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 March 31 2006.
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
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 April 28, 2006 there were 83,511,698 shares of common stock, no par
value, outstanding.
MICREL, INCORPORATED
INDEX TO
REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2006
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2006 and December 31, 2005 3
Condensed Consolidated Statements of Operations -
Three Months Ended March 31, 2006 and 2005 4
Condensed Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2006 and 2005 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 1A. Risk Factors 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 6. Exhibits 29
Signature 30
2
ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
March 31, December 31,
2006 2005 (1)
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 99,581 $ 88,130
Restricted cash 2,629 --
Short term investments 29,532 48,433
Accounts receivable, net 39,980 35,524
Inventories 33,138 30,419
Prepaid expenses and other 2,012 1,919
Deferred income taxes 21,598 22,134
---------- ----------
Total current assets 228,470 226,559
PROPERTY, PLANT AND EQUIPMENT, NET 76,993 77,554
DEFERRED INCOME TAXES 12,095 10,264
INTANGIBLE ASSETS, NET 4,346 4,752
OTHER ASSETS 421 411
---------- ----------
TOTAL $ 322,325 $ 319,540
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 18,979 $ 20,552
Income taxes payable 9,700 4,939
Deferred income on shipments to distributors 17,501 14,069
Other current liabilities 19,920 21,672
Current portion of long-term debt 113 147
---------- ----------
Total current liabilities 66,213 61,379
OTHER LONG-TERM OBLIGATIONS 458 475
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:
2006 - 83,627,078 shares;
2005 - 84,646,680 shares 62,802 73,848
Deferred stock compensation -- (294)
Accumulated other comprehensive loss (33) (52)
Retained earnings 192,885 184,184
---------- ----------
Total shareholders' equity 255,654 257,686
---------- ----------
TOTAL $ 322,325 $ 319,540
========== ==========
(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, 2005.
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
March 31,
-----------------------
2006 2005
---------- ----------
NET REVENUES $ 68,151 $ 60,685
COST OF REVENUES(1) 28,257 30,309
---------- ----------
GROSS PROFIT 39,894 30,376
---------- ----------
OPERATING EXPENSES:
Research and development(1) 13,038 11,524
Selling, general and administrative(1) 13,411 9,530
---------- ----------
Total operating expenses 26,449 21,054
---------- ----------
INCOME FROM OPERATIONS 13,445 9,322
OTHER INCOME, NET 1,252 836
---------- ----------
INCOME BEFORE INCOME TAXES 14,697 10,158
PROVISION FOR INCOME TAXES 5,996 3,555
---------- ----------
NET INCOME $ 8,701 $ 6,603
========== ==========
NET INCOME PER SHARE:
Basic $ 0.10 $ 0.07
========== ==========
Diluted $ 0.10 $ 0.07
========== ==========
WEIGHTED AVERAGE SHARES USED IN COMPUTING
PER SHARE AMOUNTS:
Basic 84,025 89,102
========== ==========
Diluted 85,794 89,624
========== ==========
(1) Stock-based compensation expense included in:
Cost of revenues $ 182 $ 51
Research and development 1,065 64
Selling, general and administrative 1,109 186
---------- ----------
Total stock compensation $ 2,356 $ 301
========== ==========
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)
Three Months Ended
March 31,
-----------------------
2006 2005
---------- ----------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 8,701 $ 6,603
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,235 5,371
Stock based compensation 2,356 301
Tax benefit on the exercise of employee
stock options 391 --
Excess tax benefits associated with stock
compensation (133) --
Loss on disposal of assets 54 102
Deferred rent (17) (20)
Deferred income taxes (1,295) (349)
Changes in operating assets and liabilities:
Accounts receivable (4,456) (236)
Inventories (2,371) 2,175
Prepaid expenses and other assets (103) 121
Accounts payable (1,573) (2,571)
Income taxes 4,761 1,482
Other current liabilities (1,752) 1,114
Deferred income on shipments to distributors 3,432 (292)
---------- ----------
Net cash provided by operating activities 12,230 13,801
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Change in restricted cash (2,629) --
Purchases of property, plant and equipment (3,322) (1,929)
Proceeds from the sale of short-term investments, net 18,920 17,078
---------- ----------
Net cash provided by investing activities 12,969 15,149
