In this discussion, "Company", "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 10% to 15% per year; (2) our having a long-range gross margin target of 35% to 40%; (3) our expectation that our future environmental compliance costs will be minimal; (4) our anticipation that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs over the next 12 months; (5) our expectation of research and development expenses, both as a percentage of sales and in dollars, to reduce significantly starting with the third quarter of fiscal 2010 primarily as a result of discontinuance of further development of display controller products and having a long term target for research and development expenses of 9% to 11% of sales; (6) our having a long term target for selling, general and administrative expenses of 16% to 20% of sales; (7) our expectation of future interest income to continue to be at a reduced level unless interest rates increase materially or we change the instruments in which we invest; (8) our expectation that we will not pay within one year any of our liability for uncertain tax positions or associated interest and tax penalties; and (9) our expectation that we will fund our contractual obligations and liability for uncertain tax positions with cash on hand or cash provided from operations. 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 share; 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 in developing new products which our customers will design into their products and whether our 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; whether we will incur any large unanticipated expenses; 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 for high volume applications in the mobile handset, High Brightness LED (HBLED), digital consumer electronics and personal computer markets. These protection devices provide Electromagnetic Interference (EMI) filtering and Electrostatic Discharge (ESD) protection. 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.

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
six months ended September 30, 2009 and 2008 (amounts in thousands):

                                     Three Months Ended September 30,                       Six Months Ended September 30,
                                      2009                        2008                      2009                       2008
                                              % of                      % of                       % of                      % of
                                               Net                       Net                        Net                       Net
                               Amount         Sales        Amount       Sales        Amount        Sales        Amount       Sales
Net sales                    $   11,115          100 %    $ 16,343         100 %    $  20,463         100 %    $ 30,443         100 %
Cost of sales                     8,184           74 %      11,239          69 %       15,251          75 %      20,595          68 %
Gross margin                      2,931           26 %       5,104          31 %        5,212          25 %       9,848          32 %
Research and development          1,810           16 %       2,887          18 %        3,927          19 %       5,171          17 %
Selling, general and
administrative                    3,826           34 %       3,832          23 %        7,443          36 %       7,697          25 %
Amortization of intangible
assets                                6            0 %          22           0 %           12           0 %          55           0 %
Restructuring charges,
assets impairment and
others                              717            7 %           -           0 %          717           4 %           -           0 %
Total operating expenses          6,359           57 %       6,741          41 %       12,099          59 %      12,923          42 %
Operating loss                   (3,428 )        (31 %)     (1,637 )       (10 %)      (6,887 )       (34 %)     (3,075 )       (10 %)
Other income (expense),
net                                  (5 )         (0 %)      1,193           7 %          (16 )        (0 %)      1,487           5 %
Loss before income taxes         (3,433 )        (31 %)       (444 )        (3 %)      (6,903 )       (34 %)     (1,588 )        (5 %)
Provision for income taxes           41            0 %       1,521           9 %           23           0 %       1,295           4 %
Net loss                     $   (3,474 )        (31 %)   $ (1,965 )       (12 %)   $  (6,926 )       (34 %)   $ (2,883 )        (9 %)

Net sales

Net sales by market during the three months ended September 30, 2009 and 2008 were as follows (amounts in millions):

                                             Three Months Ended September 30,
                                             2009                          2008
                                                    As % of                     As % of
                                                     Total                       Total           $             %
                                    Amount           Sales         Amount        Sales        Change       Change
Mobile handset                     $     6.3              57 %    $   10.7            66 %   $   (4.4 )        (41 %)
Digital consumer electronics and
personal computers                       4.0              36 %         4.3            26 %       (0.3 )         (7 %)
HBLED                                    0.8               7 %         1.3             8 %       (0.5 )        (38 %)
  Total                            $    11.1             100 %    $   16.3           100 %   $   (5.2 )        (32 %)

Net sales during the three months ended September 30, 2009 were $11.1 million, a decrease of $5.2 million or 32% from $16.3 million of net sales in the same period a year ago. Sales from products for the mobile handset market decreased by $4.4 million or 41% during the three months ended September 30, 2009 as compared to the same period a year ago primarily due to lower sales of our protection products to one of the top five handset manufacturers and lower sales of our display controller products. Sales from products for the digital consumer electronics and personal computers markets decreased to $4.0 million during the three months ended September 30, 2009 from $4.3 million in the same period a year ago, down $0.3 million or 7% due to decrease sales of our mature products partially offset by an increase in sales of our low capacitance products particularly PicoGuardŽ. Sales from products for the HBLED market decreased to $0.8 million during the three months ended September 30, 2009 from $1.3 million in the same period a year ago, down $0.5 million or 38% primarily due to inventory adjustment at a major customer.

