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

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates, and projections about our industry; our beliefs and assumptions; and our goals and objectives. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," and "estimates," and variations of these words and similar expressions are intended to identify forward-looking statements. Examples of the kinds of forward-looking statements in this report include statements regarding the following: (1) our expectation that our ASP ("Average Selling Prices") for similar products, based on a constant mix of products, will decline at the rate of 12% to 15% per year; (2) our having a target gross margin of 38% to 40%; (3) our expectation that our future environmental compliance costs will be minimal; (4) our anticipation that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs over the next 12 months; (5) our having a long term target for research and development expenses of 9% to 10% of sales but such expenses representing more than 20% of sales especially during the balance of fiscal 2009 driven by continuing development efforts for our serial interface display controller line of products and declines in sales; (6) our having a long term target for selling, general and administrative expenses of 15% to 16% of sales but expecting to exceed this target until our sales increase substantially; (7) our belief that due to the short duration and investment grade credit ratings of our investment portfolio, there is no material exposure to interest rate risk in our investment portfolio and (9) our expectation of future interest income to continue to be at a reduced level or even decline unless interest rates increase materially in the near future. These statements are only predictions, are not guarantees of future performance, and are subject to risks, uncertainties, and other factors, some of which are beyond our control, are difficult to predict, and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, whether our target markets continue to experience their forecasted growth and whether such growth continues to require the devices we supply; whether we will be able to increase our market penetration; whether our product mix changes, our unit volume decreases materially, we experience price erosion due to competitive pressures, or our contract manufacturers and assemblers raise their prices to us or we experience lower yields from them or we are unable to realize expected cost savings in certain manufacturing and assembly processes; whether there will be any changes in tax accounting rules; whether we will be successful developing new products which our customers will design into their products and whether design wins and bookings will translate into orders; whether we encounter any unexpected environmental clean-up issues with our former Tempe facility; whether we discover any further contamination at our former Topaz Avenue Milpitas facility; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under Item 1A, Risk Factors. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

Executive Overview

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

Third Quarter Key Financial Highlights

The following are key financial highlights of third quarter of fiscal 2009:

Net Sales: Our net sales were $9.7 million in the third quarter of fiscal 2009, down 35% from $15.0 million in the same period a year ago.

Gross Margin: Our gross margin was $2.5 million (26% of our net sales) in the third quarter of fiscal 2009 as compared to gross margin of $4.9 million (32% of our net sales) in the same period a year ago.

Net Income or Loss per Share: Our net loss per share, basic and diluted, was $0.38 in the third quarter of fiscal 2009 as compared to net income per share, basic and diluted, of $0.01 in the same period a year ago.

Cash Provided by or Used in Operating Activities: We used $3.4 million of cash in operating activities during the nine months ended December 31, 2008 as compared to $3.8 million of cash generated by operating activities in the same period a year ago.

Cash* Position: We ended the third quarter of fiscal 2009 with a cash position of $48.4 million as compared to $51.6 million, as of March 31, 2008.
* Cash = Cash and cash equivalents + Short-term investments

Results of Operations

The table below shows our net sales, cost of sales, gross margin, expenses and
net loss, both in dollars and as a percentage of net sales, for the three and
nine months ended December 31, 2008 and 2007 (amounts in thousands):

                                  Three Months Ended                                     Nine Months Ended
                                     December 31,                                          December 31,
                           2008                       2007                        2008                       2007
                                  % of                       % of                        % of                       % of
                                  Net                        Net                         Net                        Net
                    Amount       Sales         Amount       Sales         Amount        Sales         Amount       Sales
Net sales          $  9,659          100 %    $ 14,955          100 %    $  40,101          100 %    $ 44,201          100 %
Cost of sales         7,184           74 %      10,105           68 %       27,779           69 %      29,995           68 %
Gross margin          2,475           26 %       4,850           32 %       12,322           31 %      14,206           32 %
Research and
development           2,668           28 %       1,670           11 %        7,838           20 %       5,080           11 %
Selling, general
and
administrative        3,509           36 %       3,533           24 %       11,205           28 %      11,170           25 %
Goodwill
impairment            5,258           54 %           -            0 %        5,258           13 %           -            0 %
Amortization of
intangible
assets                   71            1 %          41            0 %          127            0 %         124            0 %
Operating loss       (9,031 )        (93 %)       (394 )         (3 %)     (12,106 )        (30 %)     (2,168 )         (5 %)
Other income,
net                     130            1 %         628            4 %        1,617            4 %       1,911            4 %
Income (loss)
before income
taxes                (8,901 )        (92 %)        234            2 %      (10,489 )        (26 %)       (257 )         (1 %)
Provision
(benefit) for
income taxes             10            0 %           4            0 %        1,305            3 %          12            0 %
Net income
(loss)             $ (8,911 )        (92 %)   $    230            2 %    $ (11,794 )        (29 %)   $   (269 )         (1 %)

Net sales

Net sales by market for the three months ended December 31, 2008 and 2007 were as follows (amounts in millions):