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (34) (50)
Proceeds from the issuance of common stock, net 1,475 780
Repurchase of common stock (15,322) (17,148)
Excess tax benefits associated with
stock compensation 133 --
---------- ----------
Net cash used in financing activities (13,748) (16,418)
---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 11,451 12,532
CASH AND CASH EQUIVALENTS - Beginning of period 88,130 101,282
---------- ----------
CASH AND CASH EQUIVALENTS - End of period $ 99,581 $ 113,814
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 163 $ 49
========== ==========
Income taxes $ 2,143 $ 2,468
========== ==========
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 March 31, 2006 and for the three months ended
March 31, 2006 and 2005 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. The
Condensed Consolidated Balance Sheet data as of December 31, 2005, was derived
from audited financial statements, but does not include all disclosures
required by accounting principles generally accepted ("GAAP") in the United
States of America. 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,
2005. 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, 2005.
Restricted Cash - During the first quarter of 2006, the Company elected to
post a surety bond to stay payment of potential damages and interest arising
from a judgment awarded to TRW by a jury during 2005 (see Note 7 and Note
11). As collateral for the surety bond, the Company placed $2.6 million in
a registered pledge account. The amount pledged is classified as Restricted
Cash in the Company's Condensed Consolidated Balance Sheets, and is invested
in high quality, short-term investment securities consistent with the
Company's cash investment policy. The interest earned on the pledged amount
accrues to the benefit of the Company.
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
March 31,
-----------------------
2006 2005
---------- ----------
Weighted average common shares outstanding 84,025 89,102
Dilutive effect of stock options outstanding using
the treasury stock method 1,769 522
---------- ----------
Shares used in computing diluted net income per share 85,794 89,624
========== ==========
For the three months ended March 31, 2006 and 2005, approximately 4.7
million stock options and 9.5 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.
2. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, the Financial Accounting Standards Board ("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. The Company
adopted SFAS No. 151 on January 1, 2006. The adoption of SFAS No. 151 had no
material effect on the Company's consolidated financial statements.
In May 2005, the FASB issued 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
6
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. The Company adopted SFAS No. 154 on January 1,
2006. The adoption of SFAS No. 154 had no material effect 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 Accounting
Principles Board Opinion No. 25 ("APB 25"). The Company adopted SFAS No.
123R on January 1, 2006 using the modified prospective method. The impact
of adopting this Standard is discussed in Note 3 below.
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments (FSP 115-1)," which replaces the measurement and recognition
guidance set forth in the Emerging Issues Task Force (EITF) Issue No. 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments," and codifies certain existing guidance on investment
impairment. FSP 115-1 clarifies that an investor should recognize an
impairment loss no later than when the impairment is deemed other-than-
temporary, even if a decision to sell the security has not been made, and
also provides guidance on the subsequent accounting for an impaired debt
security. FSP 115-1 also requires certain disclosures about unrealized
losses that have not been recognized as other-than-temporary impairments.
The guidance in FSP 115-1 amends SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" and is effective for reporting
periods beginning after December 15, 2005. The Company adopted the
provisions of FSP 115-1 on January 1, 2006 . The adoption of FSP 115-1 had
no material effect on the Company's consolidated financial statements.
3. SHARE-BASED COMPENSATION
In December 2004, the FASB issued SFAS No. 123R. Under the new standard,
companies are no longer able to account for share-based compensation
transactions using the intrinsic value method in accordance with APB No. 25.
