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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended June 30, 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):

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 outstanding as of July 31, 2006 was 23,008,031.

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California Micro Devices Corporation

Form 10-Q for the Quarter ended June 30, 2006

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

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

Item 1. Financial Statements (Unaudited)

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 June 30, 2006, and the results of operations for the three month periods ended June 30, 2006 and 2005, and cash flows for the three month periods ended June 30, 2006 and 2005. Results for the three month periods are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending March 31, 2006.

On April 13, 2006, we acquired Arques Technology, Inc. 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.

2. Use of Estimates

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

3. Share 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 generally have a vesting period of 48 months 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 June 30, 2006, our stock option plans consisted of the 2004 Omnibus Incentive Compensation Plan, the 1995 Employee Stock Option Plan and the 1995 Non-Employee Directors Plan. 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 plans 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 share-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 months ended June 30, 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.

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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.

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 months ended June 30, 2006 was as follows (in thousands, except per share amounts):

Net cash proceeds from the exercise of stock options were $358,000 for the three months ended June 30, 2006, compared to $18,000 for the same period a year ago. No income tax benefit was realized from stock option exercises during each of the three-month periods ended June 30, 2006 and 2005. In accordance with SFAS 123(R), we present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.

The following table illustrates the effect on net income (loss) after tax and net income (loss) per common share as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three months ended June 30, 2005 (in thousands, except per share amounts):

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The fair value of stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for the three months ended June 30, 2006 and 2005, respectively:

Our computation of expected volatility for the three months ended June 30, 2006 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 share-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 9%, which is based on an analysis of expected forfeiture data using our current demographics and probabilities of employee turnover.

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.

Stock option activity for the three months ended June 30, 2006, is as follows (in thousands, except share prices):

The weighted average estimated value of employee stock options granted during the three months ended June 30, 2006 was $4.01 per share.

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The following table summarizes the ranges of the exercise prices of outstanding and exercisable options at June 30, 2006:

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 $4.00 as of June 30, 2006, 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.

As of June 30, 2006, we had $3.8 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options that will be recognized over the weighted average period of 2.6 years.

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 purchase rights is determined in an analogous manner to stock option rights and is amortized over the individual exercise periods comprising the option period, each of which currently is six months long. We issued 34,038 and 64,377 shares under the ESPP during the three months ended June 30, 2006 and 2005, respectively. Net cash proceeds from the ESPP were $206,000 for the three months ended June 30, 2006, compared to $200,000 for the same period a year ago.

Shares Available for Future Issuance under Employee Stock Compensation Plans

As of June 30, 2006, 1,223,291 shares were available for future issuance, which included 96,558 shares of common stock available for issuance under our Employee Stock Purchase Plan, 41,000 under the UK sub-plan of our 1995 Employee Stock Option Plan and 1,085,733 under our 2004 Omnibus Incentive Compensation Plan.

4. Net Income (Loss) Per Share

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

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Due to our net loss for the three months ended June 30, 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 three months ended June 30, 2006, we would have added 250,807 common equivalent shares to our basic weighted-average shares outstanding to compute the diluted weighted-average shares outstanding.

Options to purchase 2,542,211 shares of common stock were outstanding during the three months ended June 30, 2005, 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 three months ended June 30, 2005.

Net income for the three months ended June 30, 2006 included stock-based compensation expense under SFAS 123(R) of $844,000, net of tax, related to employee and director stock options and employee stock purchases. There was no stock-based compensation expense related to employee and director stock options and employee stock purchases under SFAS 123 for the three months ended June 30, 2005 because we did not adopt the recognition provisions of SFAS 123. See Note 3 for additional information.

5. Inventories

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

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 technology. Additionally, our R&D capabilities will be enhanced with the added expertise of Arques’ workforce. The cost of the acquisition is approximately $8.5 million, comprised of (a) approximately $5.6 million paid at closing to Arques shareholders, (b) approximately $1.9 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

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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 have identifiable technological risk factors that indicate that even though successful completion is expected, it is 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 months ended June 30, 2006 include the results of Arques since April 13, 2006, the date of acquisition. The unaudited pro forma financial information for the three months ended June 30, 2006 combines the results for CMD for the three months ended June 30, 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 months ended June 30, 2005 combines CMD’s results for the three months ended June 30, 2005 with Arques’ results for the same period. 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. Income Taxes

We recorded income tax provisions of $204,000 and $14,000 for federal and state income taxes for the three months ended June 30, 2006 and 2005, respectively. Our effective tax rate was (11%) and 3%, respectively for the three months ended June 30, 2006 and 2005, respectively. The effective tax rate differs from the statutory rate primarily due to IPR&D, amortization of purchased intangible assets and SFAS 123(R) stock compensation expense as well as our ability to utilize loss carryforwards and other credits, limited by alternative minimum tax provisions.

As of the end of fiscal 2006, we had recorded an adjustment reducing our valuation allowance against deferred tax assets which represents potential reduced taxes in the future resulting from the potential utilization of our loss carryforwards should we realize taxable income in the future. Because of the uncertainty of being able to realize that deferred tax asset, we had established a valuation allowance against it in prior years. Until March 31, 2006, that valuation allowance had been equal to the full amount of the deferred tax asset. 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 $2.7 million of the valuation allowance. No changes were made to the allowance in the three months ended June 30, 2006. We will continue to assess the realizability of the deferred tax asset based on actual and forecasted operating results.

8. Long Term Debt

On September 30, 2004, we entered into an amended loan agreement with Silicon Valley Bank. Under this one year agreement, for which there were $55,000 of commitment and related fees, the bank provided a $15 million credit line, subject to financial and other covenants contained in the agreement. 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 credit line for one year from the original September 28, 2005 termination date. There were $11,000 of associated fees for the one year facility. We granted the bank a continuing security interest in all of our assets other than our intellectual property. The

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agreement prohibits our paying cash dividends. Borrowings under this agreement bear interest at the current prime rate, and interest is payable monthly. The bank may withdraw the commitment if we fail to comply with the covenants, if there is a material adverse change in our business, operations or condition, if we become insolvent or if other specified events or conditions occur. At June 30, 2006, no amounts were outstanding under the loan agreement.

