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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended December 31, 2006

or

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of January 31, 2007 was 23,136,403.

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California Micro Devices Corporation

Form 10-Q for the Quarter ended December 31, 2006

INDEX

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PART I. FINANCIAL INFORMATION

California Micro Devices Corporation

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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California Micro Devices Corporation

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See Notes to Condensed Consolidated Financial Statements.

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California Micro Devices Corporation

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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PART I. FINANCIAL INFORMATION

California Micro Devices Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated 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. The condensed consolidated 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, 2006. In the opinion of management, the accompanying unaudited condensed consolidated 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”, “CMD”, “we”, “us” or “our”) as of December 31, 2006, and the results of operations for the three and nine months ended December 31, 2006 and 2005, and cash flows for the nine months ended December 31, 2006 and 2005. The results of operations for the three and nine months ended December 31, 2006 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

On April 13, 2006, we acquired Arques Technology, Inc. in a reverse triangular merger so that Arques became our wholly-owned subsidiary. Consequently, Arques’ financial position, results of operations and cash flows subsequent to acquisition are included in the accompanying unaudited condensed consolidated financial statements. Intercompany accounts and transactions have been eliminated.

On September 15, 2006, we reincorporated in Delaware, having been previously incorporated in California. We accomplished this by merging into our wholly-owned Delaware corporation subsidiary that we had created for this purpose, with the California corporation ceasing to exist as a result of the merger. Effective September 30, 2006, we eliminated Arques as a separate entity by merging Arques into the Delaware corporation that had resulted from our reincorporation.

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 periods. 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

Our equity incentive program is a long-term retention program that is intended to attract and retain qualified management and technical employees and align stockholder and employee interests. Under the equity incentive program, stock options have varying vesting periods typically over four years and are generally exercisable for a period of ten years from the date of issuance and are granted at prices equal to the fair market value of the Company’s common stock at the grant date. As of December 31, 2006, our stock option plans consisted of the 2004 Omnibus Incentive Compensation Plan and the 1995 Employee Stock Option Plan and we had granted options outside of these plans as well. Additionally, we have the 1995 Employee Stock Purchase Plan (“ESPP”) that allows employees to purchase shares of common stock at 85% of the fair market value of the common stock at certain defined points in the plan offering periods. These stock option and purchase plans and non-plan options are described fully in the Notes to Financial Statements included in our Annual Report on Form 10-K for the year ended March 31, 2006.

On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123, “SFAS 123” (revised 2004), “Share-Based Payment”, “SFAS 123(R)”, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and employee stock purchases related to the ESPP, based on estimated fair values. In our adoption of SFAS 123(R), we have also applied the related provisions of SEC Staff Accounting Bulletin No. 107, “SAB 107”, which was issued in March 2005.

We elected to use the modified prospective transition method as permitted by SFAS 123(R) and therefore have not restated our financial results for prior periods. Under this transition method, stock-based compensation expense for the three and nine

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months ended December 31, 2006 includes (a) compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of April 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, (b) compensation expense for all stock-based compensation awards granted subsequent to April 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R), and (c) compensation expense related to our ESPP. We recognize compensation expense for stock option awards on a graded vesting schedule over the requisite service period of the award.

The following table sets forth the total stock-based compensation expense resulting from stock options and ESPP included in our Condensed Consolidated Statements of Operations (in thousands):

The effect of recording stock-based compensation expense for the three and nine months ended December 31, 2006 was as follows (in thousands, except per share amounts):

Net cash proceeds from the exercise of stock options were $94,000 and $509,000 for the three and nine months ended December 31, 2006, respectively, compared to $3,253,000 and $3,506,000 for the same periods a year ago. No income tax benefit was realized from stock option exercises during each of the three and nine months ended December 31, 2006 and 2005.

Prior to the adoption of SFAS 123(R), we applied SFAS 123, amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”, “SFAS 148”, which allowed companies to apply the existing accounting rules under APB 25, “Accounting for Stock Issued to Employees”, and related Interpretations. In general, as the exercise price of options granted under these plans was equal to the market price of the underlying common stock on the grant date, no stock-based employee compensation cost was recognized in our net income (loss) for periods prior to the adoption of SFAS 123(R). As required by SFAS 148 prior to the adoption of SFAS 123(R), we provided pro forma net income (loss) and pro forma net income (loss) per common share disclosures for stock-based awards, as if the fair value-based method defined in SFAS 123 had been applied.