Net sales by market during the six months ended September 30, 2009 and 2008 were as follows (amounts in millions):

                                             Six Months Ended September 30,
                                             2009                        2008
                                                   As % of                    As % of
                                                    Total                      Total           $             %
                                    Amount          Sales        Amount        Sales        Change       Change
Mobile handset                     $   11.0              54 %   $   18.9            62 %   $   (7.9 )        (42 %)
Digital consumer electronics and
personal computers                      7.7              37 %        8.9            29 %       (1.2 )        (13 %)
HBLED                                   1.8               9 %        2.6             9 %       (0.8 )        (31 %)
  Total                            $   20.5             100 %   $   30.4           100 %   $   (9.9 )        (33 %)

Net sales during the six months ended September 30, 2009 were $20.5 million, a decrease of $9.9 million or 33% from $30.4 million of net sales in the same period a year ago. Sales from products for the mobile handset market decreased by $7.9 million or 42% during the six months ended September 30, 2009 as compared to the same period a year ago primarily due to lower sales of our protection products to one of the top five handset manufacturers. Sales from products for the digital consumer electronics and personal computer market decreased to $7.7 million during the six months ended September 30, 2009 from $8.9 million in the same period a year ago, down $1.2 million or 13% due to decrease sales of our mature products partially offset by an increase in sales of our low capacitance products particularly PicoGuardŽ. Sales from products for HBLED market decreased to $1.8 million during the six months ended September 30, 2009 from $2.6 million in the same period a year ago, down $0.8 million or 31% primarily due to inventory adjustment at a major customer.

Gross Margin

Gross margin decreased by $2.2 million and $4.6 million during the three and six
months ended September 30, 2009 as compared to the same periods a year ago, due
to the following reasons:

                                                      Three Months Ended       Six Months Ended
Gross margin increase (decrease) compared to prior
periods (in millions):                                September 30, 2009      September 30, 2009
Price change of products based on a constant mix     $               (1.5 )   $              (3.1 )
Direct cost reductions of our products based on a
constant mix                                                          0.7                     1.3
Volume, mix and other factors                                        (1.4 )                  (2.8 )
                                                     $               (2.2 )   $              (4.6 )

The gross margin decrease was primarily driven by price declines of our products and lower shipments partially offset by product cost reductions. Our ASP declined 12% based on a constant mix of products in the second quarter of fiscal 2010 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 10% to 15% per year. The cost reductions of our products were primarily driven by outsourcing with lower cost subcontractors, migrating from 6" to 8" wafer size and continued improvement in our assembly and testing processes.

As a percentage of sales, gross margin decreased to 26% and 25%, respectively for the three and six months ended September 30, 2009 as compared to 31% and 32%, respectively for the same periods a year ago. Our long-range gross margin target is 35% to 40%. Our gross margin has been and will continue to be affected by a variety of factors, including average selling price of our products, the product volume and mix, the timing of cost reductions for our wafer and assembly and test as well as inventory valuation charges.

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 change in research and
development expenses for the three and six months ended September 30, 2009,
compared to the same periods a year ago, is as follows:

                                                      Three Months Ended       Six Months Ended
Expense increase (decrease) compared to prior
periods (in thousands):                               September 30, 2009      September 30, 2009
Outside services                                     $               (466 )   $              (740 )
Salaries and benefits                                                (206 )                  (342 )
Product related costs                                                (306 )                  (151 )
Other costs                                                           (99 )                   (11 )
                                                     $             (1,077 )   $            (1,244 )

Research and development expenses decreased by $1.1 million or 37% and $1.2 million or 24%, respectively during the three and six months ended September 30, 2009, as compared to the same periods a year ago, primarily as a result of discontinuance of further development of display controller products during the second quarter of fiscal 2010.