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 have made the first two of three annual lease payments of $82,000 in October 2004 and October 2005, respectively. The amount capitalized is $246,000. The outstanding capital lease obligation as of June 30, 2006 was $82,000 and prepaid interest was $2,000. Interest expense on the lease during the three months ended June 30, 2006 was $3,000.

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 and declines in value judged to be other than temporary, if any, on available for sale securities are included in other income (expense). Net interest on securities classified as available for sale is also included in other income (expense), net. The cost of securities sold is based on the specific identification method.

Short term investments were as follows (in thousands):

10. Comprehensive Income (Loss)

Comprehensive income is principally comprised of net income and unrealized gains or losses on our available for sale securities. Comprehensive income for the three months ended June 30, 2006 and 2005 was as follows (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 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 June 30, 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. Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”). SFAS 155 allows any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to be carried at fair value in its entirety, with changes in fair value recognized in earnings. In addition, SFAS 155 requires that beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or contain an embedded derivative. SFAS 155 also eliminates a prior restriction on the types of passive derivatives that a qualifying special purpose entity is permitted to hold. SFAS 155 is applicable to new or modified financial instruments in fiscal years beginning after September 15, 2006, though the provisions related to fair value accounting for hybrid financial instruments can also be applied to existing instruments. The adoption of SFAS 155 is not expected to have a material impact on our financial statements.

13. Significant Customers

A significant portion of our revenue is derived from a relatively small number of customers. For the three months ended June 30, 2006, two OEM customers each represented more than 10% of our net revenue. For the three months ended June 30, 2005, two OEM customers each represented more than 10% of our net revenue. In addition, one distributor accounted for approximately 10% of our net revenue for the three months ended June 30, 2006, and two distributors each represented more than 10% of our net revenue for the three months ended June 30, 2005.

14. Stock Issuances

During the three months ended June 30, 2006 and 2005, we issued the following shares of common stock under our employee stock option and employee stock purchase plans:

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

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 the other financial information and financial statements and related notes contained elsewhere in this report.

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 expectations that international sales will continue to represent a majority of our sales for the foreseeable future; (2) we will examine the significant goodwill we recorded from our acquisition of Arques Technology for impairment based on expected future return; (3) our view that we will continue to assess the realizability of the deferred tax asset based on actual and forecasted operating results; (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 expectation that our average unit sales price for like products will decline approximately 15% per year; (6) our expectation that our gross margin will improve toward and reach our long term target range of 39% to 41%; our expectation that our research and development expenses and sales, general and administrative expenses, in both instance net of stock-based FAS 135R compensation expenses, will improve toward our targets of 9 to 10% and 15 to 16%, respectively . 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 semiconductor products for high volume applications in the mobile handset, personal computer and digital consumer electronics markets, which we describe as our core markets. We are a leading supplier of application specific integrated passive (ASIP™) devices for mobile handsets that provide electromagnetic interference (EMI) filtering and electrostatic discharge (ESD) protection and of ASIP devices for personal computers, personal computer peripherals and digital consumer electronics that provide low capacitance ESD protection. Both types of ASIP devices are used primarily to protect various interfaces, both external and internal, used in our customers’ products. Our ASIP devices, built using our proprietary silicon manufacturing process technology, provide the function of multiple passive components in a single chip solution. They occupy significantly less space, cost our customers less, taking into account the total cost of implementation, and offer increased performance and reliability compared to traditional solutions based on discrete passive components. Some of our ASIP devices also integrate active analog elements to provide additional functionality.

We also offer selected active analog devices that complement our ASIP devices. They include white LED drivers for mobile handsets and Double Data Rate (DDR) memory voltage regulators for digital consumer electronics. Our active analog device solutions use industry standard manufacturing processes for cost effectiveness.

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 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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Results of Operations

Net sales

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

Our growth in sales from products for the mobile handset market was the result of increased sales to our top five OEM customers partially offset by decreased sales to other customers. Sales from products for the personal computer and digital consumer market increased by 28% for the three months ended June 30, 2006 compared to the three months ended June 30, 2005. 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 16% on a constant mix of products sold during the three months ended June 30, 2006 compared to the same period a year ago. In the future we continue to expect our average unit selling price for like products to decline at a rate of approximately 15% per annum.

Units shipped during the three months ended June 30, 2006 increased to approximately 197 million units from approximately 160 million units during the three months ended June 30, 2005.

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 months ended June 30, 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 share-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 months ended June 30, 2006 which was allocated as follows (in thousands):

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Gross Margin

Gross margin increased by $1.0 million for the three months ended June 30, 2006 compared to the three months ended June 30, 2005 due to the following reasons:

The gross margin increase from volume was primarily driven by a 28% increase in sales of our products used in the personal computer and digital consumer electronics markets for the three months ended June 30, 2006. The increase in net inventory reserve was due to an increase in demand reserves and additional end of life product reserves on expected distributor returns. The cost reductions of products were the result of process cost reductions and lower subcontractor costs (both by sourcing with lower cost subcontractors and by cost reductions at existing subcontractors).

Gross margin as a percentage of net sales increased to 38% for the three months ended June 30, 2006, compared to 34% for the three months ended June 30, 2005. Our long range gross margin target, excluding SFAS 123(R) stock-based compensation expense, is 39% to 41%; for the three months ended June 30, 2006, our gross margin, excluding SFAS 123(R) stock-based compensation expense, was 38.7%. We expect, based on our assumptions for the size and timing of unit sales, unit pricing and cost reductions that our gross margin will improve toward and reach this target. However, if our assumptions were to be incorrect, our gross margin could fail to improve to our 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 increases in research and development expenses for the three months ended June 30, 2006, compared to the three months ended June 30, 2005 were due to the following reasons:

The increase in outside services was due primarily to outsourced design services for new products. The increase in salaries and benefits was the result of added R&D resources associated with the Arques acquisition. Our long term target for research and development expenses, excluding SFAS 123(R) stock-based compensation expense, is 9% to 10% of sales; for the quarter ended June 30, 2006, our research and development expenses, excluding SFAS 123(R) stock-based compensation expense, was 11.6% of sales. We expect, based on our assumptions for future revenue growth that research and development expenses will move toward this target. However, if our sales were to fail to grow or even decline in future periods, research and development expenses could fail to improve to our target range and could continue to represent more than 10% of sales.