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The following table illustrates the effect on net income after tax and net income per common share as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three and nine months ended December 31, 2005 (in thousands, except per share amounts):

The fair value of stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for the three and nine months ended December 31, 2006 and 2005, respectively:

Our computation of expected volatility is based on a combination of historical and market-based implied volatility. Our computation of expected life is based on a combination of historical exercise patterns and certain assumptions regarding the exercise life of unexercised options adjusted for job level and demographics. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on our history and expectation of dividend payouts.

SFAS 123(R) also requires us to develop an estimate of the number of stock-based awards which will be forfeited due to employee turnover. Forfeitures are to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. We currently estimate our forfeiture rate to be 15%, which is based on an average of historical forfeitures.

SFAS 123(R) requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option pricing model was developed for use in estimating the fair value of short lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock.

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The following table summarizes our stock option activity for the nine months ended December 31, 2006 (in thousands, except share exercise prices and weighted average remaining contractual term):

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on options with an exercise price less than the Company’s closing stock price of $4.38 as of December 29, 2006 (the last trading day of our third quarter of fiscal 2007), which would have been received by the option holders had all option holders with in-the-money options exercised their options as of that date.

The weighted average fair value per share of options granted during the three and nine months ended December 31, 2006 was $2.27 and $2.73, respectively.

The following table summarizes the ranges of the exercise prices of outstanding and exercisable options at December 31, 2006:

As of December 31, 2006, we had $3.4 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options that will be recognized over the weighted average period of 1.9 years, compared to $4.3 million of total unrecognized, stock option related compensation expense, net of estimated forfeitures, at September 30, 2006.

Employee Stock Purchase Plan

The 1995 Employee Stock Purchase Plan provides that eligible employees may contribute up to 15% of their eligible earnings, through accumulated payroll deductions, toward the semi-annual purchase of our common stock at 85% of the fair market value of the common stock at certain defined points in the plan offering periods. The estimated fair value of ESPP

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purchase rights is determined in an analogous manner to stock option rights and is amortized over the individual exercise periods, each of which currently is six months long. Net cash proceeds from the ESPP were $206,000 and $412,000 in the three and nine months ended December 31, 2006, respectively, compared to $165,000 and $365,000 in the corresponding periods a year ago.

Shares Available for Future Issuance under Employee Stock Compensation Plans

As of December 31, 2006, 1,734,664 shares were available for future issuance, which included 443,031 shares of common stock available for issuance under our Employee Stock Purchase Plan, 32,000 under the UK sub-plan of our 1995 Employee Stock Option Plan and 1,259,633 under our 2004 Omnibus Incentive Compensation Plan.

4. Stock Issuances

During the three and nine months ended December 31, 2006, we issued the following shares of common stock under our employee stock option and employee stock purchase plans:

5. Net Income (Loss) Per Share

The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share data):

Options to purchase 4,278,287 shares of common stock were outstanding during the three months ended December 31, 2006, 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 closing share trading price reported by Nasdaq (“Average Trading Price”) of the common shares during the period. Due to our net loss for the nine months ended December 31, 2006, all of our outstanding options were excluded from the diluted loss per share calculation because their inclusion would have been anti-dilutive. If we had earned a profit during the nine months ended December 31, 2006, we would have added 139,952 common equivalent shares to our basic weighted average shares outstanding to compute the diluted weighted average shares outstanding.

Options to purchase 403,122 and 1,199,543 shares of common stock were outstanding during the three and nine months ended December 31, 2005, 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 Trading Price during each of the periods ended December 31, 2005. For the three and nine months ended December 31, 2005, all outstanding warrants were included in the computation of diluted earnings per share, because the exercise prices of the warrants were less than the Average Trading Price of the common shares during the periods.

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Net income (loss) for the three and nine months ended December 31, 2006 included stock-based compensation expense under SFAS 123(R) of $770,000 and $2.3 million, net of tax, respectively, related to employee and director stock options and employee stock purchases (ESPP). There was no stock-based compensation expense related to employee and director stock options and employee stock purchases (ESPP) under SFAS 123 for the three and nine months ended December 31, 2005 because we did not adopt the recognition provisions of SFAS 123. See Note 3 for additional information.