                                     Three Months Ended December 31,
                                   2008                           2007
                                          As % of                       As % of
                                           Total                         Total
                          Amount           Sales          Amount         Sales         $ Change        % Change
Mobile handset          $      6.2               64 %   $      9.0             60 %   $      (2.8 )          (31 %)
Digital consumer
electronics and
personal computers             2.4               25 %          4.4             29 %          (2.0 )          (45 %)
Diversified                    1.1               11 %          1.6             11 %          (0.5 )          (31 %)
  Total                 $      9.7              100 %   $     15.0            100 %   $      (5.3 )          (35 %)

Net sales for third quarter of fiscal 2009 were $9.7 million, a decrease of $5.3 million or 35% from $15.0 million of net sales in the same period a year ago. Lower sales were experienced across all product lines largely as a result of the weak global economy. Sales from products for the mobile handset market decreased by $2.8 million or 31% in third quarter of fiscal 2009 as compared to the same period a year ago. Sales from products for the digital consumer electronics and personal computer market decreased to $2.4 million in the third quarter of fiscal 2009 from $4.4 million in the same period a year ago, down $2.0 million or 45%. The decreases in sales for above product lines were driven by lower shipments and price declines. Sales from products for the diversified market decreased to $1.1 million in the third quarter of fiscal 2009 from $1.6 million in the same period a year ago, down $0.5 million or 31%, which was primarily driven by inventory adjustment at a major customer.

Net sales by market for the nine months ended December 31, 2008 and 2007 were as follows (amounts in millions):

                                      Nine Months Ended December 31,
                                    2008                           2007
                                           As % of                       As % of
                                            Total                         Total
                          Amount            Sales          Amount         Sales         $ Change       % Change
Mobile handset          $     24.8                62 %   $     27.9             63 %   $     (3.1 )          (11 %)
Digital consumer
electronics and
personal computers            10.2                25 %         12.4             28 %         (2.2 )          (18 %)
Diversified                    5.1                13 %          3.9              9 %          1.2             31 %
  Total                 $     40.1               100 %   $     44.2            100 %   $     (4.1 )           (9 %)

Net sales for nine months ended December 31, 2008 were $40.1 million, a decrease of $4.1 million or 9% from $44.2 million of net sales in the same period a year ago. Sales from products for the mobile handset market decreased by $3.1 million or 11% during nine months ended December 31, 2008, as compared to the same period a year ago. Sales from products for the digital consumer electronics and personal computer market decreased to $10.2 million during nine months ended December 31, 2008 from $12.4 million in the same period a year ago, down $2.2 million or 18%. Sales from products for the diversified market increased to $5.1 million during nine months ended December 31, 2008 from $3.9 million in the same period a year ago, up $1.2 million primarily benefited from increasing sales of our HBLED ESD products.

Gross Margin

Gross margin decreased by $2.4 million during the three months ended December
31, 2008, as compared to the same period a year ago due to the following
reasons:

Gross margin increase (decrease) compared to prior period (in millions):
Price change of products based on a constant mix for target markets        $ (1.5 )
Cost reductions of our products on a constant mix                             0.6
Volume, mix and other factors                                                (1.5 )
                                                                           $ (2.4 )

The gross margin decrease was primarily driven by lower shipments, price declines of our products and a $238,000 inventory write off, partially offset by product cost reductions. Our ASP declined 13% based on a constant mix of products in the third quarter of fiscal 2009 as compared to the same period a year ago. The cost reductions of our products were primarily due to outsourcing with lower cost subcontractors.

As a percentage of sales, gross margin decreased to 26% for the three months ended December 31, 2008, compared to 32% for the same period a year ago.

Gross margin decreased by $1.9 million during the nine months ended December 31, 2008, as compared to the same period a year ago due to the following reasons:

Gross margin increase (decrease) compared to prior period (in millions):

Price change of products based on a constant mix for target markets        $ (4.6 )
Cost reductions of our products on a constant mix                             3.2
Volume, mix and other factors                                                (0.5 )
                                                                           $ (1.9 )

The gross margin decrease was primarily driven by price declines of our products and lower shipments partially offset by cost reductions and change in our product mix. Our ASP declined 11% based on a constant mix of products in the nine months ended December 31, 2008 as compared to the same period a year ago. In the future we expect our ASP for similar products, based on a constant mix of products, to decline at the rate of 12% to 15% per year. The cost reductions of our products were primarily due to outsourcing with lower cost subcontractors.

As a percentage of sales, gross margin decreased to 31% for the nine months ended December 31, 2008, compared to 32% for the same period a year ago. Our long-range gross margin target remains 38% to 40%. However, our gross margin could fail to achieve this target range or could decline.