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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 months ended June 30, 2006 compared to the three months ended June 30, 2005 were due to the following reasons:

The increase in salaries and benefits was primarily due to added marketing, selling and administrative resources associated with the Arques acquisition. Our long term target for selling, general and administrative expenses, excluding SFAS 123(R) stock-based compensation expense, is 15% to 16% of sales; for the quarter ended June 30, 2006, our selling, general and administrative expenses, excluding SFAS 123(R) stock-based compensation expense, was 22.8% of sales. We expect, based on our assumptions for future revenue growth that selling, general and administrative expenses will move toward this target. However, if our sales were to fail to grow or even decline in future periods, selling, general and administrative expenses could fail to improve to our target range and could continue to represent more than 16% of sales.

Amortization of Purchased Intangible Assets. Amortization of purchased intangible assets of $34,000 in the three months ended June 30, 2006 was related to the Arques acquisition. There was no amortization of purchased intangible assets in the three months ended June 30, 2005. For additional information regarding purchased intangibles, see Note 6 to the Condensed Consolidated Financial Statements.

In-Process Research and Development. IPR&D expense for the three months ended June 30, 2006 was $2.2 million related to the Arques acquisition, compared to zero in the same period a year ago. See Note 6 to the Condensed Consolidated Financial Statements for additional information regarding the Arques acquisition. 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 have identifiable technological risk factors that indicate that even though successful completion is expected, it is not assured. IPR&D was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed

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 and there was no more restructuring expense. Restructuring expense was $57,000 for the three months ended June 30, 2005.

Other income. The increase in other income is primarily due to an increase in interest income from $266,000 for the three months ended June 30, 2005 to $557,000 for the three months ended June 30, 2006. Interest expense and amortization of debt issuance costs decreased by approximately $13,000 for the three months ended June 30, 2006, compared with the same period a year ago. The increase in interest income resulted from increased interest rate and our having more cash as a result of positive cash flow from operations in the intervening year, the sale of Tempe related assets during the three months ended June 30, 2005 and issuance of common stock under our employee stock option and employee stock purchase plans as reduced by the cash outlay we made to acquire Arques.

Income Taxes. Our effective tax rate was (11%) and 3%, respectively for the three months ended June 30, 2006 and 2005. Excluding certain acquisition costs, namely IPR&D and amortization of purchased intangible assets and excluding SFAS 123(R) stock based compensation expense, our effective tax rate was 16% for the three months ended June 30, 2006. The effective tax rate differs from the statutory rate primarily due to our ability to utilize loss carryforwards and other credits, limited by alternative minimum tax provisions. For fiscal 2007 we expect our effective income tax rate to be 16% of profit before taxes excluding IPR&D, amortization of purchased intangible assets and stock-based compensation expense.

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Net Income (loss). For the reasons explained above, we realized a net loss of $2.1 million for the three months ended June 30, 2006 compared to net income of $468,000 for the three months ended June 30, 2005.

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. Actual results may differ materially from our estimates. Our significant accounting policies are described in Note 2 of Notes to Financial Statements. 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 (e.g., 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. At the end of each reporting period, the sufficiency of the reserve for sales returns and allowances is also assessed based on a comparison to authorized returns for which a credit memo has not been issued.

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 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”.

Inventory and Related Reserves

Forecasting customer demand is the factor in our inventory and related reserves policy that involves significant judgments and estimates. We establish a reserve for estimated excess and obsolete inventory based on a comparison of quantity and cost of inventory on hand to management’s forecast of customer demand for the next twelve months. In forecasting customer demand, we make estimates as to, among other things, the timing of sales, the mix of products sold to customers, the timing of design wins and related volume purchases by new and existing customers, and the timing of existing customers’ transition to new products. We also use historical trends as a factor in forecasting customer demand, especially that from our distributors. We review our reserve for excess and obsolete inventory on a quarterly basis considering the known facts. Once a reserve is established, it is maintained until the product to which it relates is sold or otherwise disposed of. To the extent that our forecast of customer demand materially differs from actual demand, our cost of sales and gross margin could be impacted.

Goodwill Impairment

We have accounted for goodwill and other intangible assets resulting from our Arques acquisition in accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment at least annually, and more frequently if there are indicators of impairment. An impairment loss is recognized if the sum of the expected undiscounted cash flows from the use of the asset is less than the carrying value of the asset. The amount of impairment loss is measured as the difference between the carrying value of the assets and their estimated fair value. The process for evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis. Should actual results differ from our estimates, revisions to the recorded amount of goodwill could be required.

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Stock-based Compensation

On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”). Under the fair value recognition provisions of SFAS 123(R), stock-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized as expense on a graded vesting schedule over the requisite service period of the award.

We estimate the value of employee stock options on the date of grant using a Black-Scholes model. Prior to the adoption of SFAS 123(R), the value of each employee stock option was estimated on the date of grant for the purpose of the pro forma financial information in accordance with SFAS 123. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The use of a Black-Scholes model requires the use of extensive actual employee exercise behavior data and the use of a number of complex assumptions including expected volatility, risk-free interest rate and expected dividends.

As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the three months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on an analysis of expected forfeiture data using our current demographics and probabilities of employee turnover.

Accounting for Income Taxes

As part of the process of preparing our financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheets. Under Statement of Financial Accounting Standard No. 109 (“SFAS 109”), we must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent that management believes recovery is not likely, we must establish a valuation allowance. To the extent that a valuation allowance is established or increased in a period, we include an expense within the tax provision in the statements of operations.

Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against the Company’s deferred tax assets. Until March 31, 2006, when we released $2.7 million of the valuation allowance, we had determined that, in part due to the our recent cumulative tax loss history for the previous three-year periods, income statement loss history over various quarters and years, and the transition to a fabless model and cessation of our Medical business and the resulting uncertainties, that it was necessary to maintain a full valuation allowance to net against its deferred tax assets.