6. Business Combination

On April 13, 2006, we acquired Arques Technology, Inc. (“Arques”) a privately-held California Corporation and fabless manufacturer of analog semiconductor devices. The acquisition adds white LED drivers for mobile handsets and double data rate (DDR) memory voltage regulators for digital consumer electronics products to our product line and enables us to leverage Arques’ proprietary FlexBoost^TM technology. Additionally, our R&D capabilities will be enhanced with the added expertise of Arques’ workforce. The cost of the acquisition was approximately $8.4 million, comprised of (a) approximately $5.6 million paid at closing to Arques shareholders, (b) approximately $1.8 million related to costs of the transaction, including assumption of Arques transaction-related costs in lieu of a portion of the payment due to the shareholders and (c) another approximately $1.0 million which CMD retained and committed to pay to Arques shareholders in 12 months, as reduced by intervening indemnification obligations of Arques to CMD. In addition, the definitive merger agreement calls for CMD to pay an earn-out, 80% to Arques shareholders and 20% to certain Arques employees, in approximately 18 months, as reduced by intervening unpaid indemnification obligations of Arques to CMD.

We allocated the purchase price to tangible assets, liabilities and identifiable intangible assets acquired, as well as in-process research and development (IPR&D), based on their estimated fair values. The excess of purchase price over the aggregate fair values was recorded as goodwill. The fair value assigned to identifiable intangible assets acquired was based on estimates and assumptions determined by management. Purchased intangibles are amortized on a straight-line basis over their respective useful lives. The total preliminary allocation of the purchase price is as follows (in thousands):

The value of acquired IPR&D, which was expensed immediately, was determined based on the expected cash flow attributed to the in-process projects, taking into account revenue that was attributable to previously developed technology, the level of effort to date in the in-process research and development, the percentage of completion of the project and the level of risk associated with commercializing the in-process technology. The projects identified as in-process were those that were underway as of the acquisition date and that would, post acquisition, require additional effort in order to establish technological feasibility and that would have no alternative future uses. These projects had identifiable technological risk factors that indicated at the time of acquisition that even though successful completion was expected, it was not assured.

Intangible assets consist of acquired developed and core technology and acquired distributor relationships. Developed and core technology will be amortized over an estimated useful life of four years. The value attributed to the acquired distributor relationships was based upon the expected costs to replace such customers and will be amortized over its estimated useful life of two years.

Pro forma results

The unaudited financial information in the table below summarizes the combined results of operations of CMD and Arques, on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. CMD’s results of operations for the three and nine months ended December 31, 2006 include the results of Arques since April 13, 2006, the date of acquisition. The unaudited pro forma financial information for the three and nine months ended December 31, 2006 combines the results for CMD for the three and nine months ended December 31, 2006, including Arques subsequent to April 13, 2006 and the historical results for Arques from April 1, 2006 to April 13, 2006. The unaudited pro forma financial information for the three and nine months ended December 31, 2005 combines CMD’s results for the three and nine

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months ended December 31, 2005 with Arques’ results for the same periods. The pro forma financial information presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented (in thousands, except for per share amounts):

7. Goodwill and Other Intangible Assets

Goodwill

Goodwill as of December 31, 2006, relates entirely to our purchase of Arques Technology, Inc. in April 2006. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets: (“SFAS 142”) goodwill is tested for impairment on annual basis, or earlier if indicators of impairment exist. During the three months ended December 31, 2006, we determined that there were no current indicators of impairment. We plan to perform our annual test for impairment of goodwill during our fourth fiscal quarter.

Purchased Intangible Assets

The components of purchased intangible assets as of December 31, 2006 were as follows (in thousands):

The amortization expense for acquired developed and core technology and acquired distributor relationships was $41,000 and $117,000 for the three and nine months ended December 31, 2006, respectively. Based on purchased intangible assets recorded at December 31, 2006, and assuming no subsequent additions to, or impairment of, the underlying assets, the future estimated amortization expense is approximately $42,000, $168,000, $131,000 and $131,000 in the remainder of 2007, 2008, 2009 and 2010, respectively.

