UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30 2005.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number 0-25236
M I C R E L, I N C O R P O R A T E D
(Exact name of Registrant as specified in its charter)
California 94-2526744
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2180 Fortune Drive, San Jose, CA 95131
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 944-0800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act. Yes [ ] No [X]
As of October 31, 2005 there were 85,872,280 shares of common stock, no par
value, outstanding.
MICREL, INCORPORATED
INDEX TO
REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
September 30, 2005 and December 31, 2004 3
Condensed Consolidated Statements of Operations -
Three and Nine Months Ended September 30, 2005 and 2004 4
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2005 and 2004 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 6. Exhibits 28
Signature 30
2
ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
September 30, December 31,
2005 2004(1)
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 104,333 $ 101,282
Short term investments 36,477 46,503
Accounts receivable, net 35,915 32,055
Inventories 28,710 35,744
Other current assets 1,460 2,488
Deferred income taxes 16,293 15,962
---------- ----------
Total current assets 223,188 234,034
PROPERTY, PLANT AND EQUIPMENT, NET 77,741 81,605
LONG TERM INVESTMENTS -- 2,012
DEFERRED INCOME TAXES 11,062 9,663
INTANGIBLE ASSETS, NET 5,158 6,375
OTHER ASSETS 419 457
---------- ----------
TOTAL $ 317,568 $ 334,146
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 15,870 $ 16,275
Taxes payable 4,038 4,960
Deferred income on shipments to distributors 12,559 13,648
Other current liabilities (NOTE 5) 20,370 12,165
Current portion of long-term debt 153 164
---------- ----------
Total current liabilities 52,990 47,212
LONG-TERM DEBT -- 83
OTHER LONG-TERM OBLIGATIONS 656 1,964
SHAREHOLDERS' EQUITY:
Preferred stock, no par value -
authorized: 5,000,000 shares;
issued and outstanding: none -- --
Common stock, no par value - authorized:
250,000,000 shares; issued and outstanding:
2005 - 86,248,688 shares;
2004 - 89,825,994 shares 90,058 127,264
Deferred stock compensation (415) (1,118)
Accumulated other comprehensive loss (54) (85)
Retained earnings 174,333 158,826
---------- ----------
Total shareholders' equity 263,922 284,887
---------- ----------
TOTAL $ 317,568 $ 334,146
========== ==========
(1) Derived from the audited balance sheet included in the Annual Report on
Form 10-K of Micrel, Incorporated for the year ended December 31, 2004.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
MICREL, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
NET REVENUES $ 62,472 $ 67,853 $ 185,209 $ 198,110
COST OF REVENUES(1) (NOTE 12) 28,680 34,598 88,889 102,933
--------- --------- --------- ---------
GROSS PROFIT 33,792 33,255 96,320 95,177
--------- --------- --------- ---------
OPERATING EXPENSES:
Research and development (NOTE 12) 11,337 11,145 34,011 31,390
Selling, general and
administrative (NOTE 12) 11,527 9,955 31,563 27,394
Amortization of deferred
stock compensation(1) 117 487 516 1,659
Purchased in-process technology -- -- -- 480
Restructuring expense -- 437 -- 437
Litigation accrual -- -- 9,282 --
--------- --------- --------- ---------
Total operating expenses 22,981 22,024 75,372 61,360
--------- --------- --------- ---------
INCOME FROM OPERATIONS 10,811 11,231 20,948 33,817
OTHER INCOME, NET 1,068 363 2,909 901
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 11,879 11,594 23,857 34,718
PROVISION FOR INCOME TAXES (NOTE 12) 4,158 4,058 8,350 8,559
--------- --------- --------- ---------
NET INCOME $ 7,721 $ 7,536 $ 15,507 $ 26,159
========= ========= ========= =========
NET INCOME PER SHARE:
Basic $ 0.09 $ 0.08 $ 0.18 $ 0.28
========= ========= ========= =========
Diluted $ 0.09 $ 0.08 $ 0.18 $ 0.28
========= ========= ========= =========
WEIGHTED-AVERAGE SHARES USED IN
COMPUTING PER SHARE AMOUNTS:
Basic 86,514 91,252 87,604 91,968
========= ========= ========= =========
Diluted 88,047 91,996 88,512 93,735
========= ========= ========= =========
(1)Amortization of deferred stock
compensation included in
cost of revenues $ 35 $ 109 $ 127 $ 479
========= ========= ========= =========
Amortization of deferred stock
compensation included in
operating expenses related to:
Research and development $ 32 $ 173 $ 135 $ 609
Selling, general and
administrative 85 314 381 1,050
--------- --------- --------- ---------
Total operating expenses $ 117 $ 487 $ 516 $ 1,659
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
MICREL, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended
September 30,
---------------------
2005 2004
--------- ---------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 15,507 $ 26,159
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 15,429 18,816
Stock based compensation 643 2,138
Purchased in-process technology -- 480
Loss on disposal of assets 100 114
Deferred rent (73) --
Deferred income taxes (1,730) 10,200
Changes in operating assets and liabilities,
net of effect of acquisition:
Accounts receivable (3,860) (5,400)
Inventories 7,034 (5,930)
Prepaid expenses and other assets 1,066 693
Accounts payable (405) 4,749
Income taxes (1,554) (2,294)
Other accrued liabilities 6,970 (972)
Deferred income on shipments to distributors (1,089) 4,064
--------- ---------
Net cash provided by operating activities 38,038 52,817
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (10,448) (13,558)
Purchase of intangible assets -- (1,030)
Proceeds (purchases) of short-term investments, net 12,069 (35,096)
Purchases of long-term investments -- (3,185)
Purchase of BlueChip Communications, net
of cash acquired -- (2,033)
--------- ---------
Net cash provided by (used in) investing
activities 1,621 (54,902)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (94) (587)
Proceeds from the issuance of common stock, net 6,291 3,958
Repurchase of common stock (42,805) (29,024)
--------- ---------
Net cash used in financing activities (36,608) (25,653)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,051 (27,738)
CASH AND CASH EQUIVALENTS - Beginning of period 101,282 140,059
--------- ---------
CASH AND CASH EQUIVALENTS - End of period $ 104,333 $ 112,321
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 193 $ 262
========= =========
Income taxes $ 10,795 $ 964
========= =========
Non-cash transactions:
Deferred stock compensation (reversal) $ (60) $ (218)
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Information - The accompanying condensed consolidated
financial statements of Micrel, Incorporated and its wholly-owned
subsidiaries ("Micrel" or the "Company") as of September 30, 2005 and for
the three and nine months ended September 30, 2005 and 2004 are unaudited.
In the opinion of management, the condensed consolidated financial
statements include all adjustments (consisting only of normal recurring
accruals) that management considers necessary for a fair statement of its
financial position, operating results and cash flows for the interim periods
presented. Operating results and cash flows for interim periods are not
necessarily indicative of results for the entire year.
This financial data should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004.
This financial data should also be read in conjunction with the Company's
critical accounting policies included in the Company's Annual Report on Form
10-K for the year ended December 31, 2004.
Certain prior year amounts have been reclassified to conform to the current-
year presentation. These reclassifications had no impact on our results of
operations or changes in stockholders' equity.
Net Income Per Common and Equivalent Share - Basic net income per share is
computed by dividing net income by the number of weighted-average common
shares outstanding. Diluted net income per share reflects potential
dilution from outstanding stock options using the treasury stock method.
Reconciliation of weighted-average shares used in computing net income per
share is as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Weighted-average common
shares outstanding 86,514 91,252 87,604 91,968
Dilutive effect of stock options
outstanding using the treasury
stock method 1,533 744 908 1,767
--------- --------- --------- ---------
Shares used in computing diluted
net income per share 88,047 91,996 88,512 93,735
========= ========= ========= =========
For the three and nine months ended September 30, 2005, approximately 5.0
million and 7.7 million stock options, respectively, have been excluded from
the weighted-average number of common shares outstanding for the diluted net
income per share computations as they were anti-dilutive. For the three and
nine months ended September 30, 2004, 7.7 million and 4.7 million stock
options, respectively, have been excluded from the weighted-average number
of common shares outstanding for the diluted net income per share
computations as they were anti-dilutive.
Stock Based Awards - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees". During the years 1996 through December 2001, certain of the
Company's option pricing practices resulted in stock compensation expense
under APB 25 (for a further discussion, see Stock-based Awards included in
Note 1 of Notes to Consolidated Financial Statements in the Company's Annual
Report on Form 10-K for the year ended December 31, 2004). Deferred stock
compensation expense balances are recorded as a contra-equity amount and
amortized as a charge to operating results over the applicable vesting
periods. As of September 30, 2005 total unamortized stock compensation was
$415,000 with an anticipated remaining future amortization schedule of
$120,000 in 2005.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and earnings per share had the Company
applied the fair value method as of the beginning of fiscal 1995. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were
6
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require subjective
assumptions, including future stock volatility and expected time to
exercise, which greatly affect the calculated values. The Company's
calculations for the fair value of stock options were made using the Black-
Scholes option pricing model. Calculations are based on a multiple option
valuation approach with forfeitures recognized as they occur and the
following weighted average assumptions:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Expected life (months) 60 60 60 60
Stock volatility 76.0% 85.2% 78.8% 83.9%
Risk free interest rates 4.2% 3.4% 4.0% 3.3%
Dividends during expected terms none none none none
The Company's calculations for the fair value of stock issued under the
employee stock purchase plan were made using the Black-Scholes option
pricing model with the following weighted average assumptions:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Expected life (months) 6 6 6 6
Stock volatility 76.0% 85.2% 78.8% 83.9%
Risk free interest rates 3.8% 2.0% 3.4% 1.5%
Dividends during expected terms none none none none
SFAS No. 148 was issued in December 2002 and amended SFAS No. 123 to require
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. The following table illustrates the
effect on the Company's net income and net income per share if it had
recorded compensation costs based on the estimated grant date fair value as
defined by SFAS No. 123 for all granted stock-based awards. (in thousands,
except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net income as reported $ 7,721 $ 7,536 $ 15,507 $ 26,159
Add: stock-based employee
compensation expense included
in reported net income,
net of tax effects 92 362 391 1,300
Deduct: stock-based employee
compensation expense determined
under fair value based method,
net of tax effects (1,893) (4,012) (7,541) (12,302)
--------- --------- --------- ---------
Pro forma net income $ 5,920 $ 3,887 $ 8,357 $ 15,157
========= ========= ========= =========
Net income per share as reported:
Basic $ 0.09 $ 0.08 $ 0.18 $ 0.28
========= ========= ========= =========
Diluted $ 0.09 $ 0.08 $ 0.18 $ 0.28
========= ========= ========= =========
Pro forma net income per share:
Basic $ 0.07 $ 0.04 $ 0.10 $ 0.16
========= ========= ========= =========
Diluted $ 0.07 $ 0.04 $ 0.10 $ 0.17
========= ========= ========= =========
For the three and nine months ended September 30, 2004, pro forma stock
compensation amounts have been adjusted to correct for the estimated tax
effect of various stock option grants. This correction resulted in a
decrease of $1.0 million ($0.02 per diluted share) and $3.3 million ($0.03
per diluted share), respectively in pro forma net income for the
applicable 2004 periods presented herein.