Our methodology for determining the realizability of our deferred tax assets involves estimates of future taxable income; the estimated impact of future stock option deductions; and the expiration dates and amounts of net operating loss carryforwards. These estimates are based on near-term projections and assumptions which management believes to be reasonable.

In the event that actual results differ from these estimates or that these estimates are adjusted in future periods, we may need to adjust the amount of the valuation allowance based on future determinations of whether it is more likely than not that some or all of our deferred tax assets will be realized. A decrease in the valuation allowance through a partial or full release would be recorded as an income tax benefit or a reduction of income tax expense or a credit to stockholders’ equity whereas an increase in the valuation allowance would be recorded as an income tax expense. Our net operating losses available to reduce future taxable income expire on various dates from fiscal year 2012 through fiscal year 2024. To the extent that we generate taxable income in jurisdictions where the deferred tax asset relates to net operating losses that have been offset by the valuation allowance, the utilization of these net operating losses would result in the reversal of the related valuation allowance.

We will continue to assess the realizability of the deferred tax asset based on actual and forecasted operating results.

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Litigation

We are a party to lawsuits, claims, investigations, and proceedings, including commercial and employment matters, which are being handled and defended in the ordinary course of business. We review the current status of any pending or threatened proceedings with our outside counsel on a regular basis and, considering all the known relevant facts and circumstances, we recognize any loss that we consider probable and estimable as of the balance sheet date. For these purposes, we consider settlement offers we may make to be indicative of such a loss under certain circumstances. As of June 30, 2006, there were no accruals for settlement offers.

Liquidity and Capital Resources

We have historically financed our operations through a combination of debt and equity financing and cash generated from operations.

Total cash, cash equivalents and short term investments as of June 30, 2006 were $45.9 million compared to $49.7 million as of March 31, 2006, a decrease of $3.8 million due to cash payments related to the Arques acquisition partially offset by positive operating cash flow.

Despite net loss of $2.1 million for the three months ended June 30, 2006, operating activities provided $2.6 million of cash due primarily to a reduction in accounts receivable of $1.8 million and non-cash charges comprised principally of IPR&D of $2.2 million and SFAS 123(R) stock-based compensation expense of $844,000. In the three months ended June 30, 2005, operating activities provided $441,000 of cash, due primarily to net income of $468,000 and non-cash charges that included depreciation and amortization of $321,000, increases to inventory reserves of $111,000 which were reduced by an increase in accounts receivable of $2.0 million and a reduction in accounts payable and other current liabilities of $452,000.

Accounts receivable decreased to $8.9 million at June 30, 2006 compared to $10.7 million at March 31, 2006, primarily due to the lower level of sales. Receivables days of sales outstanding were 51 days and 55 days as of June 30, 2006 and March 31, 2006, respectively. Net inventory was $5.5 million as of June 30, 2006, comparable to that as of March 31, 2006. Inventory turns improved to 7.3 at June 30, 2006 from 6.7 at March 31, 2006.

Accounts payable and accrued liabilities totaled $9.8 million at June 30, 2006 compared to $9.1 million at March 31, 2006. The $700,000 increase was primarily the result of the remainder of the Arques purchase price held in escrow.

Investing activities during the three months ended June 30, 2006 used $4.2 million of cash, primarily reflecting the purchase of Arques Technology, funded partially by the net redemption of short-term investments. Investing activities during the three months ended June 30, 2005 used $6.6 million of cash, primarily as the result of purchases of short term investments including the investment of the $1.7 million of net proceeds from the sale of our Tempe facility.

Net cash provided by financing activities for the three months ended June 30, 2006 was $564,000 and was the result of net proceeds from the issuance of common stock under our stock option plans and the ESPP. Net cash provided by financing activities for the three months ended June 30, 2005 was $192,000 and was primarily the result of $218,000 of net proceeds from the issuance of common stock, partially offset by repayments of capital lease obligations of $26,000.

On September 30, 2004, we entered into an amended loan agreement with Silicon Valley Bank. Under this one year agreement, for which there were $55,000 of commitment and related fees, the bank provided a $15 million credit line, subject to financial and other covenants contained in the agreement. 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 credit line for one year from the original September 28, 2005 termination date. There were $11,000 of associated fees for the one year facility. We granted the bank a continuing security interest in all of our assets other than our intellectual property. The agreement prohibits our paying cash dividends. Borrowings under this agreement bear interest at the current prime rate and interest is payable monthly. The bank may withdraw the commitment if we fail to comply with the covenants, if there is a material adverse change in our business, operations or condition, if we become insolvent or if other specified events or conditions occur. At June 30, 2006, no amounts were outstanding under the loan agreement.

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The following table summarizes our contractual obligations as of June 30, 2006:

We anticipate that our existing cash, cash equivalents, short term investments and loan agreement will be sufficient to meet our anticipated cash needs for the next twelve months. Should we desire to expand our level of operations more quickly, either through increased internal development or through the acquisition of product lines from other entities, we may need to raise additional funds through public or private equity or debt financing. The funds may not be available to us, or if available, we may not be able to obtain them on terms favorable to us.

Off-Balance Sheet Arrangements

We do not have off balance sheet arrangements that have, or are reasonably likely to have, a current or future effect upon our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors, other than operating leases and purchase obligations shown above.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

As of June 30, 2006 we held $37.2 million of investments in short term, liquid debt securities. Due to the short duration and investment grade credit ratings of these instruments, we do not believe that there is a material exposure to interest rate risk in our investment portfolio. We do not own derivative financial instruments.

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

The table below presents principal amounts and related weighted average interest rates by year of maturity for our debt obligations and their fair value as of June 30, 2006. The fair value of our debt is based on the estimated market rate of interest for similar debt instruments with the same remaining maturities.

We have little exposure to foreign currency risk as most of our sales and expenditures are denominated in US dollars.

ITEM 4. Controls and Procedures

(a) Disclosure Controls and Procedures.

(i) Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

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(ii) Limitations on the Effectiveness of Disclosure Controls. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

(iii) Evaluation of Disclosure Controls and Procedures. The Company’s principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2006, and have determined that they were effective at the reasonable assurance level taking into account the totality of the circumstances, including the limitations described above.