In assessing the recoverability of goodwill and purchased intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. It is reasonably possible that these estimates, or their related assumptions, may change in the future, in which case we may be required to record additional impairment charges for these assets.

8. Line of Credit and Long Term Debt

On September 30, 2004, we entered into a loan agreement with Silicon Valley Bank for a $15 million credit line with an initial term of one year. We granted the bank a continuing security interest in all of our assets other than our intellectual property. The agreement prohibited our paying cash dividends. Borrowings under this agreement had interest at the current prime rate, and interest was payable monthly. The bank had the option to withdraw the commitment if we failed to comply with the covenants, if there was a material adverse change in our business, operations or condition, if we became insolvent or if other specified events or conditions have occurred. The agreement expired on September 28, 2005. On October 24, 2005, we entered into an amended loan agreement with Silicon Valley Bank which extended the $15 million

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credit line for one year from the original September 28, 2005 termination date, with terms substantially the same as the original. The credit line agreement expired on September 28, 2006 and we are currently negotiating with the Silicon Valley Bank to extend the credit Facility. We did not borrow against the credit line during the nine months ended December 31, 2006.

In September 2004, we entered into a three year software lease with Synopsys at an interest rate of 5%. We accounted for the agreement as a capital lease. Under the agreement, we made the first two of three annual lease payments of $82,000 in October 2004 and October 2005, respectively. In October, 2006, we terminated the original lease agreement and entered into a new agreement with Synopsys. The capitalized amount associated with the new lease is $362,000. Concurrently, we also entered into a capital lease agreement with Applied Wave Research, for which the capitalized amount is $34,000. The imputed interest rate for each of these leases is approximately 8%. Both leases have three year durations, with three annual lease and maintenance payments in October 2006, October 2007 and October 2008, totaling to $162,000 annually. The outstanding capital lease obligation as of December 31, 2006 was $264,000. Interest expense on the lease during the three and nine months ended December 31, 2006 was $1,000 and $6,000, respectively.

Total fixed assets purchased under capital leases and the associated accumulated amortization was as follows (in thousands):

Amortization expense for fixed assets purchased under capital leases is included in the line item titled “Depreciation and amortization” on our Condensed Consolidated Statements of Cash Flows.

9. Short-Term Investments

Cash and cash equivalents represent cash and money market funds.

Short-term investments represent investments in certificates of deposit and debt securities with remaining maturities less than one year. We invest our excess cash in high quality financial instruments. We have classified our marketable securities as available for sale securities. Our available for sale securities have contractual maturities of 365 days or less and are carried at fair value, with unrealized gains and losses reported in a separate component of shareholders’ equity. Realized gains and losses on available for sale securities are included in other income, net. We monitor our investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other than temporary, an impairment charge is recorded and a new cost basis for the investment is established. Net interest on securities classified as available for sale is also included in other income, net. The cost of securities sold is based on the specific identification method.

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

10. Inventories

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

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11. Contingencies

Environmental

We have been subject to a variety of federal, state and local regulations in connection with the discharge and storage of certain chemicals used in our manufacturing processes, which are now fully outsourced to independent contract manufacturers. We had obtained all necessary permits for such discharges and storage, and we believe that we have been in substantial compliance with the applicable environmental regulations. Industrial waste generated at our facilities was either processed prior to discharge or stored in double-lined barrels until removed by an independent contractor. With the completion of our Milpitas site remediation and the closure of our Tempe facility during fiscal 2005, we now expect our environmental compliance costs to be minimal.

Guarantees

We enter into certain types of contracts from time to time that require us to indemnify parties against third party claims. These contracts primarily relate to (1) certain agreements with our directors and officers under which we may be required to indemnify them for, the liabilities arising out of their efforts on behalf of the company; and (2) agreements under which we have agreed to indemnify our contract manufacturers and customers for claims arising from intellectual property infringement. The conditions of these obligations vary and generally a maximum obligation is not explicitly stated. Because the obligated amounts under these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. We have not recorded any associated obligations at December 31, 2006. We carry coverage under certain insurance policies to protect ourselves in the case of any unexpected liability; however, this coverage may not be sufficient.

