these major customers decides to reduce its purchase of our products or purchase some or all of its requirements for devices from other suppliers, or loses market share in its markets, our business would be adversely affected. There can be no assurance that these customers will continue to purchase our products in the quantities forecasted, or at all.

During the quarter ended June 30, 2004, one of our distributors, Epco Technology, represented 15% of our net sales. If we were to lose Epco as a distributor, we might not be able to obtain another distributor to represent us or a new distributor might not have the same relationships with the current end customers to maintain our current level of net sales. Additionally the time and resources involved with the changeover and training could have potentially adverse impacts on our business.

We currently rely heavily upon a few core markets for the bulk of our sales. If we are unable to further penetrate the mobile, computing and digital consumer markets, our revenues could stop growing and might decline. Additionally, our revenues may also decline if we are unable to maintain our current expected level of sales of medical devices.

The bulk of our revenues in recent periods has been, and is expected to continue to be, derived from sales to manufacturers of mobile, computing and digital consumer and medical devices. In order for us to be successful, we must continue to penetrate

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the mobile, computing and digital consumer markets, both by obtaining more business from our current customers and by obtaining new customers. In the near future, in order for us to achieve our revenue and profit goals, we must achieve our current expected level of sales of medical devices. Due to our narrow market focus, we are susceptible to materially lower revenues due to material adverse changes to one of these markets. For example, should the mobile phone demand in China prove to be a bubble, or should growth not occur in the markets we have penetrated the most, our future revenues would be adversely impacted.

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

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

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

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

Because we operate in different semiconductor product markets, we generally encounter different competitors in our various market areas. Competitors with respect to our integrated passive products include ON Semiconductor, Philips Electronics, Semtech and STMicroelectronics. Our integrated passive products also compete with discrete passives from competitors such as Murata, Samsung and Vishay. For our other semiconductor products, our competitors include Fairchild Semiconductor, Linear Technology, Maxim Integrated Products, Micrel, National Semiconductor, ON Semiconductor, RichTek, Semtech, STMicroelectronics and Texas Instruments. Many of our competitors are larger than we are, have substantially greater financial, technical, marketing, distribution and other resources than we do and have their own facilities for the production of semiconductor components.

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

We have in the past had deficiencies in certain of our internal control processes. We are vulnerable to difficulties as many of our recordkeeping processes are manual or involve software that has not been upgraded and for which we have no adequate backup if the software were to fail. We have also experienced in the past, high turnover in our finance department, due in part to the relocation of several functions from Tempe to Milpitas and the employees performing those functions being unwilling to relocate. While preparing our financial statements for the 2003 fiscal year, both our internal staff and prior outside accountants found errors in certain primary financial processes, which they corrected during such preparation. However, these errors caused inaccuracies in the fiscal 2003 interim results for the three, six and nine month periods that required these interim period results to be restated. As a result, our prior outside accountants informed us that they had noted a combination of reportable conditions that, taken together, constituted a material weakness in our internal controls. The material weakness included issues with our inventory costing systems and procedures, accounts payable cutoff, information systems user administration and finance organization. We have instituted additional processes and procedures to mitigate the conditions identified and to provide reasonable assurance that our internal control objectives are met. During fiscal 2004, we recruited an almost entirely new finance department and we have instituted back-up procedures for our manual processes as we automate them, although some key controls remain manual and are consequently inefficient. We have devoted substantial effort and resources to improving our internal controls, and in connection with our fiscal 2004 audit our current auditors (who were engaged on December 15, 2003, after our prior accountants had resigned on October 14, 2003) did not note and inform us of any reportable condition or material weakness as to our internal controls. We are continuing our efforts to improve and automate our financial processes and procedures; however, there can be no assurance that we will nonetheless have a material error in our financial statements.

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We are currently implementing enterprise resource planning software. Should we encounter schedule delays, our assessment of our internal control over financial reporting as of March 31, 2005, or that of our independent accountants, both of which will be contained in our fiscal 2005 report on Form 10-K, may indicate significant deficiencies or a material weakness in such internal control. Any such material weakness may need to be corrected before our outside accountants would be able to issue an audit report.