7
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2004, the Financial Accounting Standards Board ("FASB") Emerging
Issues Task Force ("EITF") reached a consensus on recognition and
measurement guidance previously discussed under EITF Issue No. 03-01, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." ("EITF 03-01"). The consensus clarifies the meaning of other-
than-temporary impairment and its application to investments in debt and
equity securities, in particular investments within the scope of FASB
Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and investments accounted for under the cost method. In
September 2004, the FASB delayed the accounting provisions of EITF Issue No.
03-01; however the disclosure requirements remain effective and were adopted
by the Company as of the year ended December 31, 2004. The Company will
evaluate the effect, if any, of EITF Issue No. 03-01 when final guidance is
issued.
In November 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 151, "Inventory Costs," which clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material. Companies will no longer be permitted to
capitalize inventory costs on their balance sheets when the production
defect rate varies significantly from the expected rate as SFAS No. 151
requires that those items be recognized as current-period charges regardless
of whether they meet the criterion of "so abnormal". It also makes clear
that fixed overhead should be allocated based on "normal capacity" of the
production facilities. SFAS No. 151 will be effective for inventory costs
incurred during fiscal years beginning after June 15, 2005, which is 2006
for calendar year companies. The Company is currently evaluating the
potential impacts, if any, that the adoption of SFAS No. 151 may have on the
Company's consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." SFAS
No. 123R is a revision of SFAS No. 123, and supersedes APB 25. Among other
items, SFAS No. 123R eliminates the use of APB 25 and the intrinsic value
method of accounting, and requires companies to recognize the cost of
employee services received in exchange for awards of equity instruments,
based on the fair value of those awards as of the grant date, in the
financial statements. As a result of the SEC's April 2005 deferral of the
effective date of SFAS No. 123R, the Company will be required to adopt SFAS
No. 123R effective January 1, 2006., although early adoption is allowed.
SFAS No. 123R permits companies to adopt its requirements using either a
"modified prospective" method, or a "modified retrospective" method. Under
the "modified prospective" method, compensation cost is recognized in the
financial statements beginning with the effective date, based on the
requirements of SFAS No. 123R for all share-based payments granted after
that date, and based on the requirements of SFAS No. 123 for all unvested
awards granted prior to the effective date of SFAS No. 123R. Under the
"modified retrospective" method, the requirements are the same as under the
"modified prospective" method, but also permits entities to restate
financial statements of previous periods based on proforma disclosures made
in accordance with SFAS No. 123.
In May 2005, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 154, "Accounting Changes and
Error Corrections." This statement generally requires retrospective
application to prior periods' financial statements of voluntary changes in
accounting principles. Under the prior rules, changes in accounting
principles were generally recognized by including in net income of the
period of the change the cumulative effect of changing to the new accounting
principle. This statement does not change the previous guidance for
reporting the correction of an error in previously issued financial
statements, change in accounting estimate or justification of a change in
accounting principle on the basis of preferability. This statement is
effective for accounting changes made in fiscal years beginning after
December 15, 2005. Management does not expect the adoption of this standard
to have a material effect on the Company's consolidated financial
statements.
The Company currently utilizes a standard option pricing model (Black-
Scholes) to measure the fair value of stock options granted to employees.
While SFAS No. 123R permits entities to continue to use such a model, the
standard also permits the use of a "lattice" model. The Company has not yet
determined which model it will use to measure the fair value of employee
stock options upon the adoption of SFAS No. 123R.
The Company currently expects to adopt SFAS 123R in the quarter and year
beginning January 1, 2006; however, the Company has not yet determined which
of the aforementioned adoption methods it will use. Subject to a complete
review of the requirements of SFAS 123R, the Company expects that the
adoption of SFAS 123R may have a material adverse impact on its results of
operations.
8
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS
Short-term and long-term investments consist primarily of liquid debt
instruments and are classified as available-for-sale securities and are
stated at market value with unrealized gains and losses included in
shareholders' equity. Unrealized losses are charged against income when a
decline in the fair market value of an individual security is determined to
be other than temporary. Realized gains and losses on investments are
included in other income or expense. Investments purchased with remaining
maturity dates of greater than three months and less than 12 months are
classified as short-term. Investments purchased with remaining maturity
dates of 12 months or greater are classified either as short-term or as
long-term based on maturities and the Company's intent with regards to those
securities (expectations of sales and redemptions). A summary of investments
at September 30, 2005 is as follows (in thousands):
Unrealized Unrealized
Amortized Market Holding Holding
Cost Value Gains Losses
---------- ---------- ---------- -----------
Short-term investments $ 36,531 $ 36,477 $ -- $ 54
As of September 30, 2005, all investments with unrealized loss positions
have been in such positions for twelve months or less.
4. INVENTORIES
Inventories consist of the following (in thousands):
September 30, December 31,
2005 2004
------------ ------------
Finished goods $ 10,290 $ 15,912
Work in process 17,538 18,585
Raw materials 882 1,247
---------- ----------
$ 28,710 $ 35,744
========== ==========
5. OTHER CURRENT LIABILITES
Other current liabilities consist of the following (in thousands):
September 30, December 31,
2005 2004
------------ ------------
Accrued current liability under patent
license agreement $ -- $ 1,852
Accrued current restructuring expenses 2,021 2,021
Accrued workers compensation and health insurance 1,945 1,555
Accrued litigation 9,282 --
Accrued compensation 4,876 4,899
Accrued commissions 1,342 1,292
All other current accrued liabilities 904 546
---------- ----------
Total other current liabilities $ 20,370 $ 12,165
========== ==========
9
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. BORROWING ARRANGEMENTS
Borrowing arrangements consist of a $6 million revolving line of credit from
a commercial bank. The revolving line of credit agreement includes a
provision for the issuance of commercial or standby letters of credit by the
bank on behalf of the Company. The value of all letters of credit
outstanding reduces the total line of credit available. There were no
borrowings under the revolving line of credit at September 30, 2005, and
there were $875,000 in standby letters of credit outstanding. The revolving
line of credit agreement expires on June 30, 2006. Borrowings under the
revolving line of credit bear interest rates of, at the Company's election,
the prime rate (6.75% at September 30, 2005), or the bank's revolving
offshore rate, which approximates LIBOR (4.1% at September 30, 2005) plus
2.0%. The agreement contains certain restrictive covenants that include a
restriction on the declaration and payment of dividends without the lender's
consent. The Company was in compliance with all such covenants at September
30, 2005.
Associated with the acquisition of BlueChip Communications, the Company has
$153,000 outstanding in term notes payable to the Norwegian Industrial and
Regional Development Fund.
7. SIGNIFICANT CUSTOMERS
During the nine months ended September 30, 2005, three customers, a direct
original equipment manufacturer ("OEM"), a world wide distributor and an
Asian based stocking representative accounted for $28.8 million (16%), $21.4
million (12%) and $21.3 million (12%) of net revenues, respectively. During
the nine months ended September 30, 2004, two customers, a world wide
distributor and an Asian based stocking representative accounted for $27.5
million (14%) and $26.7 million (13%) of net revenues, respectively, and no
direct original equipment manufacturer ("OEM") accounted for 10% or more of
net revenues.
At September 30, 2005, three customers accounted for 21%, 14% and 13% of
total accounts receivable. At December 31, 2004, two customers accounted
for 18% and 15% of total accounts receivable.
8. COMPREHENSIVE INCOME
Comprehensive income, which is comprised of the Company's net income for
the periods and changes in unrealized gains or losses on investments was
equal to net income for the three and nine months ended September 30, 2005
and 2004.
9. SEGMENT REPORTING
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for reporting information regarding operating segments in annual
financial statements and requires selected information for those segments to
be presented in interim financial reports issued to stockholders. Operating
segments are identified as components of an enterprise about which separate
discrete financial information is available for evaluation by the chief
operating decision maker. The Company has two reportable segments: standard
products and custom and foundry products. The chief operating decision maker
evaluates segment performance based on revenue. Accordingly, all expenses
are considered corporate level activities and are not allocated to segments.
Therefore, it is not practical to show profit or loss by reportable
segments. Also, the chief operating decision maker does not assign assets to
these segments. Consequently, it is not practical to show assets by
reportable segments.