(b) Changes in Internal Control over Financial Reporting

Our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) is designed to provide reasonable assurance regarding the reliability of our financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles. There were no significant changes in the Company’s internal control over financial reporting that occurred during our first quarter of fiscal 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

None

ITEM 1A. Risk Factors

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

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

We incurred a quarterly loss on a GAAP basis during the first quarter of fiscal 2007, ending a string of four quarters of quarterly profit during fiscal 2006, which had been preceded by a loss in the quarter ended March 31, 2005, and quarterly losses for ten consecutive quarters beginning with the quarter ended March 31, 2001 and ending with the quarter ended June 30, 2003. We may not be able to return to profitability or thereafter to sustain it.

After seven quarters of profitability, we incurred a loss of $1.0 million for the quarter ended March 31, 2005. Prior to achieving profitability in the second quarter of fiscal 2004, we had been unprofitable for ten consecutive quarters, incurring a cumulative loss of $36.4 million more than doubling our accumulated deficit from $31.3 million to $67.7 million. We were then profitable for the four quarters during fiscal 2006 until we sustained a substantial GAAP loss of nine cents per share during the first quarter of fiscal 2007. This GAAP loss would have been a one cent per share profit but for the one time in-process research and development charge we incurred due to our acquisition of Arques Technology, Inc. There are many factors that affect our ability to sustain profitability including the health of the mobile handset, personal computer and digital consumer markets on which we focus, continued demand for our products from our key customers, availability of capacity from our manufacturing subcontractors, ability to reduce manufacturing costs faster than price decreases thereby attaining a healthy gross margin, continued product innovation and design wins, and our continued ability to manage our operating expenses. In order to obtain and sustain profitability on a GAAP basis in the long term, we will need to continue to grow our business in our core markets and to reduce our product costs rapidly enough to maintain our gross margin. The semiconductor industry has historically been cyclical, and we may be subject to such cyclicality, which could lead to our incurring losses again.

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

Our sales strategy has been to focus on customers with large market shares in their respective markets. As a result, we have several large customers. During the first quarter of fiscal 2007, two customers in the mobile handset market represented 53% of our net sales. There can be no assurance that these two customers will purchase our products in the future in the quantities we have forecasted, or at all.

During the first quarter of fiscal 2007, one distributor represented 10% of our net sales. If we were to lose that distributor, we might not be able to obtain another distributor to represent us or a new distributor might not have sufficiently strong relationships with the current end customers to maintain our current level of net sales. Additionally, the time and resources involved with the changeover and training could have an adverse impact on our business in the short term.

We currently rely heavily upon a few core markets for the bulk of our sales. If we are unable to further penetrate the mobile handset, personal computer and digital consumer electronics markets, our revenues could stop growing and might decline leading us to reduce our investment in research and development and marketing.

Our revenues in recent periods have been derived from sales to manufacturers of mobile handsets, personal computers and peripherals, and digital consumer electronics. In order for us to be successful, we must continue to penetrate the mobile handset, personal computer and digital consumer electronics markets, both by obtaining more business from our current customers and by obtaining new customers. Due to our narrow market focus, we are susceptible to materially lower revenues due to material adverse changes to one of these markets. For example, should growth not occur in the markets we have penetrated, our future revenues could be adversely impacted.

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More than seventy percent of our revenues in the first quarter of fiscal 2007 were from sales to the mobile handset market. If sales of mobile handsets decline, and in particular if sales by our mobile handset customers decline, our future revenues could stop growing and might decline. This might cause us to choose to cut our spending on research and development and marketing to reduce our loss or to avoid operating at a loss which could further adversely affect our future prospects.

The fastest growing market for our products has been the mobile handset market. A slowdown in the adoption of ASIPs by mobile handset manufacturers would reduce our future growth in that market.

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

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

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

Because we operate in different semiconductor product markets, we generally encounter different competitors in our various market areas. Within the ASIP product families for the mobile handset, personal computer and digital consumer electronic markets, we compete with ON Semiconductor Corporation, Royal Philips Electronics N.V., Semtech Corporation and STMicroelectronics, N.V. For EMI filter ASIP devices used in mobile handsets, we also compete with ceramic devices based on high volume Multi-Layer Ceramic Capacitor (MLCC) technology from companies such as Amotek Company, Ltd., AVX Corporation, Innochip Technology, Inc., Murata Manufacturing Co., Ltd., and TDK Corp. MLCC devices are generally low cost and our revenues would suffer if their features and performance meet the requirements of our customers and we are unable to reduce the cost of our ASIP products sufficiently to be competitive. We have recently seen ceramic filters obtain significant design wins for low end applications in the mobile handset market. We have also seen the use of higher performance ceramic filters and if we are not able to demonstrate superior performance at an acceptable price with our devices then our revenues would also suffer. In the active analog device area, our competitors include Advanced Analogic Technologies, Inc., Liner Technology Corp., Maxim Integrated Products, Inc., National Semiconductor Corp., and Semtech Corp. Many of our competitors are larger than we are, have substantially greater financial, technical, marketing, distribution and other resources than we do and have their own facilities for the production of semiconductor components.

One of our competitive advantages for our mobile ASIP products may be lessening as some of our customers choose to use plastic packages rather than chip scale packaging. This could lead to our customers purchasing products from our competitors rather than us or to our having to reduce prices, thereby decreasing our revenues.

Among our competitive advantages for our ASIP products, which comprise the dominant portion of our products sold in the mobile handset market, has been our rapid adoption of chip scale packaging (CSP) with respect to which our early entry and high volume has allowed us to gain advantage over competitors. Certain customers have indicated a preference for the use of plastic packages rather than CSP and the percentage of our mobile ASIP products using CSP packaging has declined by approximately 6% during fiscal 2006. Should this preference become more widespread, then packaging could cease to give us a competitive advantage and could even become an area in which we are somewhat competitively disadvantaged, since some of our competitors have high volume internal packaging operations, unless we are able to match their capabilities and cost structure using merchant suppliers. This could lead to our losing sales or to reducing prices, thereby decreasing our revenues.