We are implementing enterprise resource planning (“ERP”) software, which is a costly and complex task requiring large amounts of internal personnel resources as well as consultants, significant management time and attention, and a great deal of training. It is not uncommon for companies implementing ERP software to encounter delays. We are relying on our ERP software to automate our inventory control and costing systems, and we are on a very tight schedule. Should we be delayed by more than a month or two, we will not have time to test our ERP software even if we are able to implement it prior to March 31, 2005. As a result, we would have to rely on our current system, which utilizes manual checks and balances, for inventory costing to avoid errors in our financial reporting of our year-end results, as we have done for the past five quarters. These checks and balances, while adequate in the past for such purposes, may lead us, or our outside accountants, to assess our internal control over financial reporting as having significant deficiencies. If we had other significant deficiencies as well, it is possible that we or our independent accountants assessing our internal control over financial reporting as part of our fiscal 2005 report on Form 10-K could determine that we have a material weakness in such control. Any such material weakness may need to be corrected before our outside accountants would be able to issue an audit report.

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

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

As our revenues become increasingly subject to macroeconomic cycles, they are more likely to decline if there is an economic downturn.

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

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

International sales for the past few years have accounted for approximately two-thirds of our total net sales. International sales include sales to a U.S. based customer if the product is delivered outside the United States. International sales may account for an increasing portion of our revenues, which would subject us to the following risks:

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

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

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

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

Given the current size of our business, we believe it is impractical for us to spread our use of foundry partners and assembly and test subcontractors over more than a few partners and subcontractors as it would lead to significant increases in our costs. Currently, in addition to our Tempe, Arizona thin film facility, we have only two foundry partners and rely on a small number of assembly and test subcontractors. Many of our products are sole sourced at one of our foundry partners near Shanghai, China or in Japan. Our intention is to add additional foundry partners to reduce our dependence and increase our flexibility, although no assurance can be given that we will be successful. One of our assembly steps is the “ball drop” process, which is a key step in the chip scale packaging used for the bulk of our mobile products. We currently use a single third party vendor for ball drop but plan to add a second source in the near term. There are only a limited number of suppliers of this service at this time. Furthermore, for many of our products, due to their relatively low volumes, we may still choose to rely on only one

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supplier for wafer fabrication, assembly and test. If the operations of one or more of our suppliers should be disrupted, or if they should choose not to devote capacity to our products in a timely manner, our business would be adversely impacted as we would be unable to manufacture some of our products on a timely basis. In addition, the cyclicality of the semiconductor industry has periodically resulted in shortages of wafer fabrication, assembly and test capacity and other disruption of supply. We may not be able to find sufficient suppliers at a reasonable price or at all if such disruptions occur. As a result, we face significant risks, including:

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

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

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

We currently operate our own thin film wafer manufacturing facility in Tempe, Arizona. Much of our equipment has been utilized for a long time, and can be subject to unscheduled downtime. Our Tempe, Arizona facility is the only fabrication facility in which we can run the thin film processes associated with our medical products. Any disruption at our Tempe, Arizona facility would preclude our manufacturing of our medical products, which would have a material adverse impact on our revenues and gross margin. Other significant risks associated with our wafer manufacturing include:

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Our Tempe, Arizona facility is used only for thin film products, which are sold primarily to Guidant. Should a drop in Guidant’s demand or the demand for our other thin film products result in lower sales of our thin film products, it would become uneconomic for us to continue to run this facility.

As we only manufacture a limited number of low volume products in our Tempe, Arizona manufacturing facility, our fixed costs comprise a large portion of the cost of goods for our thin film products. Currently, our thin film products are sold primarily to Guidant. We therefore depend upon our sales to Guidant to cover the fixed costs of operating our Tempe facility. Should volumes decrease, unless we are able to raise our prices commensurately, we would incur losses on these products, which could lead us to decide to close this facility and incur shut-down expenses as well as lose the revenue and margin contribution that our thin film products provide. Currently, we are the sole source of these products to Guidant, but Guidant is trying to qualify another supplier to serve as a second source. If they do so, it is likely that their demand for these products from us will decrease, in which case our revenues from Guidant would not be adequate to cover our fixed costs.