10
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Net Revenues by Segment
(Dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net Revenues:
Standard Products $ 59,532 $ 65,332 $ 177,660 $ 190,084
Custom and Foundry Products 2,940 2,521 7,549 8,026
--------- --------- --------- ---------
Total net revenues $ 62,472 $ 67,853 $ 185,209 $ 198,110
========= ========= ========= =========
As a Percentage of Total Net Revenues:
Standard Products 95% 96% 96% 96%
Custom and Foundry Products 5% 4% 4% 4%
--------- --------- --------- ---------
Total net revenues 100% 100% 100% 100%
========= ========= ========= =========
10. LITIGATION AND OTHER CONTINGENCIES
On February 26, 1999, the Lemelson Medical, Education & Research Foundation
(the "Lemelson Partnership") filed a complaint which was served on the
Company on June 15, 1999, entitled Lemelson Medical, Education & Research
Foundation, Limited Partnership v. Lucent Technologies Inc., et al. in the
United States District Court in Phoenix, Arizona, against eighty-eight
defendants, including the Company, alleging infringement of Lemelson
Foundation patents. The complaint in the lawsuit seeks unspecified
compensatory damages, treble damages and attorneys' fees, as well as
injunctive relief against further infringement of the Lemelson patents at
issue. The case is currently in the motion and hearing phase. A claim
construction hearing has not yet been scheduled. The Company intends to
continue to defend itself against these claims.
On May 9, 1994, Linear Technology Corporation ("Linear" or "LTC"), a
competitor of the Company, filed a complaint against the Company, entitled
Linear Technology Corporation v. Micrel, Incorporated, in the United States
District Court in San Jose, California, alleging patent and copyright
infringement and unfair competition. All claims, except the patent
infringement claim, have been settled or dismissed. After many years of
motions and appeals, a claim construction hearing (also called a "Markman"
hearing) was held before the District Court on December 16, 2003. The Court
issued its ruling on January 24, 2004, interpreting the claims at issue in
the litigation. Furthermore, the parties have attended three settlement
conferences before the District Court. A trial date has been set for
November 28, 2005. The Company intends to continue to defend itself against
the claims alleged in this litigation
On December 27, 2002, the Company filed a complaint against TRW, Inc.
("TRW") entitled Micrel, Incorporated v. TRW, Inc., dba TRW Automotive
Electronics Group, in the United States District Court, Northern District
of Ohio, Eastern Division, alleging various causes of action relating to
breach of a relationship surrounding the development of certain custom
products by Micrel for TRW. In this lawsuit, Micrel is alleging that TRW
breached various agreements to assist in Micrel's development of, and to
purchase, certain Application Specific Integrated Circuits. The complaint
seeks compensatory damages, attorneys' fees and costs of suit. On
February 24, 2003, TRW filed an answer to the Company's complaint and a
counterclaim alleging various causes of action relating to breach of the
above-mentioned relationship concerning ASIC development. On July 22,
2005, a jury ruled against the Company and in favor of TRW in its counter
claim against Micrel. The outcome of the jury trial was a judgment on
July 26, 2005 awarding damages for the benefit of TRW in the amount of
$9.3 million. The damages amount was accrued in the Company's second
quarter 2005 financial statements. On August 9, 2005, the Company filed a
Motion for an order setting aside the jury verdict and the subsequent
judgment and granting a new trial on the issue of the Company's breach of
contract claim against TRW.
11
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On April 21, 2003, the Company filed a complaint against its former
principal accountants Deloitte & Touche LLP ("Deloitte") entitled Micrel,
Incorporated v. Deloitte & Touche LLP in the Superior Court of the State of
California, County of Santa Clara, alleging various causes of action
relating to certain professional advice received by Micrel from Deloitte.
In this lawsuit, Micrel is alleging that Deloitte negligently rendered
services as accountants to Micrel, breached certain agreements with Micrel
by failing to perform services using ordinary skill and competence and in
conformance with generally accepted principles for such work and made
certain false representations upon which Micrel justifiably relied. As a
direct result of Deloitte's actions, Micrel alleges damages including:
expenses incurred in the form of payments to various professionals to
address the impact on Micrel's financial statements and other effects of the
wrongful conduct; loss of cash as well as equity from stock options;
additional charges to earnings that Micrel would not incur but for the
wrongful advice and the harm to Micrel in both financial and semiconductor
markets resulting in loss of overall value of the company as a whole.
Deloitte has denied all allegations in the complaint. The complaint seeks
compensatory damages, costs of suit and such other relief that the court may
deem just and proper. The case is currently in the discovery and pre-trial
phase. A trial date has been set for January 9, 2006.
On November 11, 2004, the Company filed a complaint against Monolithic Power
Systems ("MPS"), entitled Micrel, Inc. v. Monolithic Power Systems, in the
United States District Court, Northern District of California (the "Court")
alleging two causes of action for infringement by MPS of certain patents
owned by Micrel. In the complaint, the Company alleges that MPS has been
and is infringing U.S. patent no. 5,517,046 (the " '046 patent") and U.S.
patent no. 5,556,796 (the " '796 patent"). Micrel alleges damages
attributable to MPS' infringement of the '046 and '796 patents as a direct
result of MPS' actions, including treble damages for wanton, deliberate,
malicious and willful conduct. Subsequently, on November 29, 2004 the
Company filed an amended complaint adding Michael R. Hsing, MPS' President
and Chief Executive Officer ("Hsing"), and James C. Moyer, MPS' Chief Design
Engineer ("Moyer") as defendants. Hsing and Moyer are both former employees
of Micrel. In addition to the original two causes of action against MPS for
infringement of the '046 and '796 Patents, the amended complaint adds causes
of action for statutory and common law misappropriation of Micrel's trade
secrets, breach of confidentiality agreements by Hsing and Moyer, and
violation of California's Unfair Competition Law. The amended complaint
seeks compensatory damages, costs of suit and such other relief that the
Court may deem proper. On December 16, 2004, MPS filed a Motion to Dismiss
the Company's claims for statutory and common law misappropriation of
Micrel's trade secrets. On April 8, 2005, the Court granted MPS' Motion to
Dismiss with leave to amend the complaint. On May 2, 2005, Micrel filed a
second amended complaint for patent infringement, misappropriation of trade
secrets, common law misappropriation, breach of confidentiality agreement,
and statutory unfair competition. On May 23, 2005, MPS filed a Motion to
Dismiss the Company's claims for statutory and common law misappropriation
of trade secrets contained in the second amended complaint. A hearing was
held on September 30, 2005 on MPS' Motion to Dismiss. The Court has not yet
issued a ruling on the Motion.
With the exception of the TRW litigation discussed above, for which the
company has recorded $9.3 million in litigation expense, the Company
believes that the ultimate outcome of the legal actions discussed will not
result in a material adverse effect on the Company's financial condition,
results of operation or cash flows, and the Company believes it is not
reasonably possible that a material loss has been incurred. However,
litigation is subject to inherent uncertainties, and no assurance can be
given that the Company will prevail in these lawsuits. Accordingly, the
pending lawsuits, as well as potential future litigation with other
companies, could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
The semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights. To the extent that the
Company becomes involved in such intellectual property litigation, in
addition to litigation mentioned herein, it could result in substantial
costs and diversion of resources to the Company and could have a material
adverse effect on the Company's financial condition, results of operation or
cash flows.
In the event of an adverse ruling in any intellectual property litigation
that now exists or might arise in the future, the Company might be required
to discontinue the use of certain processes, cease the manufacture, use and
sale of infringing products, expend significant resources to develop non-
infringing technology or obtain licenses to the infringing technology.
12
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
There can be no assurance, however, that under such circumstances, a license
would be available under reasonable terms or at all. In the event of a
successful claim against the Company and the Company's failure to develop or
license substitute technology on commercially reasonable terms, the
Company's financial condition, results of operations, or cash flows could be
adversely affected. Based on the status of the litigation described above,
the Company does not believe that any material and specific risk exists
related to the loss of use of patents, products or processes.
Certain additional claims have been filed by or have arisen against the
Company in its normal course of business. The Company believes that these
claims and lawsuits will not have a material adverse effect on the Company's
financial condition, results of operation or cash flows.
11. STOCK REPURCHASE PROGRAM
In March 2005, Micrel's Board of Directors approved a $75 million share
repurchase program for calendar year 2005. Shares of common stock
purchased pursuant to the repurchase program are cancelled upon
repurchase, and are intended to offset dilution from the Company's stock
option plans, employee stock purchase plans and 401(k) plan. During the
nine months ended September 30, 2005, the Company repurchased, 4,250,900
shares of its common stock for $42.8 million.
12. INCOME TAXES
Deferred tax assets and liabilities result primarily from temporary
differences between book and tax bases of assets and liabilities, state
and federal research and development credit carryforwards and state
manufacturers credit carryforwards. The Company had net current deferred
tax assets of $16.3 million and net long-term deferred tax assets of $11.1
million as of September 30, 2005. The Company must regularly assess the
likelihood that future taxable income levels will be sufficient to
ultimately realize the tax benefits of these deferred tax assets. The
Company currently believes that future taxable income levels will be
sufficient to realize the tax benefits of these deferred tax assets and
has not established a valuation allowance. Should the Company determine
that future realization of these tax benefits is not likely, a valuation
allowance would be established, which would increase the Company's tax
provision in the period of such determination.
The calculation of the Company's tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. The Company
records liabilities for anticipated tax audit issues based on its estimate
of whether, and the extent to which, additional taxes may be due. Actual
tax liabilities may be different than the recorded estimates and could
result in an additional charge or benefit to the tax provision in the
period when the ultimate tax assessment is determined.
During the second quarter of 2004, the Company reversed $3.8 million of
accrued income tax liabilities as a result of the completion of a federal
income tax audit. In May 2004, the Company received an audit report from
the Internal Revenue Service ("IRS") which recommended no changes to
Micrel's federal tax return filings covering the tax years 1994 through
2001. In addition, the Company subsequently received a notice dated July
6, 2004 from the Joint Committee on Taxation which stated that the
committee took no exceptions to conclusions in the IRS audit report. This
reversal of accrued income tax liabilities was recorded as a reduction to
provision for income taxes in the second quarter of 2004.
In addition, related to the federal tax audit completion, the Company also
reversed $3.9 million (offset in part by a $1.4 million income tax effect)
in accrued payroll tax liabilities, which were previously recorded as part
of the Company's restatement of financials for the years December 31,
1998, 1999, and 2000, and the quarters ended March 31, 2001, June 30,
2001, and September 30, 2001 to reflect previously unrecorded stock
compensation expense and related payroll tax and income tax effects.