Product Warranty

We typically provide a one-year warranty that our products will be free from defects in material and workmanship and will substantially conform in all material respects to our most recently published applicable specifications although sometimes we provide shorter or longer warranties. We have experienced minimal warranty claims in the past, and we accrue for such contingencies in our sales returns and allowances reserve.

12. Significant Customers

A significant portion of our revenue is derived from a relatively small number of customers. For the three and nine months ended December 31, 2006, two original equipment manufacturer (OEM) customers each represented more than 10% of our net revenue for a combined total of 55% and 55% of our net revenue, respectively. For the three and nine months ended December 31, 2005, one OEM customer accounted for approximately 44% and 41% of our net revenue, respectively. In addition, two distributors accounted for approximately 21% and 17% our net revenue for the three and nine months ended December 31, 2006, respectively. One distributor accounted for approximately 12% and 13% of our net revenue for the three and nine months ended December 31, 2005, respectively.

13. Income Taxes

We recorded income tax provisions of $23,000 and $692,000 for federal, state and foreign income taxes for the three and nine months ended December 31, 2006, respectively. For the three and nine months ended December 31, 2005, we recorded income tax provisions of $52,000 and $129,000, respectively, for federal and state income taxes. Our effective tax rate differs from the statutory rate primarily due to IPR&D, amortization of purchased intangible assets and SFAS 123(R) stock-based compensation expense as well as our ability to utilize loss carry forwards and other credits, limited by alternative minimum tax provisions.

We are required to estimate our income taxes in each federal, state and international jurisdiction in which we operate. This process requires that we estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets. Deferred tax assets are recognized based on the expected realization of available net operating loss carryforwards. A valuation allowance is recorded to reduce a deferred tax asset to an amount that we expect to realize in the future. We continually review the adequacy of the valuation allowance and recognize a benefit if a reassessment indicates that it is more likely than not that these benefits

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will be realized. As of March 31, 2006, we determined that it is more likely than not that $2.7 million of the deferred tax asset will be utilized and accordingly we have reduced the valuation allowance by $2.7 million. The net deferred tax asset decreased to $2.2 million as of December 31, 2006 primarily due to lower income than expected in the first three quarters of fiscal 2007. We will continue to assess the realizability of the deferred tax asset based on actual and forecasted operating results.

14. Comprehensive Income (Loss)

Comprehensive income (loss) is principally comprised of net income (loss) and unrealized gains (losses) on our available for sale securities. Comprehensive income (loss) for the three and nine months ended December 31, 2006 and 2005 was as follows (in thousands):

15. Recent Accounting Pronouncements

In July 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation, and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently in the process of evaluating the impact of FIN 48 on our financial position and results of operations.

In September 2006, the SEC released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides interpretive guidance on the SEC’s views regarding the process of quantifying materiality of financial statement misstatements. SAB 108 is effective for fiscal years ending after November 15, 2006, with early application preferable for the first interim period ending after November 15, 2006. We do not believe that the application of SAB 108 will have a material effect on our results of operations or financial position.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently assessing the impact that SFAS 157 will have on our results of operations and financial position.

16. Subsequent Event

On January 24, 2007, we entered into agreement with SPEL Semiconductor Limited (“SPEL”), who currently provides packaging and testing of TDFN semiconductor devices for us, for SPEL to expand these services to include UDFN and uUDFN packages. As part of the agreement, we will purchase and consign to SPEL approximately $2.2 million of equipment in exchange for discounted pricing on SPEL packaging services. Once SPEL has provided us with cumulative discounts equal to the cost of the consigned equipment, title to the equipment will be transferred to SPEL.

In this discussion, “CMD,” the “Company”, “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 other financial information and financial statements and related notes contained elsewhere in this report.