We determined that we had material weaknesses in our internal control over financial reporting as of March 31, 2005, one of which was still continuing as of December 31, 2005. As a result, we had to implement supplemental compensating procedures to determine that our financial statements are reliable. These material weaknesses, and any future adjustment to our financial statements which may result from them, could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on Form 10-K for the fiscal year ending March 31, 2005, and annually thereafter, we are required to furnish a report by our management on our internal control over financial reporting. Such report will contain, among other matters, a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Such report must also contain a statement that our auditors have issued an attestation report on management’s assessment of such internal controls.

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As of March 31, 2005, management identified, and the auditors attested to, material weaknesses in the Company’s internal control over financial reporting, in the operating effectiveness within a portion of the revenue cycle and in the controls over the proper recognition of subcontractor invoices related to inventory and accounts payable. Management believed it had subsequently remediated these material weaknesses; however, while reviewing our fiscal 2006 third quarter financial results, our independent accountants identified some quarter-end vendor invoices which had not been accrued for in the proper quarter, which in turn led us to discover further such mis-timed invoice accruals. We believe these mis-timed accruals, which evidenced a continuing material weakness in this control, resulted not from a problem with the fundamental design of the control process but rather the operation of the control process, as Company personnel were not following the prescribed procedures for the accrual of services performed but not invoiced or for the analysis and encoding of invoices, and the management review in both instances was inadequate. We have replaced and trained the clerical personnel who perform much of this work and we have provided additional training to the other personnel involved, and management has begun to review their work more carefully. We have also enhanced our review of open purchase orders in an effort to reduce their number. During the required assessment of our internal control over financial reporting as of March 31, 2006, we concluded that we have remediated the material weaknesses which were discovered in previous periods to which our auditors have attested. However, should we or our auditors discover that we have a material weakness in our internal control over financial reporting at another time in the future, especially considering that we have had material weaknesses in the past which we incorrectly believed had been remediated, investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.

Deficiencies in our internal controls could cause us to have material errors in our financial statements, which could require us to restate them. Such restatement could have adverse consequences on our stock price, potentially limiting our access to financial markets.

In March, 2003 and in December, 2004, we discovered deficiencies in certain of our internal control processes which caused us to have material errors in our historic financial statements, which in turn required us to restate them. In addition, during our internal control assessment as of March 31, 2005, we determined that we had two material weaknesses in our internal controls; one of which we have learned was continuing as of December 31, 2005. One common link in our two restatements and our continuing material weakness involves difficulties with our inventory costing system and operating expense determinations due to accounts payable issues at the end of a fiscal period.

We have been susceptible to difficulties as many of our record keeping processes had been manual or had involved software that had not been upgraded for a significant period of time. As a result we implemented Oracle enterprise resource planning (ERP) software as part of our financial processes. In addition, we have experienced a relatively high personnel turnover in our finance department, including replacing our controller, which contributed to our difficulties. We had thought that we had remediated our accounts payable cut-off material weakness by implementing a three-way match via Oracle during fiscal 2006; however, during the process of reviewing our third quarter financial results, our independent accountants identified some quarter-end vendor invoices which had not been accrued for in the proper quarter, which in turn led us to discover further such mis-timed invoice accruals which comprise a continuing material weakness in this control. We believe these issues resulted not from a problem with the fundamental design of the control process but rather the operation of the control process, as Company personnel were not following the prescribed procedures for the accrual of services performed but not invoiced and for the analysis and encoding of invoices, and management review in both instances was inadequate. We have replaced and trained the clerical personnel who perform much of this work and have provided additional training to the other personnel involved, and management has begun to review their work more carefully. We have also enhanced our review of open purchase orders in an effort to reduce their number. While the design and operation of our new Oracle ERP system combined with our new clerical personnel, enhanced training, and management oversight, and the other remediation steps we took helped us improve our internal control over our business and financial processes to the extent we concluded in our assessment that we no longer had any material weaknesses, there can be no assurance that we will nonetheless not have an error in our financial statements. Such an error, if material, could require their restatement, having adverse effects on our stock price, potentially causing additional expense, and could limit our access to financial markets.

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

Our most successful products are not covered by patents and have in the past and may in the future be reverse engineered. Thus, our competitors can become second sources of these products for our customers or our customers’ competitors, which could decrease our unit sales or our ability to increase unit sales and also could lead to price competition. This price competition could result in lower prices for our products, which would also result in lower revenues and gross margins. Certain of our competitors have announced products that are pin compatible with some of our most successful products, especially in the mobile handset

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market, where many of our largest revenue generating products have been second sourced. To the extent that the revenue secured by these competitors exceeds the expansion in market size resulting from the availability of second sources, this decreases the revenue potential for our products. Furthermore, should a second source vendor attempt to increase its market share by dramatic or predatory price cuts for large revenue products, our revenues and margins could decline materially.

In the future our revenues will become increasingly subject to macroeconomic cycles and more likely to decline if there is an economic downturn.

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

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

During the first quarter of fiscal 2007, international sales accounted for 94% of our net sales. International sales include sales to U.S. based customers if the product was delivered outside the United States.

International sales subject us to the following risks:

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

If our distributors experience financial difficulty and become unable to pay us or choose not to promote our products, our business could be harmed.

During the first quarter of fiscal 2007, 30% of our sales were through distributors, primarily in Asia. Our distributors could reduce or discontinue sales of our products or sell our competitors’ products. They may not devote the resources necessary to sell our products in the volumes and within the time frames that we expect. In addition, we are dependent on their continued financial viability, and some of them are small companies with limited working capital. If our distributors experience financial difficulties and become unable to pay our invoices, or otherwise become unable or unwilling to promote and sell our products, our business could be harmed.

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Our dependence on a limited number of foundry partners and CSP ball drop contractors, and the limited capacity for plastic assembly and test subcontractors, exposes us to a risk of manufacturing disruption or uncontrolled price changes.