13
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The effects of these accrued tax liability reversals on the below-noted
items in the Company's statement of operations is summarized as follows:
Nine Months
Ended
September 30,
2004
-------------
Cost of revenues $ (1,111)
Research and development (1,697)
Selling, general and administrative (1,140)
Provision for income taxes (2,378)
---------
$ (6,326)
=========
The income tax provision for the three and nine months ended September 30,
2005 is based on the Company's estimated annual effective tax rate of 35%
of pretax income. The income tax provision for the three and nine months
ended September 30, 2004 was based on the Company's estimated annual
effective tax rate of 35% of pretax income, reduced by the $3.8 million
reversal of accrued income tax liabilities recorded in the quarter ended
June 30, 2004 and increased by $168,000 as a result of $480,000 of non-
deductible purchased in-process technology charges recorded in the three
months ended March 31, 2004.
13. RESTRUCTURING AND MANUFACTURING FACILITY IMPAIRMENT
During 2003 the Company closed its Santa Clara wafer fabrication facility.
A summary of restructuring expense accruals associated with this facility
closure is as follows: ($000)
Contractual
Facility Equipment
Costs Disposal Total
----------- --------- ---------
Balance December 31, 2003 $ 4,119 $ 411 $ 4,530
2004 Charges 584 -- 584
Uses (1,654) (51) (1,705)
--------- --------- ---------
Balance December 31, 2004 3,049 360 3,409
2005 Charges -- -- --
Uses (1,234) -- (1,234)
--------- --------- ---------
Balance September 30, 2005 $ 1,815 $ 360 $ 2,175
========= ========= =========
Of the $2.2 million in accrued restructuring costs, $2.0 million has been
classified as other current liabilities and $154,000 has been classified
as other long-term obligations as of September 30, 2005. These
restructuring costs are expected to be paid in cash over the remaining
facility lease term, which expires in October 2006. Actual future costs or
actual sublease income may be different than these estimates and could
require an adjustment to the restructuring accrual in the period such
determination is made.
14
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended and Section 21E of the Securities
Exchange Act of 1934,as amended, including statements regarding the Company's
expectations, hopes, intentions or strategies regarding the future. Forward-
looking statements include, but are not limited to: statements regarding
future revenues and dependence on standard products sales and international
sales; statements regarding the levels of international sales; statements
regarding future products or product development; statements regarding future
research and development spending and the Company's product development
strategy; statements regarding future expansion or utilization of
manufacturing capacity; statements regarding future expenditures; statements
regarding current or future acquisitions; and statements regarding our ability
to meet our anticipated short term and long term cash requirements; and
statements regarding the future realization of tax benefits. In some cases,
forward-looking statements can be identified by the use of forward-looking
terminology such as "believe," "estimate," "may," "can," "will," "could,"
"would," "intend," "objective," "plan," "expect," "likely," "potential,"
"possible" or "anticipate" or the negative of these terms or other comparable
terminology. All forward-looking statements included in this document are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements.
These statements are subject to risks and uncertainties that could cause
actual results and events to differ materially from those expressed or implied
by such forward-looking statements. Some of the factors that could cause
actual results to differ materially are set forth below. Additional factors
that may affect operating results are contained within the Company's Form 10-K
for the year ended December 31, 2004.
Micrel designs, develops, manufactures and markets a range of high-
performance analog power integrated circuits ("ICs"), mixed-signal and digital
ICs. These circuits are used in a wide variety of electronics products,
including those in the computer, telecommunications, industrial and networking
markets. In addition to standard products, the Company manufactures custom
analog and mixed-signal circuits and provides wafer foundry services.
The Company's 2004 revenues grew to the highest level since 2000,
increasing 22 percent over 2003 The increase in customer demand in the first
half of 2004 caused lead times for semiconductor components, including
Micrel's, to expand during the first and second quarters of 2004 as customers
and distributors became concerned about availability of supply. The Company's
revenues continued to grow in the first half of the year and gross margin,
operating margin and net income increased on a sequential basis in both the
first and second quarters. By the end of the second quarter, customers began
to perceive that the supply of semiconductor components was generally
sufficient and lead times for certain components began to shrink.
In the third and fourth quarter of 2004, demand was below normal seasonal
levels as customers reacted quickly to uncertain demand for their products,
decreasing semiconductor lead times and uncertain economic conditions by
reducing their order rates. Customers in certain end markets such as
networking, enterprise computing and high speed communications experienced
lower demand for their end products than they had anticipated. This factor,
combined with rapidly shrinking lead times from most semiconductor suppliers,
led to lower order rates for the Company's products in the second half of 2004
as customers attempted to control their inventory levels. The Company's level
of on hand inventory remained above prior year levels to provide a high level
of customer service in response to shorter customer lead times. As a result
of lower order rates, the Company's backlog and revenues declined in both the
third and fourth quarter of 2004.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
In the first quarter of 2005, demand as measured by order rates, improved
substantially over fourth quarter of 2004 levels. First quarter bookings
increased by 40% over fourth quarter 2004 levels. The improvement in order
rates was driven by customers serving the industrial, computing and
communications end markets. Orders from customers serving the wireless handset
end market were slightly less than fourth quarter levels, which is normal for
the first calendar quarter. Bookings from Micrel's major distributors
increased in the first quarter after falling sharply in the second half of
2004 as distributors adjusted to shorter industry lead times and reduced their
inventory levels. Despite increased bookings during the first quarter and
lean supply chain inventory levels, order lead times from our customers
continued to average two to three weeks. Despite relatively flat revenues,
the Company continued to improve gross margin. First quarter of 2005 gross
margin of 50.1% was the highest quarterly gross margin for Micrel since the
first quarter of 2001. First quarter of 2005 gross margin improved by 3.8%
from the fourth quarter of 2004 and was more than 5% higher than the year ago
period on approximately the same level of revenues. Operating profit and net
income in the first quarter of 2005 also increased from both the first and
fourth quarters of 2004.
In the second quarter of 2005, the ongoing short lead time environment
continued to motivate customers to order only what was required for their
short term needs. Second quarter order rates declined from first quarter
levels primarily due to lower order amounts from the Company's distributors
and certain customers serving the wireless handset end market. Bookings from
the Company's major sell-through distributors declined from strong first
quarter levels and were less than overall resales for the second quarter as
our distributors attempted to increase their inventory turns to improve their
return on working capital. Inventories at the Company's Asia-based stocking
representatives also declined sequentially in second quarter. In the wireless
handset market, customers reduced both orders and production levels in
coordination with efforts to reduce channel inventories of handsets.
Second quarter revenues increased sequentially by 2% but were 10% below the
revenues of the year ago period. The Company continued to exercise pricing
discipline for most of its products in an attempt to improve gross profit.
Consequently, sales of certain products, such as those serving the SOHO
Ethernet market and the low end personal computer market, declined resulting
in a lower rate of revenue growth for the Company. Gross margin continued to
improve in the second quarter, increasing to 52% from 49% in the year ago
period and 50% in the first quarter of 2005. The increase in gross margin was
primarily due to: better pricing discipline, improved sales mix of higher
margin products, ongoing manufacturing cost reductions and lower depreciation
expense as a result of disciplined capital spending.
Third quarter order rates increased substantially from second quarter
levels, increasing sequentially in all geographic regions. Throughout the
third quarter customers continued to place orders with extremely short
delivery requirements, even as the aggregate order level increased. Order
levels from our distributors increased in the third quarter, returning to a
level consistent with sales of Micrel's products to their end customers.
Inventories at the Company's Asia-based stocking representatives declined
sequentially in third quarter. Third quarter revenues increased sequentially
by 1% but were 8% below the revenue level of the year ago period. Although
order rates were strong, third quarter revenue growth was impacted by product
shortages for our Ethernet products due to longer manufacturing cycle times at
third party wafer suppliers and reduced demand for certain commodity products
possibly as a result of continued pricing discipline. Gross margin improved
further in the third quarter, increasing to 54% from 48% in the year ago
period and 52% in the second quarter. The increase in gross margin is
primarily attributed to an improved sales mix of higher margin products and
ongoing manufacturing cost reductions. Micrel has significantly improved
gross margin through the first three quarters of 2005 while continuing to
operate its wafer fabrication facility at approximately 50% of equipped
utilization. Year-to-date gross margin of 52% is 4% higher than the first
nine months of 2004, although year-to-date revenues in 2005 are approximately
$13 million lower than 2004
In March 2004, Micrel completed the acquisition of BlueChip Communications
AS ("BlueChip") of Oslo, Norway. BlueChip is a fabless semiconductor company
that designs, develops and markets high performance RF ICs and modules for the
actuation and connectivity markets. The acquisition was accounted for as a
purchase under SFAS No. 141 "Business Combinations" and, accordingly, the
results of operations of BlueChip from the date of acquisition forward have
been included in the Company's consolidated financial statements.
The Company derives a substantial portion of its net revenues from standard
products. For the three and nine month periods ended September 30, 2005 and
2004 the Company's standard products sales accounted for 95% and 96% of the
Company's net revenues, respectively. The Company believes that a substantial
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
portion of its net revenues in the future will depend upon standard products
sales, although such sales as a proportion of net revenues may vary as the
Company adjusts product output levels to correspond with varying economic
conditions and demand levels in the markets which it serves. The standard
products business is characterized by short-term orders and shipment
schedules, and customer orders typically can be canceled or rescheduled
without significant penalty to the customer. Since most standard products
backlog is cancelable without significant penalty, the Company typically plans
its production and inventory levels based on internal forecasts of customer
demand, which is highly unpredictable and can fluctuate substantially. In
addition, the Company is limited in its ability to reduce costs quickly in
response to any revenue shortfalls.
The Company may experience significant fluctuations in its results of
operations. Factors that affect the Company's results of operations include
the volume and timing of orders received, changes in the mix of products sold,
the utilization level of manufacturing capacity, competitive pricing pressures
and the successful development of new products. These and other factors are
described in further detail later in this discussion. As a result of the
foregoing or other factors, there can be no assurance that the Company will
not experience material fluctuations in future operating results on a
quarterly or annual basis, which could materially and adversely affect the
Company's business, financial condition, results of operations or cash flows.