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

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

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

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

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

The markets for our products are characterized by:

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

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

We may not be able to identify new product opportunities, to develop or use new technologies successfully, to develop and bring to market new products, or to respond effectively to new technological changes or product announcements by our competitors. There can be no assurance even if we are able to do so that our customers will design our products into their products or that our customers’ products will achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense and involve engineering risk. Failure in any of these areas could harm our operating results.

We may be unable to reduce the costs associated with our products quickly enough for us to meet our margin targets, particularly in the computing and digital consumer market.

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

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

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

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

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

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

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

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

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

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

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

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

The majority of our operating expenses are labor related and therefore cannot be reduced quickly without impairing our ability to effectively conduct business. Much of the remainder of our operating costs such as rent are relatively fixed. Therefore, we have limited ability to reduce expenses quickly in response to any revenue shortfalls.

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Consequently, our operating results will be harmed if our revenues do not meet our projections. We may experience revenue shortfalls for the following and other reasons:

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

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

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

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

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

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

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

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

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

We are subject to a variety of federal, state and local laws, rules and regulations relating to the protection of health and the environment. These include laws, rules and regulations governing the use, storage, discharge, release, treatment and disposal of hazardous chemicals during and after manufacturing, research and development and sales demonstrations, as well as the

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maintenance of healthy and environmentally sound conditions within our facilities. If we fail to comply with applicable requirements, we could be subject to substantial liability for cleanup efforts, property damage, personal injury and fines or suspension or cessation of our operations. In these regards, during the closure of our Milpitas facility, residual contaminants from our operations were detected in concrete and soil samples, and we have been required by the State Department of Toxic Substances Control (“DTSC”) to conduct a further investigation of soil and groundwater conditions at the site, involving the collection of numerous additional samples and analysis for a broad range of chemicals. We have retained an environmental engineering firm for this purpose, which will do the work under the oversight of DTSC. The possible outcomes of this further investigation range from “no further action required” to cleanup of soils and groundwater, depending upon the extent and magnitude of the contamination. Based on the information available at this time, we cannot estimate the cost of any remediation that may be required. Similarly, our Tempe facility is located in an area of documented regional groundwater contamination. While we have no reason to believe that our operations at the facility have contributed to this regional contamination, we can give no such assurance. If we were found to have contributed to the contamination, then we could be required to conduct an investigation to determine the extent of our contribution and could be required to undertake remedial action if warranted.

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

Our California facilities and some of our suppliers are located near major earthquake faults that have experienced earthquakes in the past. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of our major suppliers, like the one that occurred in Taiwan in September 1999, could disrupt the operations of those suppliers, limit the supply of our products and harm our business. Additionally, our facility in Tempe, Arizona is located in a desert region of the southwestern United States. Disruption of water supplies or other infrastructure support could limit the supply of our products and harm our business. We have occasionally experienced power interruptions at our Tempe facility and power shortages have been reported in California and Arizona. We cannot assure that if power interruptions or shortages occur in the future, they will not adversely affect our business.

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

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

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

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

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

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

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

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

Our board of directors adopted a shareholder rights plan in the Fall of 2001 to encourage third parties interested in acquiring us to work with and obtain the support of our board of directors. The effect of the rights plan is that any person who does not obtain the support of our board of directors for its proposed acquisition of us would suffer immediate dilution upon achieving ownership of more than 15% of our stock. Under the rights plan, we have issued rights to purchase shares of our preferred stock that are redeemable by us prior to a triggering event for a nominal amount at any time and that accompany each of our outstanding common shares. These rights are triggered if a third party acquires more than 15% of our stock without board of director approval. If triggered, these rights entitle our shareholders, other than the third party causing the rights to be triggered, to purchase shares of the company’s preferred stock at what is expected to be a relatively low price. In addition, these rights may be exchanged for common stock under certain circumstances if permitted by the board of directors.