As a percentage of sales, research and development expenses decreased to 16% during the three months ended September 30, 2009 from 18% during the same period a year ago. Despite a decrease in research and development expenses, as a percentage of sales, research and development expenses increased to 19% during the six months ended September 30, 2009 from 17% during the same period a year ago primarily due to the decrease in net sales. We expect the research and development expenses, both as a percentage of sales and in dollars, to decline significantly starting with the third quarter of fiscal 2010 primarily as a result of discontinuance of further development of display controller products. Our long term target for research and development expenses is 9% to 11% of 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, and other professional fees; and information technology expenses.
The change in selling, general, and administrative expenses for the three and
six months ended September 30, 2009, compared to the same periods a year ago, is
as follows:

                                                      Three Months Ended       Six Months Ended
Expense increase (decrease) compared to prior
periods (in thousands):                               September 30, 2009      September 30, 2009
Salaries and benefits                                $               (369 )   $              (465 )
Sales Commissions                                                    (116 )                  (220 )
Travel expenses                                                       (47 )                  (128 )
Stock based compensation charge                                       (40 )                  (131 )
Other expenses                                                        (16 )                     4
Proxy related expenses                                                582                     686
                                                     $                 (6 )   $              (254 )

Selling, general and administrative expenses decreased by $6,000 or 0% and $254,000 or 3%, respectively during the three and six months ended September 30, 2009 as compared to the same periods a year ago primarily due to decreases in salaries and benefits, sales commissions, travel expenses and stock based compensation charge which was largely offset by an increase in proxy related expenses.

Decrease in salaries and benefits was primarily the result of headcount reduction, no target bonus payouts and mandatory time off for all employees of the Company; decrease in sales commission was due to reduced sales during the three and six months ended September 30, 2009 as compared to the same periods a year ago; and decrease in travel expenses was the result of cost cutting measures taken by the Company to reduce discretionary spending.

During the three and six months ended September 30, 2009, we incurred additional proxy expenses of $0.6 million and $0.7 million, respectively as compared to the same periods a year ago, primarily due to the contested solicitation for election of directors in the 2009 annual meeting of shareholders.

As a percentage of sales, selling, general and administrative expenses increased to 34% and 36%, respectively during the three and six months ended September 30, 2009 from 23% and 25%, respectively during the same periods a year ago, primarily due to additional proxy related expenses as a result of contested solicitation for election of directors. Our long term target for selling, general and administrative expenses is 16% to 20% of sales.

Amortization of Intangible Assets

Amortization of intangible assets was $6,000 and $12,000, respectively during the three and six months ended September 30, 2009 as compared to $22,000 and $55,000, respectively during the same periods a year ago. The decrease in amortization expense during the three and six months ended September 30, 2009 as compared to the same periods a year ago was due to the intervening sale of certain intangible assets and partial impairment of others. For additional information regarding intangible assets, see Note 6 of notes to condensed consolidated financial statements in this Form 10-Q.

Restructuring and asset impairment charges

In the second quarter of fiscal year 2010, we implemented a restructuring plan to discontinue any further development of display controller products. As a result, we have reduced our workforce through involuntary terminations and impaired some of our assets related to display controller products. During the three and six months ended September 30, 2009, restructuring and asset impairment charges were $717,000, out of which employee severance, contract termination costs and asset impairment charges were $214,000, $51,000 and $452,000 respectively. As of September 30, 2009, we had $91,000 of accrued restructuring liability which is expected to be paid during the remainder of current fiscal year 2010. We expect to fund the obligations with cash on hand.

There were no restructuring charges incurred during the three and six months ended September 30, 2008.

Other Income (Expense), Net

Other income (expense), net, mainly includes interest income, interest expense and other non-operating income and expense.

Interest income decreased by $0.2 million and $0.5 million, respectively during the three and six months ended September 30, 2009, as compared to the same periods a year ago primarily as a result of the overall decline in interest rates and our moving our short-term investments into money market funds and to a lesser extent due to our reduced total amount of cash, cash equivalents and short-term investments. We expect interest income, in the near future, to remain at this reduced level unless interest rates increase materially or we change the instruments in which we invest.

Interest expense was immaterial during the three and six months ended September 30, 2009 and 2008.

Other non-operating income decreased by $1.0 million during the three and six months ended September 30, 2009, as compared to the same periods a year ago primarily due to the gain on sale of LED Driver intellectual property and related fixed assets during the second quarter of fiscal 2009.

Income Taxes

During the three and six months ended September 30, 2009, we recorded an income tax expense of $41,000 and $23,000 respectively as compared to $1.5 million and $1.3 million, respectively during the same periods a year ago. Our income tax expense decreased during the three and six months ended September 30, 2009 compared to the same periods a year ago, primarily as a result of our changed estimates of our ability to utilize loss carryforwards and the increased valuation allowance against our deferred tax assets. See Note 13 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 changes in the accounting methodology used to establish our estimates and assumptions during the second quarter of fiscal 2010. 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 year ended March 31, 2009. 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 customer credit worthiness. 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, for which we provide price concessions or product return rights, is recognized when the distributor sells the product to an end customer. When we sell such 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. 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.

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 . . .