Critical Accounting Policies and Estimates
The financial statements included in this Form 10-Q and discussed within
this Management's Discussion and Analysis of Financial Condition and Results
of Operations have been prepared in accordance with accounting principles
generally accepted in the United States of America. Preparation of these
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. On an on-going basis, management evaluates its estimates
and judgments. Management bases its estimates and judgments on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The Company considers
certain accounting policies related to revenue recognition, inventory
valuation, income taxes, and litigation to be critical to the fair
presentation of its financial statements. For a detailed discussion of the
Company's significant accounting policies, see Note 1 of Notes to Consolidated
Financial Statements in Item 14 of the Company's Annual Report on Form 10 K
for the year ended December 31, 2004.
Revenue Recognition and Receivables. Micrel generates revenue by selling
products to original equipment manufacturers ("OEM"s), distributors and
stocking representatives. Stocking representative firms may buy and stock the
Company's products for resale or may act as the Company's sales representative
in arranging for direct sales from the Company to an OEM customer. The
Company's policy is to recognize revenue from sales to customers when the
rights and risks of ownership have passed to the customer, when persuasive
evidence of an arrangement exists, the product has been delivered, the price
is fixed or determinable and collection of the resulting receivable is
reasonably assured.
Micrel allows certain distributors, primarily located in North America and
Europe, and in certain countries in Asia, significant return rights, price
protection and pricing adjustments subsequent to the initial product shipment.
As these returns and price concessions have historically been significant, and
future returns and price concessions are difficult to reliably estimate, the
Company defers recognition of revenue and related cost of sales (in the
balance sheet line item "deferred income on shipments to distributors")
derived from sales to these distributors until they have resold the Company's
products to their customers. Although revenue recognition and related cost of
sales are deferred, the Company records an accounts receivable and relieves
inventory at the time of initial product shipment. As standard terms are FOB
shipping point, payment terms are enforced from shipment date and legal title
and risk of inventory loss passes to the distributor upon shipment. In
addition, the Company may offer to its distributors, where revenue is deferred
upon shipment and recognized on a sell-through basis, price adjustments to
allow the distributor to price the Company's products competitively for
specific resale opportunities. The Company estimates and records an allowance
for distributor price adjustments for which the specific resale transaction
has been completed, but the price adjustment claim has not yet been received
and recorded by the Company.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Sales to OEM customers and Asian based stocking representatives are
recognized upon shipment. The Company does not grant return rights, price
protection or pricing adjustments to OEM customers. The Company offers
limited contractual stock rotation rights to stocking representatives. In
addition, the Company is not contractually obligated to offer, but may
infrequently grant, price adjustments or price protection to certain stocking
representatives on an exception basis. At the time of shipment to OEMs and
stocking representatives, an allowance for returns is established based upon
historical return rates, and an allowance for price adjustments is established
based on an estimate of price adjustments to be granted. Actual future returns
and price adjustments could be different than the allowance established.
The Company also maintains an allowance for doubtful accounts for estimated
uncollectible accounts receivable. This estimate is based on an analysis of
specific customer creditworthiness and historical bad debts experience. Actual
future uncollectible amounts could exceed the doubtful accounts allowance
established.
Inventory Valuation. Inventories are stated at the lower of cost (first-in,
first-out method) or market. The Company records adjustments to write down the
cost of obsolete and excess inventory to the estimated market value based on
historical and forecasted demand for its products. If actual future demand for
the Company's products is less than currently forecasted, additional inventory
adjustments may be required. Once a reserve is established, it is maintained
until the product to which it relates is sold or otherwise disposed of. This
treatment is in accordance with Accounting Research Bulletin 43 and SEC Staff
Accounting Bulletin 100 "Restructuring and Impairment Charges."
Income Taxes. Deferred tax assets and liabilities result primarily from
temporary timing differences between book and tax valuation of assets and
liabilities, state and federal research and development credit carryforwards
and state manufacturers credit carryforwards.
The Company must regularly assess the likelihood that future taxable income
levels will be sufficient to ultimately realize the tax benefits of these
deferred tax assets. As of September 30, 2005, the Company believes that
future taxable income levels will be sufficient to realize the tax benefits of
these deferred tax assets and has not established a valuation allowance.
Should the Company determine that future realization of these tax benefits is
not likely, a valuation allowance would be established, which would increase
the Company's tax provision in the period of such determination.
In addition, the calculation of the Company's tax liabilities involves
dealing with uncertainties in the application of complex tax regulations. The
Company records liabilities for anticipated tax audit issues based on its
estimate of whether, and the extent to which, additional taxes may be due.
Actual tax liabilities may be different than the recorded estimates and could
result in an additional charge or benefit to the tax provision in the period
when the ultimate tax assessment is determined.
Litigation. The semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. The
Company is currently involved in such intellectual property litigation (see
Note 10 of Notes to Condensed Consolidated Financial Statements) and has not
accrued a liability for such litigation. The Company regularly evaluates
current information available to determine whether such accruals should be
made. An estimated liability would be accrued when it is determined to be
probable that a liability has been incurred and the amount of loss can be
reasonably estimated. If the Company were to determine that such a liability
was probable and could be reasonably estimated, the adjustment would be
charged to income in the period such determination was made.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Results of Operations
The following table sets forth certain operating data as a percentage of total
net revenues for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 45.9 51.0 48.0 52.0
--------- --------- --------- ---------
Gross profit 54.1 49.0 52.0 48.0
--------- --------- --------- ---------
Operating expenses:
Research and development 18.2 16.4 18.4 15.8
Selling, general and
administrative 18.4 14.7 17.0 13.8
Amortization of deferred
stock compensation 0.2 0.7 0.3 0.9
Purchased in-process technology - - - 0.2
Restructuring expense - 0.6 - 0.2
Litigation accrual - - 5.0 -
--------- --------- --------- ---------
Total operating expenses 36.8 32.4 40.7 30.9
--------- --------- --------- ---------
Income from operations 17.3 16.6 11.3 17.1
Other income, net 1.7 0.5 1.6 0.4
--------- --------- --------- ---------
Income before income taxes 19.0 17.1 12.9 17.5
Provision for income taxes 6.6 6.0 4.5 4.3
--------- --------- --------- ---------
Net income 12.4% 11.1% 8.4% 13.2%
========= ========= ========= =========
Net Revenues. For the three months ended September 30, 2005, net revenues
decreased 8% to $62.5 million from $67.9 million for the same period in the
prior year. For the nine months ended September 30, 2005, net revenues
decreased 7% to $185.2 million from $198.1 million for the same period in the
prior year. These decreases were primarily due to decreased standard products
revenues.
Standard products revenues for the three months ended September 30, 2005
decreased 9% to $59.5 million from $65.3 million for the same period in the
prior year. For the nine months ended September 30, 2005, standard products
revenues decreased 7% to $177.7 million from $190.1 for the same period in the
prior year. These decreases resulted primarily from decreased unit shipments
of standard products to the computer products, industrial and network
communications end markets.
Custom and foundry products revenues for the three months ended September
30, 2005 increased 17% to $2.9 million from $2.5 million for the same period
in the prior year. For the nine months ended September 30, 2005, custom and
foundry products revenues decreased 6% to $7.5 million from $8.0 million for
the same period in the prior year.
Customer demand for semiconductors can change quickly and unexpectedly.
The Company's revenue levels have been highly dependent on the amount of new
orders that are received for which product is requested to be delivered to the
customer within the same quarter. Within the semiconductor industry these
orders that are booked and shipped within the quarter are called "turns fill"
orders. When the turns fill level exceeds approximately 35% of quarterly
revenue, it makes it very difficult to predict near term revenues and income.
Because of the long cycle time to build its products, the Company's lack of
visibility into demand when turns fill is high makes it difficult to predict
what product to build to match future demand.
Although overall semiconductor industry channel inventories appear to be
equal to or below long term historical trends, customers continue to place
orders as if semiconductor components are readily available. Customers are
cautious in committing new orders, relying instead on short lead times and the
willingness of semiconductor manufacturers to hold inventory and react quickly
to supply their short term needs. As a result, order lead times from the
Company's customers remained in the two to three week range in the third
quarter of 2005. The corresponding low backlog level, increased reliance on
turns fill orders, and the uncertain growth rate of the world economy make it
difficult to predict near term demand. The uncertainty in demand arising from
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
these factors, together with the effects of product mix and pricing, make it
difficult to precisely predict future levels of sales and profitability. In
this environment the Company, its stocking representatives and distributors
may have to carry higher levels of inventory to service anticipated customer
demand.
International sales represented 74% and 77% of net revenues for the three
months ended September 30, 2005 and 2004, respectively. For the nine months
ended September 30, 2005 and 2004, international sales represented 75% and 76%
of net revenues, respectively.
The trend for the Company's customers to move their electronics
manufacturing to Asian countries has brought increased pricing pressure for
Micrel and other semiconductor manufacturers. Asian based manufacturers are
typically more concerned about cost and less concerned about the capability of
the integrated circuits they purchase. This can make it more difficult for
United States based companies to differentiate themselves except by price. The
increased concentration of electronics procurement and manufacturing in the
Asia Pacific region has led, and may continue to lead, to continued price
pressure for the Company's products in the future.
Gross Profit. Gross profit is affected by a variety of factors including
the volume of product sales, product mix, manufacturing utilization, product
yields and average selling prices. The Company's gross margin increased to
54% for the three months ended September 30, 2005 from 49% for the comparable
period in 2004. For the nine months ended September 30, 2005, gross margin
increased to 52% from 48% for the comparable period in 2004. These increases
in gross margin resulted primarily from an increased sales mix of higher
margin products combined with decreased depreciation and other manufacturing
cost reductions. In addition, the second quarter of 2004 included a benefit of
$1.1 million from the reversal of accrued payroll tax liabilities associated
with the conclusion of a tax audit (see Note 12 of Notes to Condensed
Consolidated Financial Statements). Depreciation and amortization (excluding
amortization of deferred stock compensation) as a percent of sales declined to
8% for the three and nine months ended September 30, 2005 from 9% for the same
periods in 2004. This reduction in depreciation was primarily due to existing
equipment becoming fully depreciated, which was partially offset by additional
depreciation on new equipment purchases.