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

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

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

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the SEC and by the NASDAQ National Market and new accounting

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

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

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

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

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

Our having only a limited number of authorized shares available may adversely impact our ability to recruit employees or raise additional financing.

As of June 30, 2004, we had only approximately 313,000 authorized common shares that are unissued and not subject to already outstanding but unexercised options and warrants. To remedy this condition, we presently intend to ask our shareholders at our August 2004 annual meeting to authorize additional shares. We could also, but do not presently intend to, rely on our shareholders’ prior approval of approximately 2.2 million options to correspondingly increase our authorized common shares pursuant to California Corporations Code Section 405(b). If we do not obtain shareholder approval to increase authorized shares and do not rely on their previous approval of additional options, we will be constrained in our ability to grant additional options or to sell additional shares. This may adversely impact our ability to recruit or retain employees or to raise financing.

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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

As of June 30, 2004 we held $17.3 million of investments in debt securities, but did not hold investments in equity securities. As of March 31, 2004 we did not hold investments in debt or equity securities. We have owned and may own financial instruments in the future that are sensitive to market risks and subject to fluctuations in interest rates as part of our investment portfolio. We do not own derivative financial instruments.

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

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

During the quarter ended June 30, 2004, we repaid all but $255,000 of our long-term debt obligations. See Note 9 of Notes to Condensed Financial Statements. The table below presents principal amounts and related weighted average interest rates by year of maturity for our long-term debt obligations and their fair value as of March 31, 2004. At that date, our long-term debt securities were scheduled to mature from between one and a half years and five years. The fair value of our long-term debt was based on the estimated market rate of interest for similar debt instruments with the same remaining maturities.

At March 31, 2004:

ITEM 4. Controls and Procedures

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

(b) Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting during our first quarter of fiscal 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Some of our key controls are manual and are consequently inefficient. We are in process of implementing enterprise resource planning software which we anticipate will be operational in time for testing and use in the preparation of our year-end fiscal 2005 financial statements.

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PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

At March 31, 2004 we had separate pending litigation with two former employees, Tarsaim Batra and Chan Desaigoudar. We resolved both matters in the first quarter of fiscal 2005 for amounts that had previously been accrued. The payments during the first quarter of fiscal 2005 had minimal effect on our liquidity.

ITEM 2. Changes in Securities and Use of Proceeds

None.

ITEM 3. Defaults Upon Senior Securities

None.

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

None.

ITEM 5. Other Information

None.

ITEM 6. Exhibits and Reports on Form 8-K

The following documents are filed as Exhibits to this report:

*Portions omitted pursuant to a request for confidential treatment

On April 22, 2004, we filed a Report on Form 8-K dated April 15, 2004, which reported under Item 12 both (1) the issuance on April 15, 2004, of a news release relating to updated estimates of financial results for our fiscal 2004 fourth quarter and our 2004 fiscal year ended March 31, 2004, and (2) the presentation of certain information via slideshow concerning such fiscal quarter and fiscal year.

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On April 28, 2004, we filed a Report on Form 8-K dated April 27, 2004, which reported under Item 5 our entering into an underwriting agreement relating to a public offering and which included as exhibits such agreement, the form of legal opinion regarding legality of the securities being issued, the form of share certificate, and a news release relating to the pricing of that offering. Under Item 5 we also explained a mistake we had noted in the breakdown of the change in our cost of sales for the third quarter of fiscal 2004 compared to the third quarter of fiscal 2003 as contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Form 10-Q for the nine-month period ended December 31, 2003. This mistaken break-down did not affect our financial statements, which are unchanged.

On May 6, 2004, we filed a Report on Form 8-K dated May 6, 2004, which reported under Item 12 the issuance of a news release on May 6, 2004, relating to results for our fiscal 2004 fourth quarter ended March 31, 2004, and for our entire fiscal 2004.

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SIGNATURE

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

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