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Forward Looking Statements

This discussion 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 plan to examine the significant goodwill we recorded from our acquisition of Arques Technology for impairment based on expected future return; (2) our view that we will continue to assess the realizability of the deferred tax asset based on actual and forecasted operating results; (3) 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; (4) our having a target gross margin, net of stock-based FAS 123(R) compensation expenses, of 39% to 41%; (5) our expectation that our research and development expenses and sales, general and administrative expenses, in both instance net of stock-based FAS 123(R) compensation expenses, will improve toward our targets of 9 to 10% and 15 to 16%, respectively;(6) our expectation that our gross margin for the three months ending March 31, 2007, excluding SFAS 123R stock based compensation expense, will fall below our long-range target due to certain near term factors such as decreased revenues and a product mix shift to lower margin packaged parts from higher margin CSP parts. 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 core markets continue to experience growth and whether such growth continues to require the devices we supply; our ability 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 there will be any changes in tax accounting rules; whether our sales will increase at a faster rate than our expenses; and whether we will have large unanticipated cash requirements, as well as other risk factors detailed in this report, especially under Risk Factors, Item 1A of Part II. 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 and mixed signal semiconductor products for high volume applications in the mobile handset, digital consumer electronics and personal computer markets. We are a leading supplier of Application Specific Integrated Passives (ASIP™) protection devices for mobile handsets that provide Electromagnetic Interference (EMI) filtering and Electrostatic Discharge (ESD) protection and of low capacitance ESD protection devices for digital consumer electronics and personal computers. Both types of protection devices are typically used to protect various interfaces, both external and internal, used in our customers’ products. Our protection products are built using our proprietary silicon manufacturing process technology and provide the function of multiple discrete passive components in a single silicon chip. They occupy significantly less space, cost our customers less on a total cost of ownership basis, offer higher performance and are more reliable than traditional solutions based on discrete passive components. Some of these devices also include active circuit analog elements that provide additional functionality.

We also offer application specific active analog and mixed signal ICs for mobile handset displays including serial interface display controllers and white LED drivers. These products use industry standard silicon manufacturing process technology.

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.

We are completely fabless, using independent providers of wafer fabrication services. We operate in one operating segment and the bulk of our sales 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 contract wafer manufacturers, assemblers and test houses.

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On September 15, 2006, we reincorporated in Delaware from being previously incorporated in California by merging into a newly-created wholly-owned Delaware corporation subsidiary.

Results of Operations

Net Sales

Net sales by market were as follows (in millions):

Sales from products for the mobile handset market decreased by 16% and 8% for the three and nine months ended December 31, 2006, respectively, compared to the corresponding periods a year ago. The decrease was primarily due to price decline and a shift in product mix towards lower priced products partially offset by an increase in volume. Sales from products for the digital consumer electronics and personal computer market increased by 14% and 25% for the three and nine months ended December 31, 2006, respectively, compared to the corresponding periods a year ago. The increase was primarily driven by increased sales of our low capacitance ESD products, reflecting continued strong adoption of our PicoGuard and MediaGuard devices.

Our average unit price declined approximately 12% and 14% on a constant mix of products sold during the three and nine months ended December 31, 2006, respectively, compared to the corresponding periods a year ago.

Units sold during the three and nine months ended December 31, 2006 increased to approximately 255 million units and approximately 685 million units, respectively, from approximately 229 million and 589 million units in the three and nine months ended December 31, 2005, respectively.

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Comparison of 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 and nine months ended December 31, 2006 and 2005 (in thousands):

Stock-Based Compensation Expense

On April 1, 2006, we adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee and director stock options and employee stock purchases under the ESPP based on estimated fair values. The following table summarizes stock-based compensation expense related to employee and director stock options and employee stock purchases under SFAS 123(R) for the three and nine months ended December 31, 2006 which was expensed as follows (in thousands):

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Gross Margin

Gross margin decreased by $911,000 for the three months ended December 31, 2006 compared to the three months ended December 31, 2005 due to the following reasons:

Gross Margin Increase (Decrease), in thousands

Gross margin decrease was driven by a 12% price decrease due to lower prices and unfavorable change in product mix, slightly offset by volume increase. Cost reductions were the results of improved production efficiency as a result of process improvement and shifting production from higher to lower cost subcontractors.

Gross margin increased by $578,000 for the nine months ended December 31, 2006 compared to the nine months ended December 31, 2005 due to the following reasons:

Gross Margin Increase (Decrease), in thousands

Gross margin increase was primarily driven by our cost reduction efforts and increase in the sales volume offset by lower prices. Cost reductions were the results of improved production efficiency as a result of process improvement and shifting production from higher to lower cost subcontractors.