Research and Development Expenses. Research and development expenses as a
percentage of net revenues represented 18% and 16%, for the three months ended
September 30, 2005 and 2004, respectively. On a dollar basis, research and
development expenses increased $192,000 or 2% to $11.4 million for the three
months ended September 30, 2005 from $11.1 million for the comparable period
in 2004. For the nine months ended September 30, 2005 and 2004, research and
development expenses represented 18% and 16% as a percentage of net revenues,
respectively. On a dollar basis, research and development expenses increased
$2.6 million or 8% to $34.0 million for the nine months ended September 30,
2005 from $31.4 million for the comparable period in 2004. The second quarter
of 2004 included a benefit of $1.7 million from the reversal of accrued
payroll tax liabilities associated with the conclusion of a tax audit (see
Note 12 of Notes to Condensed Consolidated Financial Statements). The Company
believes that the development and introduction of new products is critical to
its future success and expects to continue its investment in research and
development activities in the future.
Selling, General and Administrative Expenses. As a percentage of net
revenues, selling, general and administrative expenses represented 18% and 15%
for the three months ended September 30, 2005 and 2004, respectively. On a
dollar basis, selling, general and administrative expenses increased $1.6
million or 16% to $11.5 million for the three months ended September 30, 2005
from $10.0 million for the comparable period in 2004. For the nine months
ended September 30, 2005 and 2004, selling, general and administrative
expenses represented 17% and 14% as a percentage of net revenues,
respectively. On a dollar basis, selling, general and administrative expenses
increased $4.2 million or 15% to $31.6 million for the nine months ended
September 30, 2005 from $27.4 million for the comparable period in 2004.
These dollar increases were principally attributable to increased outside
legal costs. In addition, the second quarter of 2004 included a benefit of
$1.1 million from the reversal of accrued payroll tax liabilities associated
with the conclusion of a tax audit. (see Note 12 of Notes to Condensed
Consolidated Financial Statements).
Amortization of Deferred Stock Compensation. The Company accounts for
stock-based awards to employees using the intrinsic value method in accordance
with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Issued to Employees". During the years 1996 through December 2001, certain of
the Company's option pricing practices resulted in stock compensation expense
under APB 25. As of September 30, 2005 total unamortized stock compensation
was $415,000 with an anticipated remaining future amortization schedule of
$120,000 in 2005.
In December 2004, the Financial Accounting Standards Board ("FASB" or the
"Board") issued Statement of Accounting Standards ("SFAS") No. 123R, "Share-
Based Payment". SFAS No. 123R is a revision of SFAS No. 123, and supersedes
APB 25 (see Note 2 of Notes to Condensed Consolidated Financial Statements for
more discussion of SFAS No. 123R).
Purchased In-process Technology. Associated with the acquisition of
BlueChip, Micrel allocated $2.6 million of the total purchase cost to
intangible assets. Of that amount, $480,000 was expensed for purchased in-
process technology, which had not reached technological feasibility and had no
alternative future use, in the three months ended March 31, 2004. This amount
was adjusted and reversed in part as of December 31, 2004 to reflect the final
determination of conditional consideration that had previously been allocated
in part to purchased in-process technology.
Litigation Accrual. On July 22, 2005, a jury ruled against Micrel in its
suit against TRW Automotive and for TRW automotive in its counter suit against
Micrel. The suits were related to a contract dispute between the two
companies. As a result of the jury's verdict, Micrel accrued $9.3 million in
litigation expense in the second quarter 2005 financial statements (see Note
10 of Notes to Condensed Consolidated Financial Statements).
Other Income, Net. Other income, net reflects interest income from
investments in short-term and long-term investment grade securities and money
market funds and other non-operating income, offset by interest expense
incurred on term notes and accrued interest related to accrued litigation
liabilities. Other income, net increased $705,000 to $1.1 million for the
three months ended September 30, 2005 from $363,000 for the comparable period
in 2004. Other income, net increased $2.0 million to $2.9 million for the
nine months ended September 30, 2005 from $901,000 for the comparable period
in 2004. The increase was primarily due to an increase in average interest
rates and returns on investment balances and decreased interest expense
resulting from a decrease in average debt.
Provision for Income Taxes. The income tax provision for the three and
nine months ended September 30, 2005 represented 35% of pretax income. The
income tax provision for the three and nine months ended September 30, 2004
represented of 35% of pretax income, reduced by a $3.8 million reversal of
accrued income tax liabilities as a result of the completion of a federal
income tax audit (see Note 12 of Notes to Condensed Consolidated Financial
Statements) and increased by $168,000 as a result of $480,000 of non-
deductible purchased in-process technology charges recorded in the quarter
ended March 31, 2004. The income tax provision for such interim periods
reflects the Company's estimated annual income tax rate and differs from taxes
computed at the federal statutory rate primarily due to the effect of state
income taxes, state research and development credits, federal extraterritorial
income exclusion and federal qualified production activity deductions.
Liquidity and Capital Resources
Since inception, the Company's principal sources of funding have been its
cash from operations, bank borrowings and sales of common stock. Principal
sources of liquidity at September 30, 2005, consisted of cash and short-term
investments of $140.8 million and a $6 million revolving line of credit from a
commercial bank (see Note 6 of Notes to Condensed Consolidated Financial
Statements).
The Company generated $38.0 million in cash flows from operating activities
for the nine months ended September 30, 2005, primarily attributable to net
income of $15.5 million plus additions for non-cash activities of $14.4
million and a $7.0 million decrease in inventories combined with a $7.0
million increase in other accrued liabilities, which were partially offset by
a $3.9 million increase in accounts receivable.
For the nine months ended September 30, 2004, the Company generated $52.8
million in cash flows from operating activities, primarily attributable to net
income of $26.2 million plus additions for non-cash activities of $31.7
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
million and a $4.7 million increase in accounts payable, which was partially
offset by a $5.4 million increase in accounts receivables and a $5.9 million
increase in inventories.
The Company generated $1.6 million of cash from investing activities during
the nine months ended September 30, 2005 comprised of $12.1 million in
proceeds from net sales of short-term investments that were partially offset
by $10.5 million in purchases of property, plant and equipment.
For the nine months ended September 30, 2004, the Company used $54.8
million in cash for investing activities consisting of $13.6 million in
purchases of property, plant and equipment, $38.3 million in purchases of
short term and long-term investments, $2.0 million for the purchase of
BlueChip Communications and $1.0 million for the purchase of intangible
assets.
The Company used $36.6 million of cash in financing activities during the
nine months ended September 30, 2005 primarily for the repurchase of $42.8
million of the Company's common stock, which was partially offset by $6.3
million in proceeds from employee stock transactions.
For the nine months ended September 30, 2004, the Company used $25.7
million of cash in financing activities primarily for the repurchase of $29.0
million of the Company's common stock, which was partially offset by $3.9
million in proceeds from employee stock transactions.
The Company currently intends to spend approximately $15 million to $20
million to purchase capital equipment and make facility improvements during
the next twelve months primarily for manufacturing equipment for wafer
fabrication and product testing and additional research and development
related software and equipment. In March 2005, the Company announced that its
Board of Directors had approved a $75 million stock repurchase program and the
Company is currently authorized by its Board of Directors to repurchase an
additional $32.2 million of its common stock through December 31, 2005. Since
inception, the Company's principal sources of funding have been its cash from
operations, bank borrowings and sales of common stock. The Company believes
that its cash from operations, existing cash balances and short-term
investments, and its credit facility will be sufficient to meet its cash
requirements for 2005. In the longer term, the Company believes future cash
requirements will continue to be met by its cash from operations, credit
arrangements and future debt or equity financings as required.
Recently Issued Accounting Standards
Please refer to Note 2 of Notes to Condensed Consolidated Financial
Statements for a discussion of the expected impact of recently issued
accounting standards.
Contractual Obligations and Commitments
As of September 30, 2005, the Company had the following contractual
obligations and commitments (in thousands):
Payments Due By Period
------------------------------------------------
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
-------- -------- -------- -------- --------
Long-term debt $ 153 $ 153 $ - $ - $ -
Operating leases 9,037 3,146 2,699 2,503 689
Open purchase orders 23,000 23,000 - - -
-------- -------- -------- -------- --------
Total $ 32,190 $ 26,299 $ 2,699 $ 2,503 $ 689
======== ======== ======== ======== ========
Open purchase orders are defined as agreements to purchase goods or
services that are enforceable and legally binding and that specify all
significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum or variable pricing provisions; and the approximate timing of
the transactions.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Borrowing agreements consisted of a $5 million revolving line of credit
from a commercial bank. The revolving line of credit agreement includes a
provision for the issuance of commercial or standby letters of credit by the
bank on behalf of the Company. The value of all letters of credit outstanding
reduces the total line of credit available. There were no borrowings under
the revolving line of credit at September 30, 2005 and there were $875,000 in
standby letters of credit outstanding. The letters of credit are issued to
guarantee payments for the Company's workers compensation program.
The Company has no other off-balance sheet arrangements and has not entered
into any transactions involving unconsolidated, limited purpose entities or
commodity contracts.
Factors That May Affect Operating Results
If a company's operating results are below the expectations of public
market analysts or investors, then the market price of its common stock could
decline. Many factors that can affect a company's quarterly and annual results
are difficult to control or predict. Some of the factors which can affect a
multinational semiconductor business such as the Company are described below.
Additional factors that may affect the Company and its operating results are
contained within the Company's Form 10-K for the year ended December 31, 2004.