Given the current size of our business, we believe it is impractical for us to use more than a limited number of foundry partners and CSP ball drop subcontractors as it would lead to significant increases in our costs. Currently, we have three foundry partners and rely on two CSP ball drop subcontractors. Some of our products are sole sourced at one of our foundry partners in China or Japan. CSP ball drop is a key step in the chip scale packaging used for the bulk of our mobile handset products. Currently, there are only a limited number of suppliers of this service and we currently use two of them. There is also a limited capacity of plastic assembly and test contractors, especially for TFDN packaging, for which customer demand is increasing. Our ability to secure sufficient plastic assembly and test capacity, especially the fast ramping TDFN offerings, may limit our ability to satisfy our customers’ demand. If the operations of one or more of our partners or subcontractors should be disrupted, or if they should choose not to devote capacity to our products in a timely manner, our business could be adversely impacted as we might be unable to manufacture some of our products on a timely basis. In addition, the cyclicality of the semiconductor industry has periodically resulted in shortages of wafer fabrication, assembly and test capacity and other disruption of supply. We may not be able to find sufficient capacity at a reasonable price or at all if such disruptions occur. As a result, we face significant risks, including:

We have outsourced our wafer fabrication, and assembly and test operations and may encounter difficulties in expanding our capacity.

We have adopted a fabless manufacturing model that involves the use of foundry partners and assembly and test subcontractors to provide our production capacity. We chose this model in order to reduce our overall manufacturing costs and thereby increase our gross margin, reduce the impact of fixed costs when volume is low, provide us with upside capacity in case of short term demand increases and provide us with access to newer process technology, production facilities and equipment. During the past four years we have outsourced our wafer manufacturing and assembly and test operations overseas in Asia and we continue to seek additional foundry and assembly and test capacity to provide for growth. If we experience delays in securing additional or replacement capacity at the time we need it, we may not have sufficient product to fully meet the demand of our customers.

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

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

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

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

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

The markets for our products are characterized by:

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

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

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

It is possible that a significant portion our research and development expenditures will not yield products with meaningful future revenue.

We are attempting to develop one or more new mixed signal integrated circuit products, which have a higher development cost than our ASIP device products. This limits how many of such products we can undertake at any one time increasing our risk that such efforts will not result in a working product for which there is a substantial demand at a price which will yield good margins. We are engaging third parties to assist us with these developments and have also added personnel with new skills to our engineering group. These third parties and new personnel may not be successful. These new product developments involve technology in which we have less expertise which also increases the risk of failure. On the other hand, we believe that the potential payoff from these products makes it reasonable for us to take such risks.

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We may be unable to reduce the costs associated with our products quickly enough for us to meet our margin targets.

In the mobile handset market our competitors have been second sourcing many of our products and as a result this market has become more price competitive. We are seeing the same trend develop in our low capacitance ESD devices for digital consumer electronics, personal computers and peripherals. We need to be able to reduce the costs associated with our products in order to achieve our target gross margins. We have in the past achieved and may attempt in the future to achieve cost reductions by obtaining reduced prices from our manufacturing subcontractors, using larger sized wafers, adopting simplified processes, and redesigning parts to require fewer pins or to make them smaller. There can be no assurance that we will be successful in achieving cost reductions through any of these methods, in which case we will experience lower margins.

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

There is intense competition for qualified personnel in the semiconductor industry, in particular for the highly skilled design, applications and test engineers involved in the development of new analog integrated circuits. Competition is especially intense in the San Francisco Bay area, where our corporate headquarters and engineering group is located. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our employ in the future. This is especially true for analog chip designers since competition is fierce for experienced engineers in this discipline. Growth is expected to place increased demands on our resources and will likely require the addition of management and engineering personnel, and the development of additional expertise by existing management personnel. The loss of services and/or changes in our management team, in particular our CEO, or our key engineers, or the failure to recruit or retain other key technical and management personnel, could cause additional expense, potentially reduce the efficiency of our operations and could harm our business. During fiscal 2006, we hired new vice presidents of engineering and sales and a material portion of our future success will depend upon their performance. In addition, we have recently replaced our chief financial officer and corporate controller on an interim basis.

We are dependent upon retaining key employees of recently acquired Arques Technology in order to realize many of the hoped-for benefits of the acquisition. Loss of such employees could cause us to record a significant amount of expenses due to the loss of the goodwill asset associated with the acquisition.

As part of our acquisition of Arques Technology in April 2006, we recorded $5.3 million of goodwill. Many of Arques’ products are under development and our ability to realize revenue from the Arques assets is dependent upon Arques personnel remaining Company employees and successfully completing these products. Many of these Arques personnel are located in Taiwan and are experiencing cultural differences in addition to being associated with an established company instead of a start-up. Should certain of the key former Arques employees choose to leave the Company, we might not be able to realize value from the Arques assets and may need to write-off as impaired some or all of the goodwill associated with the Arques acquisition which could cause us to incur a loss during the quarter and/or year in which such write-off occurred which could adversely affect the market for our stock.

When we acquired Arques Technology, Inc. in April, 2006, we recognized approximately $5.3 million as goodwill on our balance sheet. We may incur an impairment charge to the extent we determine that it is not likely that the undiscounted cash flow from the Arques operations is insufficient to recover the recorded goodwill.

When we acquired Arques Technology, Inc. in April, 2006, we recognized approximately $5.3 million as goodwill on our balance sheet. We acquired this company for several reasons, including obtaining additional products, a proven analog design team, and a more visible Asian presence, and therefore consider the acquisition to have been a success. However, under GAAP, we will need to incur an impairment charge to the extent we determine that future undiscounted cash flow is insufficient to recover the recorded goodwill. This will be determined in part by the profitability of the Arques operations. We are required to make such an assessment annually. Any such impairment charge will correspondingly decrease our profitability and could lead to a decline in our stock price.