Gross margin as a percentage of net sales decreased to 36% for the three months ended December 31, 2006 as compared to 37% for the three months ended December 31, 2005. Gross margin as a percentage of net sales increased to 38% for the nine months ended December 31, 2006 as compared to 37% for the nine months ended December 31, 2005. Excluding SFAS 123(R) stock-based compensation expense, our gross margin was 36% and 39% of sales for the three and nine months ended December 30, 2006 respectively. Our long-range gross margin target, excluding SFAS 123(R) stock-based compensation expense, remains 39% to 41%. However, our gross margin, excluding SFAS 123(R) stock based compensation expense, could fail to achieve this target range or could decline. In addition, we expect our gross margin for the three months ending March 31, 2007, excluding SFAS 123(R) stock based compensation expense, to fall below our long-range target due to certain near term factors such as decreased revenues and a product mix shift to lower margin packaged parts from higher margin CSP parts.

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 decrease and increase in total research and development expenses for the three and nine months ended December 31, 2006, compared to the three and nine months ended December 30, 2005 respectively, was due to the following reasons:

The decrease in prototypes, tooling, and other expenses for the three months ended December 31, 2006 was due to lower tooling expenses for protection products. For the three and nine months ended December 31, 2006, our research and development expenses, excluding SFAS 123(R) stock-based compensation expense, was 10% and 11% of sales, respectively. Our long term target for research and development expenses, excluding SFAS 123(R) stock-based compensation expense, is 9% to 10% of sales. We expect, based on our assumptions for future revenue growth that research and development expenses,

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excluding SFAS 123(R) stock based compensation expense, will approximate this target. However, if our sales were to fail to grow or even decline in future periods, such research and development expenses could continue to represent more than 10% of sales.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of compensation and related costs for employees, 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, 2006 compared to the three and nine months ended December 31, 2005 was due to the following reasons:

The increase in salary expense was primarily due to added marketing, selling and administrative resources associated with the Arques acquisition. The increase in employee related expenses was due to increased travel in sales and marketing. For the three and nine months ended December 31, 2006, our selling, general and administrative expenses, excluding SFAS 123(R) stock-based compensation expense, was 22% and 21% of sales, respectively. Our long term target for selling, general and administrative expenses, excluding SFAS 123(R) stock-based compensation expense, is 15% to 16% of sales. We expect, based on our assumptions for future revenue growth that selling, general and administrative expenses, excluding SFAS 123(R) stock based compensation expense, will approximate this target. However, if our sales were to fail to grow or even decline in future periods, such selling, general and administrative expenses could continue to represent more than 16% of sales.

Amortization of Purchased Intangible Assets. Amortization of purchased intangible assets of $41,000 and $117,000 in the three and nine months ended December 31, 2006, respectively, was related to the Arques acquisition. There was no amortization of purchased intangible assets in the corresponding periods a year ago. For additional information regarding purchased intangibles, see Note 6 and Note 7 to the Condensed Consolidated Financial Statements.

In-Process Research and Development. IPR&D expense for the three and nine months ended December 31, 2006 of zero and $2.2 million, respectively, was related to the Arques acquisition and was zero in the corresponding periods a year ago. The value of acquired IPR&D was determined based on the expected cash flow attributed to the in-process projects, taking into account revenue that was attributable to previously developed technology, the level of effort to date in the in-process research and development, the percentage of completion of the project and the level of risk associated with commercializing the in-process technology. The projects identified as in-process were those that were underway as of the acquisition date and that will, post acquisition, require additional effort in order to establish technological feasibility and have no alternative future uses. These projects had identifiable technological risk factors at the time of acquisition that indicated that even though successful completion was expected, it was not assured. IPR&D was entirely expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. We do not expect future IPR&D expenses related to the Arques acquisition.

Restructuring Charges. On October 19, 2004 our Board of Directors approved a plan to close our manufacturing operation in Tempe, Arizona and other associated activities. The plan identified employees to be terminated, impaired assets and other shutdown costs. As of March 31, 2006, we had completed all activities associated with the Restructuring Plan. Restructuring expense was ($1,000) and $59,000 for the three and nine months ended December 31, 2005, respectively. There was no restructuring expense for three and nine months ended December 31, 2006.