Geopolitical and Macroeconomic Risks That May Affect Multinational Enterprises
- -------------------------------------------------------------------------------
Demand for semiconductor components is increasingly dependent upon the rate
of growth of the global economy. If the rate of global economic growth
slows, or contracts, customer demand for products could be adversely affected,
which in turn could negatively affect revenues, results of operations and
financial condition. Many factors could adversely affect regional or global
economic growth. Some of the factors that could slow global economic growth
include: increased price inflation for goods, services or materials, rising
interest rates in the United States, a slowdown in the rate of growth of the
Chinese economy, a significant act of terrorism which disrupts global trade or
consumer confidence, geopolitical tensions including war and civil unrest.
Reduced levels of economic activity, or disruptions of international
transportation, could adversely affect sales on either a global basis or in
specific geographic regions.
The Company has generated a substantial portion of its net revenues from
export sales. The Company believes that a substantial portion of its future
net revenues will depend on export sales to customers in international
markets, including Asia. In 2004 and the first nine months of 2005, 66% of the
Company's revenues were derived from shipments to customers in Asia, an
increase from 32% in 2000 and 60% in 2003. International markets are subject
to a variety of risks, including changes in policy by the U.S. or foreign
governments, acts of terrorism, foreign government instability, social
conditions such as civil unrest, economic conditions including high levels of
inflation, fluctuation in the value of foreign currencies and currency
exchange rates and trade restrictions or prohibitions. Changes in exchange
rates that strengthen the U.S. dollar could increase the price of the
Company's products in the local currencies of the foreign markets it serves.
This would result in making the Company's products relatively more expensive
than its competitors' products that are denominated in local currencies,
leading to a reduction in sales or profitability in those foreign markets. The
Company has not taken any protective measures against exchange rate
fluctuations, such as purchasing hedging instruments. In addition, the Company
sells to domestic customers that do business worldwide and cannot predict how
the businesses of these customers may be affected by economic or political
conditions elsewhere in the world. Such factors could adversely affect the
Company's future revenues, financial condition, results of operations or cash
flows.
The Company is reliant on certain key suppliers for wafer fabrication,
circuit assembly and testing services. Most of these suppliers are based
outside of the U.S. The Company's supply could be interrupted as a result of
any of the previously mentioned risk factors relating to international
markets.
Market conditions may lead the Company to initiate additional cost
reduction plans, which may negatively affect near term operating results.
Weak customer demand, competitive pricing pressures, excess capacity, weak
economic conditions or other factors, may cause the Company to initiate
additional actions to reduce the Company's cost structure and improve the
Company's future operating results. The cost reduction actions may require
incremental costs to implement, which could negatively affect the Company's
operating results in periods when the incremental costs or liabilities are
incurred.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Semiconductor Industry Specific Risks
- -------------------------------------
The volatility of customer demand in the semiconductor industry limits a
company's ability to predict future levels of sales and profitability.
Semiconductor suppliers can rapidly increase production output, leading to a
sudden oversupply situation and a subsequent reduction in order rates and
revenues as customers adjust their inventories to true demand rates. A rapid
and sudden decline in customer demand for products can result in excess
quantities of certain products relative to demand. Should this occur the
Company's operating results may be adversely affected as a result of charges
to reduce the carrying value of the Company's inventory to the estimated
demand level or market price. The Company's quarterly revenues are highly
dependent upon turns fill orders (orders booked and shipped in the same
quarter). The short-term and volatile nature of customer demand makes it
extremely difficult to accurately predict near term revenues and profits.
The short lead time environment in the semiconductor industry has allowed
many end consumers to rely on stocking representatives and distributors to
carry inventory to meet short term requirements and minimize their investment
in on-hand inventory. The Company maintains a network of stocking
representatives and distributors, that carry inventory to service the volatile
short-term demand of the end customer. Should the relationship with a
distributor or stocking representative be terminated, the future level of
product returns could be higher than the returns allowance established, which
could negatively affect the Company's revenues and results of operations.
The semiconductor industry is highly competitive and subject to rapid
technological change, price-erosion and increased international competition.
Significant competitive factors include product features, performance and
price; timing of product introductions; emergence of new computer and
communications standards; quality and customer support.
Many semiconductor companies face risks associated with a dependence upon
third parties that manufacture, assemble or package certain of its products.
These risks include reduced control over delivery schedules and quality;
inadequate manufacturing yields and excessive costs; the potential lack of
adequate capacity during periods of excess demand; difficulties selecting and
integrating new subcontractors; potential increases in prices; disruption in
supply due to civil unrest, terrorism or other events which may occur in the
countries in which the subcontractors operate; and potential misappropriation
of the Company's intellectual property. Any of these risks may lead to
increased costs or delay delivery of the Company's products, which would harm
its profitability and customer relationships. Additionally, the Company's
wafer and product requirements typically represent a relatively small portion
of the total production of the third-party foundries and outside assembly,
testing and packaging contractors. As a result, Micrel is subject to the risk
that a foundry will provide delivery or capacity priority to other larger
customers at the expense of Micrel, resulting in an inadequate supply to meet
customer demand or higher costs to obtain the necessary product supply.
During a period when economic growth and customer demand have been less
certain, both the semiconductor industry and the Company have experienced
significant price erosion since the beginning of 2001. If price erosion
continues, it will have the effect of reducing revenue levels and gross
margins in future periods. Furthermore, the trend for the Company's customers
to move their electronics manufacturing to Asian countries has brought
increased pricing pressure for Micrel and the semiconductor industry. Asian
based manufacturers are typically more concerned about cost and less concerned
about the capability of the integrated circuits they purchase. The increased
concentration of electronics procurement and manufacturing in the Asia Pacific
region may lead to continued price pressure and additional product advertising
costs for the Company's products in the future.
An important part of the Company's strategy is to continue to focus on the
market for high-speed communications ICs. If the recovery in the
telecommunications infrastructure and wire line networking markets is not
sustainable, resulting in reduced demand for the Company's high bandwidth
products, the Company's future revenue growth and profitability could be
adversely affected.
Our customers are requiring that the Company offer its products in lead-
free packages. Governmental regulations in certain countries and our
customers' intention to produce products that are less harmful to the
environment has resulted in a requirement from many of the Company's customers
to purchase integrated circuits that do not contain lead. The Company has
responded by offering its products in lead-free versions. While the lead-free
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
versions of the Company's products are expected to be more friendly to the
environment, the ultimate impact is uncertain. The transition to lead-free
products may produce sudden changes in demand depending on the packaging
method used, which may result in excess inventory of products packaged using
traditional methods. This may have an adverse affect on the Company's results
of operations. In addition, the quality, cost and manufacturing yields of the
lead free products may be less favorable compared to the products packaged
using more traditional materials which may result in higher costs to the
Company.
The markets that the Company serves frequently undergo transitions in which
products rapidly incorporate new features and performance standards on an
industry-wide basis. If the Company's products are unable to support the new
features or performance levels required by OEMs in these markets, it would
likely lose business from existing or potential customers and would not have
the opportunity to compete for new design wins until the next product
transition. If the Company fails to develop products with required features or
performance standards, or experiences even a short delay in bringing a new
product to market, or if its customers fail to achieve market acceptance of
their products, its revenues could be significantly reduced for a substantial
period of time.
Because the standard products market for ICs is diverse and highly
fragmented, the Company encounters different competitors in various market
areas. Most of these competitors have substantially greater technical,
financial and marketing resources and greater name recognition than the
Company. There can be no assurance that the Company will be able to compete
successfully in either the standard products or custom and foundry products
business in the future or that competitive pressures will not adversely affect
the Company's financial condition, results of operations, or cash flows.
The significant investment in semiconductor manufacturing capacity and the
rapid growth of circuit design centers in China may present a competitive
threat to established semiconductor companies due to the current low cost of
labor and capital in China. The emergence of low cost competitors in China
could reduce the revenues and profitability of established semiconductor
manufacturers.
There is intense competition for qualified personnel in the semiconductor
industry, in particular design engineers. The Company may not be able to
continue to attract and train engineers or other qualified personnel necessary
for the development of its business or to replace engineers or other qualified
personnel who may leave its employ in the future. Loss of the services of, or
failure to recruit, key design engineers or other technical and management
personnel could be significantly detrimental to the Company's product and
process development programs.
The success of companies in the semiconductor industry depends in part upon
intellectual property, including patents, trade secrets, know-how and
continuing technology innovation. There can be no assurance that the steps
taken by the Company to protect its intellectual property will be adequate to
prevent misappropriation or that others will not develop competitive
technologies or products. There can be no assurance that any patent owned by
the Company will not be invalidated, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages or that any of
its pending or future patent applications will be issued with the scope of the
claims sought, if at all. Furthermore, there can be no assurance that others
will not develop technologies that are similar or superior to the Company's
technology, duplicate technology or design around the patents owned by the
Company. Additionally, the semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. There can
be no assurance that existing claims or any other assertions or claims for
indemnity resulting from infringement claims will not adversely affect the
Company's business, financial condition, results of operations, or cash flows.
The recently issued Statement of Accounting Standards ("SFAS") No. 123R,
"Share-Based Payment" will require the Company to recognize the cost of
employee services received in exchange for awards of equity instruments, based
on the grant date fair value of those awards, in the financial statements. As
discussed in Note 2 of Notes to Condensed Consolidated Financial Statements,
the ultimate impact from the adoption of this accounting standard is uncertain
but it is expected to significantly increase stock based compensation expense
in future periods after adoption. The pro forma effect to net income and
earnings per share had the Company applied the fair value method to stock-
based awards has been disclosed in the Company's previous Form 10-K filings
and is contained in Note 1 of the Notes to Condensed Consolidated Financial
Statements of this Form 10-Q. However, a reduction in net income and earnings
per share from the expensing of stock option awards in the Company's future
results of operation may have an adverse affect on the value of the Company's
common stock. If the Company reduces the number of stock option grants to
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
employees to minimize the cost associated with share based incentive awards,
it will most likely make it more difficult for the Company to hire and retain
employees.