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

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

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

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

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

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

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

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

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

The majority of our operating expenses are labor related and therefore cannot be reduced quickly without impairing our ability to effectively conduct business. Much of the remainder of our operating costs such as rent is relatively fixed. Therefore, we have limited ability to reduce expenses quickly in response to any revenue shortfalls. Consequently, our operating results will be harmed if our revenues do not meet our projections. We may experience revenue shortfalls for the following and other reasons:

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

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

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

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

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

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

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

We have in the past supplied products predominantly to Guidant and to a much lesser extent to Medtronic for use in implantable defibrillators and pacemakers, which help sustain human life. While we are no longer selling products into the Medical market, large numbers of our products are or will be used in implanted medical devices, which could fail and expose us to claims. Should our products cause failure in the implanted devices, we may be sued and ultimately have liability, although under federal law Guidant and Medtronic would be required to defend and take responsibility in such instances until their liability was established, in which case we could be liable for that part of those damages caused by our willful misconduct or, in the case of Medtronic only, our negligence.

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

We are subject to a variety of federal, state and local laws, rules and regulations relating to the protection of health and the environment. These include laws, rules and regulations governing the use, storage, discharge, release, treatment and disposal of hazardous chemicals during and after manufacturing, research and development and sales demonstrations, as well as the maintenance of healthy and environmentally sound conditions within our facilities. If we fail to comply with applicable requirements, we could be subject to substantial liability for cleanup efforts, property damage, personal injury and fines or suspension or cessation of our operations. In these regards, during the closure of our Milpitas facility in fiscal 2003, residual contaminants from our operations were detected in concrete and soil samples which were remediated under a work plan approved the State Department of Toxic Substances Control (“DTSC”). The DTSC informed us in a letter dated February 3, 2005, that they had determined that the site does not pose significant threat to public health and the environment. However, if other contaminants should later be found at the site, the DTSC or owner could attempt to hold us responsible. Similarly, our Tempe facility, which we closed in December 2004, is located in an area of documented regional groundwater contamination. While we have no reason to believe that our operations at the facility have contributed to this regional contamination, we can give no assurance that this is the case. In connection with our closure of this facility, we have conducted environmental studies at the site that did not identify any issues but should contaminants be found at the site at a later date a government agency or the new owner could attempt to hold us responsible. Under the agreement, we retain liability for any environmental issues that arise due to the condition of the property at the time of closing.

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

Our California facilities and some of our suppliers are located near major earthquake faults that have experienced earthquakes in the past. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of our major suppliers, like the ones that occurred in Taiwan in September 1999 and in Japan in October 2004, could disrupt the operations of those suppliers, limit the supply of our products and harm our business. The October 2004 earthquake in Japan temporarily shut down operations at one of the wafer fabrication facilities at which our products were being produced. We have since transferred that capacity to other fabs. Power shortages have occurred in California in the past. We cannot assure that if power interruptions or shortages occur in the future, they will not adversely affect our business.

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

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

Implementation of the new FASB rules for the accounting of employee equity and the issuance of new laws or other accounting regulations, or reinterpretation of existing laws or regulations, could materially impact our business or stated results.

From time to time, the government, courts and financial accounting boards issue new laws or accounting regulations, or modify or reinterpret existing ones. For example, starting with the first quarter of fiscal 2007, we implemented Financial Accounting Standards Board (“FASB”) financial accounting standard 123(R) for the accounting for share based payments. These regulations cause us to recognize an expense associated with our employee and director stock options and our employee stock purchase plan which will decrease our earnings. We have chosen to have lower earnings rather than not to use options as widely for our employees, which we believe would have adversely impacted our ability to hire and retain key employees. During the fiscal 2007 first quarter, we incurred approximately an extra $844,000 of expenses due to FAS 123(R), which is between three and four cents per share. There may be other future changes in laws, interpretations or regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally.

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

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

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

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

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

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

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

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

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the SEC and by the NASDAQ National Market and new accounting pronouncements will result in increased costs to us as we evaluate the implications of these laws, regulations and standards and respond to their requirements. To maintain high standards of corporate governance and public disclosure, we intend to invest substantial resources to comply with evolving standards. This investment may result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities. For example, we spent approximately an incremental $800,000 versus our prior financial audit only fees on internal control documentation, testing, and auditing to complete our first annual review associated with filing of 10-K for the year ended March 31, 2005 to comply with section 404 of the Sarbanes-Oxley Act. We also spend a significant but not separately determinable amount in fiscal 2006 in internal control documentation, testing, and auditing. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are taking steps to comply with the recently enacted laws and regulations in accordance with the deadlines by which compliance is required, but cannot predict or estimate the amount or timing of additional costs that we may incur to respond to their requirements.

Our acquisition of Arques Technology and any future acquisitions and strategic alliances may harm our operating results or cause us to incur debt or assume contingent liabilities.

In April, 2006, we acquired Arques Technology, Inc. and we may in the future acquire, or form strategic alliances relating to, other businesses, products and technologies. Successful acquisitions and alliances in the semiconductor industry are difficult to accomplish because they require, among other things, efficient integration and alignment of product offerings and manufacturing operations and coordination of sales and marketing and research and development efforts. We have no recent experience in making such acquisitions or alliances. The difficulties of integration and alignment may be increased by the necessity of coordinating geographically separated organizations, the complexity of the technologies being integrated and aligned and the necessity of integrating personnel with disparate business backgrounds and combining different corporate cultures. In the case of Arques, we need to complete the development of several products and, to be cost effective, we need to make their products using our supply chain, both of which will take significant effort on our part and involve technical and economic risk. Furthermore, the Arques product designs involve analog engineering while our expertise is primarily in integrated passive device design digital signal processing. In addition,

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most of their personnel are located in Taiwan which adds to the challenge of making them feel part of our corporate culture. The integration and alignment of operations following an acquisition or alliance requires the dedication of management resources that may distract attention from the day to day business, and may disrupt key research and development, marketing or sales efforts. In the case of Arques, for sixteen quarters, we will incur expenses of $32,500 as we amortize the acquired developed and core technology and for eight quarters we will incur expense of $8,800 as we amortize the acquired distributor relationships. In connection with future acquisitions and alliances, we may not only acquire assets which need to be amortized, but we may also incur debt or assume contingent liabilities which could harm our operating results.

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

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

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

ITEM 3. Defaults upon Senior Securities

None.

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

None.

ITEM 5. Other Information

None.

ITEM 6. Exhibits

The following documents are filed as Exhibits to this report:

The following documents are hereby incorporated by reference as Exhibits to this report:

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SIGNATURE

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