Research and Development

Research and development expenses consist primarily of compensation and related
costs for employees, prototypes, masks and other expenses for the development of
new products, process technology and packages. The increase in research and
development expenses for the three and nine months ended December 31, 2008,
compared to the same periods a year ago, was due to the following reasons:

                                                               Three Months      Nine Months
                                                                   Ended            Ended
                                                               December 31,       December
Expense increase compared to prior period (in thousands):          2008           31, 2008
Outside services                                               $         160     $       901
Salaries and benefits and other costs                                     28             201
Engineering supplies and product related costs                           810           1,656
                                                               $         998     $     2,758

Research and development expenses increased by $1.0 million and $2.8 million, respectively during the three and nine months ended December 31, 2008, as compared to the same periods a year ago, primarily due to increased spending for the serial interface display controller line of products which is anticipated to continue during the remainder of fiscal 2009.

As a percentage of sales, research and development expenses increased to 28% and 20%, respectively during the three and nine months ended December 31, 2008 from 11% during the same periods a year ago. Our long term target for research and development expenses is 9% to 10% of sales. However, research and development expenses will continue to exceed our target range and represent more than 20% of sales especially during the balance of fiscal 2009 driven by continuing development efforts for our serial interface display controller line of products and declines in sales.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of compensation
and other employee related costs, sales commissions, marketing expenses, legal,
accounting, other professional fees and information technology expenses. The
increase in selling, general, and administrative expenses for the three and nine
months ended December 31, 2008, compared to the same periods a year ago, is as
follows:

                                                               Three Months     Nine Months
                                                                  Ended            Ended
Expense increase (decrease) compared to prior period (in       December 31,     December 31,
thousands):                                                        2008             2008
Salaries and benefits                                          $         71     $        203
Sales Commissions                                                      (110 )           (205 )
Other expenses                                                           15               37
                                                               $        (24 )   $         35

Selling, general and administrative expenses decreased by $24,000 and increased by $35,000 during the three and nine months ended December 31, 2008, respectively, as compared to the same periods a year ago primarily driven by reduction in sales commission partially offset by increase in employee salaries and benefits.

As a percentage of sales, selling, general and administrative expenses were 36% and 28% during the three and nine months ended December 31, 2008 as compared to 24% and 25% during the same periods a year ago. Our long term target for selling, general and administrative expenses is 15% to 16% of sales. However, selling, general and administrative expenses will continue to exceed our target range and represent more than 16% of sales until our sales increase substantially.

Goodwill Impairment

Goodwill impairment was $5.3 million during the three months ended December 31, 2008. As a result of current economic environment, our operating results, and the sustained decline in our market valuation, we performed an interim goodwill analysis during the third quarter ended December 31, 2008. The analysis indicated that the estimated fair value is less than the corresponding carrying amount and the full amount of goodwill is no longer recoverable. Our entity is deemed as a single reporting unit for our impairment analysis. The fair value was estimated using present value of estimated future cash flows which was consistent with a market-based approach. For additional information regarding goodwill, see Note 6 in the notes to condensed financial statement of the Form 10-Q.

Amortization and Impairment of Intangible Assets

Amortization of intangible assets was $16,000 and $72,000, respectively during the three and nine months ended December 31, 2008 as compared to $41,000 and $124,000 respectively during the same periods a year ago. The intangible assets were related to the Arques acquisition in fiscal 2007. The decrease in amortization expense was primarily due to the sale of intangible assets, related to our line of LED Drivers in the second quarter of fiscal 2009. An impairment charge of $55,000 was recorded during the third quarter of fiscal 2009. For additional information regarding intangible assets, see Note 6 in the notes to condensed consolidated financial statements of this Form 10-Q.

Other Income, Net

Other income, net, mainly includes interest income, interest expense, gain/loss on sale of intangibles and fixed assets and other expenses.

The decrease in other income is primarily driven by decline in interest rates this year in part due to our moving the bulk of our short-term investments into treasury bills. Interest income decreased by $0.6 million and $1.3 million during the three and nine months ended December 31, 2008, respectively as compared to the same periods a year ago. We expect interest income, in the near future, to remain at this reduced level or even decline unless interest rates increase materially or we change the instruments in which we invest.

Income Taxes

During the three and nine months ended December 31, 2008, income tax provision was $10,000 and 1.3 million, respectively, as compared to $5,000 and $12,000, respectively, during the same periods a year ago. Our income tax provision increased during the three and nine months ended December 31, 2008 compared to the same periods a year ago, primarily as a result of the decrease in our estimates to utilize loss carryforwards, and the resulting increase in the valuation allowance of the deferred tax assets. See Note 14 in the notes to condensed consolidated financial statements of this Form 10-Q for further discussion.

Critical Accounting Policies and Estimates

The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes. We base our estimates on historical experience and the known facts and circumstances that we believe are relevant. We have not made any material change in the accounting methodology used to establish our estimates and assumptions during the third quarter of fiscal 2009. We do not believe there is a reasonable likelihood that there will be a material change in the accounting methodology used to establish our estimates or assumptions. However, actual results may differ materially from our estimates. Our significant accounting policies are described in Note 2 of notes to consolidated financial statements in our Annual Report on Form 10-K for fiscal 2008. The significant accounting policies that we believe are critical, either because they relate to financial line items that are key indicators of our financial performance such as revenue or because their application requires significant management judgment, are described in the following paragraphs.

Revenue Recognition

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

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

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

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

Inventories

. . .