Companies in the semiconductor industry are subject to a variety of
federal, state and local governmental regulations related to the use, storage,
discharge and disposal of toxic, volatile or otherwise hazardous chemicals
used in its manufacturing process. Any failure to comply with present or
future regulations could result in the imposition of fines, the suspension of
production, alteration of manufacturing processes or a cessation of
operations. In addition, these regulations could restrict the Company's
ability to expand its facilities at their present locations or construct or
operate a new wafer fabrication facility or could require the Company to
acquire costly equipment or incur other significant expenses to comply with
environmental regulations or clean up prior discharges. The Company's failure
to appropriately control the use of, disposal or storage of, or adequately
restrict the discharge of, hazardous substances could subject it to future
liabilities and could have a material adverse effect on its business.
Company-Specific Risks
- ----------------------
In addition to the risks that affect multinational semiconductor companies
listed above, there are additional risks which are more specific to the
Company such as:
The Company's gross margin, operating margin and net income are highly
dependent on the level of revenue and capacity utilization that the Company
experiences. Semiconductor manufacturing is a capital-intensive business
resulting in high fixed costs. If the Company is unable to utilize its
installed wafer fabrication or test capacity at a high level, the costs
associated with these facilities and equipment would not be fully absorbed,
resulting in higher average unit costs and lower profit margins.
The cellular telephone (wireless handset) market comprises a significant
portion of the Company's standard product revenues. The proportion of the
Company's annual revenues from customers serving the cellular telephone market
has been increasing over the last three years, growing from less than 20% of
worldwide sales in 2001 to approximately 25% in 2004 and 27% in the first nine
months of 2005. Due to the highly competitive and fast changing environment in
which the Company's cellular telephone customers operate, demand for the
product the Company sells into this end market can change rapidly and
unexpectedly. If the Company's cellular telephone customers lose market
share, or accumulate too much inventory of completed handsets, the demand for
the Company's products can decline sharply which could adversely affect the
Company's revenues and results of operations.
The Company is currently involved in a number of lawsuits. The Company
currently has four significant pending litigations. Litigation is by its
nature unpredictable and costly. Two cases are currently scheduled for trial
in the fourth quarter of 2005 and the first quarter of 2006, respectively, and
the Company filed a Motion for an order setting aside the July 22, 2005 jury
verdict in the Micrel vs. TRW case. The Company currently expects that outside
legal expenses will continue to be significant through the first half of 2006.
If the level of effort required to prosecute or defend the Company's position
in any of the law suits increases significantly, or if a judgment is entered
against the Company, the resulting expense could adversely affect the
Company's results of operations or cash flows.
The Company derives a significant portion of its revenues from customers
located in certain geographic regions or countries. A significant portion of
the Company's revenues come from customers located in South Korea. In the
event that political tensions surrounding North Korea evolve into military or
social conflict, or other factors disrupt the Korean economy, the Company's
revenues, results of operations, cash flow and financial condition could be
adversely affected. A significant portion of the Company's revenues come from
customers located in Taiwan and China. In the event that economic activity in
these two countries declines, or is disrupted by geopolitical events, the
Company's revenues and results of operations could be adversely affected.
The Company manufactures most of its semiconductors at its San Jose,
California fabrication facilities. The Company's existing wafer fabrication
facility, located in Northern California, may be subject to natural disasters
such as earthquakes. A significant natural disaster, such as an earthquake or
prolonged drought, could have a material adverse impact on the Company's
business, financial condition and operating results. Furthermore,
manufacturing semiconductors requires manufacturing tools that are unique to
each product being produced. If one of these unique manufacturing tools was
damaged or destroyed, the Company's ability to manufacture the related product
would be impaired and its business would suffer until the tool was repaired or
replaced. Additionally, the fabrication of ICs is a highly complex and
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
precise process. Small impurities, contaminants in the manufacturing
environment, difficulties in the fabrication process, defects in the masks
used to print circuits on a wafer, manufacturing equipment failures, wafer
breakage or other factors can cause a substantial percentage of wafers to be
rejected or numerous die on each wafer to be nonfunctional. The Company
maintains approximately two to three months of inventory that has completed
the wafer fabrication manufacturing process. This inventory is generally
located offshore at third party subcontractors and can act to buffer some of
the adverse impact from a disruption to the Company's San Jose wafer
fabrication activity arising from a natural disaster such as an earthquake.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 2005, the Company held $36.5 million in short-term
investments. Short-term investments consist primarily of liquid debt
instruments and are classified as available-for-sale securities. Investments
purchased with remaining maturity dates of greater than three months and less
than 12 months are classified as short-term. Investments purchased with
remaining maturity dates of 12 months or greater are classified either as
short-term or as long-term based on maturities and the Company's intent with
regards to those securities (expectations of sales and redemptions). These
available-for-sale securities are subject to interest rate risk and will fall
in value if market interest rates increase. If market interest rates were to
increase immediately and uniformly by 10 percent from levels at September 30,
2005, the fair value of the short-term investments would decline by an
immaterial amount. The Company generally expects to have the ability to hold
its fixed income investments until maturity and therefore would not expect
operating results or cash flows to be affected to any significant degree by
the effect of a sudden change in market interest rates on short-term
investments.
At September 30, 2005, the Company held no fixed-rate long-term debt
subject to interest rate risk.
ITEM 4: CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's reports
under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission, and that such information is accumulated
and communicated to the Company's management, including its chief executive
officer and chief financial officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As required by Securities and Exchange Commission Rule 13a-15(b), the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
the end of the period covered by this report. Based on the foregoing, the
Company's chief executive officer and chief financial officer have concluded
that the Company's disclosure controls and procedures are effective at the
reasonable assurance level as of September 30, 2005.
There has been no change in the Company's internal control over financial
reporting during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information included in Note 10 of Notes to Condensed Consolidated
Financial Statements under the caption "Litigation and Other Contingencies" in
Item 1 of Part I is incorporated herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Dividend Payment Restrictions
The Company has entered into borrowing agreements that contain restrictions on
the declaration and payment of dividends without the lender's consent. In
addition, the Company currently intends to retain future earnings to fund
operations, and does not anticipate paying dividends on its common stock in
the foreseeable future.
Issuer Purchases of Equity Securities
Issuer Purchases of Equity Securities
Maximum Dollar
Total Number of Value of Shares
Total Shares Purchased that May Yet be
Number Average as Part of Repurchased Under
of Shares Price Paid Publicly Announced the Plans or
Period Purchased Per Share Plans or Programs Programs ($000)
- ----------------- --------- ---------- ------------------ -----------------
January 2005 478,500 $ 9.19 478,500 $ 31,216
February 2005 415,800 $ 8.85 415,800 $ 27,535
March 2005 943,900 $ 9.61 943,900 $ 57,852
April 2005 722,600 $ 8.69 722,600 $ 51,574
May 2005 507,600 $ 10.30 507,600 $ 46,348
June 2005 308,400 $ 11.67 308,400 $ 42,746
July 2005 254,600 $ 12.35 254,600 $ 39,601
August 2005 349,400 $ 11.83 349,400 $ 35,466
September 2005 270,100 $ 12.11 270,100 $ 32,194
--------- ---------
Total 4,250,900 $ 10.07 4,250,900
========= =========
In February 2002, the Company's Board of Directors approved a plan to
repurchase shares of the Company's common stock in the open market. Shares of
common stock purchased pursuant to the repurchase program are cancelled upon
repurchase, and are intended to offset dilution from the Company's stock
option plans, employee stock purchase plans and 401(k) plan. In August 2004,
the Board of Directors amended the repurchase program and authorized the
repurchase of common stock up to a maximum value of $75 million during the
period from January 1, 2004 through June 30, 2005. In March 2005, the Board of
Directors approved a $75 million share repurchase program for calendar year
2005. This action supercedes the Company's previously approved authorization
to repurchase Micrel common stock announced in August, 2004.
ITEM 6. EXHIBITS
Exhibit No. Description
- ----------- -----------
31 Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
28
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.
MICREL, INCORPORATED
--------------------
(Registrant)
Date: November 8, 2005 By /s/ Richard D. Crowley, Jr.
------------------------------
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
29
EXHIBIT 31
Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Raymond D. Zinn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Micrel,
Incorporated;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in the Exchange Act Rules 13a-15(d) and 15d-
15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) designed such internal control over financial reporting, or
caused such internal control over financial control to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation;
d) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 8, 2005 By /s/ Raymond D. Zinn
Raymond D. Zinn
President, Chief Executive Officer and Director
(Principal Executive Officer)
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Richard D. Crowley, Jr. certify that:
1. I have reviewed this quarterly report on Form 10-Q of Micrel,
Incorporated;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in the Exchange Act Rules 13a-15(d) and 15d-
15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) designed such internal control over financial reporting, or
caused such internal control over financial control to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation;
d) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 8, 2005 By /s/ Richard D. Crowley, Jr.
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Principal Financial and Accounting Officer)
EXHIBIT 32
Certification of Chief Executive Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Pursuant to 18 U.S.C. ? 1350, as created by Section 906 of the Sarbanes-
Oxley Act of 2002, the undersigned officer of Micrel, Incorporated (the
"Company") hereby certifies, to such officer's knowledge, that:
(i) the accompanying Quarterly Report on Form 10-Q of the Company for
the quarterly period ended September 30, 2005 (the "Report") fully complies
with the requirements of Section 13(a) or Section 15(d), as applicable, of
the Securities Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 8, 2005 /s/ Raymond D. Zinn
Raymond D. Zinn
Chief Executive Officer
Certification of Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Pursuant to 18 U.S.C. ? 1350, as created by Section 906 of the Sarbanes-
Oxley Act of 2002, the undersigned officer of Micrel, Incorporated (the
"Company") hereby certifies, to such officer's knowledge, that:
(i) the accompanying Quarterly Report on Form 10-Q of the Company for
the quarterly period ended September 30, 2005 (the "Report") fully complies
with the requirements of Section 13(a) or Section 15(d), as applicable, of
the Securities Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 8, 2005 /s/ Richard D. Crowley, Jr.
Richard D. Crowley
Chief Financial Officer
48