Instead, companies are required to account for such transactions using a
fair-value method and recognize the expense in the consolidated statements
of operations. Effective January 1, 2006, the Company adopted SFAS No. 123R
using the modified-prospective-transition method. Under this transition
method, stock compensation cost recognized beginning January 1, 2006
includes: (a) compensation cost for all share-based payments granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of SFAS No. 123,
and (b) compensation cost for all share-based payments granted or modified
on or subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123R. In addition,
compensation cost to be recognized under SFAS No. 123R must consider an
estimate of options which will be forfeited. Results for prior periods have
not been restated.
Stock Option Plans - Under the Company's 2003 Incentive Award Plan, 1994
Stock Option Plan and its 2000 Non-Qualified Stock Incentive Plan (the
"Option Plans"), 39,958,672 shares of Common Stock are authorized for
issuance to employees. The Option Plans provide that the option price will
be determined by the Board of Directors at a price not less than the fair
value as represented by the closing price of the Company's Common Stock on
the last market trading day before the date of grant. Certain
shareholder/employees of the Company are granted options at 110% of the
current fair market value. Options granted under the 2000 Non-Qualified
Stock Incentive Plan are exercisable in 20% increments with the initial 20%
vesting occurring six months after the date of grant and then in annual
increments of 20% per year from the date of grant. Options granted under the
2003 Incentive Award Plan and 1994 Stock Option Plan typically become
exercisable in not less than cumulative annual increments of 20% per year
from the date of grant. The term of each stock option is no more than ten
years from the date of grant.
7
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A summary of the Company's stock option plan activities for the three months
ended March 31, 2006 is as follows:
Weighted
Weighted Average Aggregate
Number Average Remaining Intrinsic
of Exercise Contractual Value
Shares Price Term (years) ($000)
---------- -------- ------------ ---------
Outstanding, December 31, 2005 12,487,003 $ 12.65
Granted 652,700 14.24
Exercised (182,517) 8.05
Forfeited or expired (75,208) 14.00
----------
Outstanding, March 31, 2006 12,881,978 $ 12.78 5.7 $ 43,155
Exercisable at March 31, 2006 8,419,790 $ 13.15 4.3 $ 29,855
Exercisable and expected to
vest at March 31, 2006 12,212,650 $ 12.83 5.6 $ 41,160
The weighted average fair value (computed using the Black-Scholes option
pricing model) of options granted under the stock option plans during the
three months ended March 31, 2006 was $8.40 per share. The total intrinsic
value of options (which is the amount by which the stock price exceeded the
exercise price of the options on the date of exercise) exercised during the
three months ended March 31, 2006 was $1.0 million. During the three months
ended March 31, 2006, the amount of cash received from the exercise of stock
options was $1.5 million.
Employee Stock Purchase Plan - Under the 1994 Employee Stock Purchase
Plan, amended and restated as of January 1, 1996, (the "Purchase Plan"),
eligible employees are permitted to have salary withholdings to purchase
shares of Common Stock at a price equal to 85% of the lower of the market
value of the stock at the beginning or end of each six-month offer period,
subject to an annual limitation. At December 31, 2005, there were
2,278,346 shares of Common Stock issued under the Purchase Plan. The
Purchase Plan expired on December 31, 2005.
Accounting for Stock-based Compensation - Under SFAS No. 123R, stock-based
compensation costs for stock option grants are based on the fair value
calculated from a stock option pricing model on the date of grant. The
Company has utilized the Black-Scholes option pricing model to determine the
fair value for stock option grants. The fair value of stock option grants
issued from January 1, 2006 onwards are recognized as compensation expense
on a straight-line basis over the vesting period of the grants. Compensation
expense recognized is shown in the operating activities section of the
consolidated statements of cash flows.
Prior to adopting SFAS No. 123R, the Company accounted for stock option
grants under the recognition and measurement provisions of APB 25.
Compensation cost related to stock options granted at fair value under those
plans were not recognized in the consolidated statements of operations.
Compensation cost related to stock options granted below the fair market
value on the grant date were recognized in the consolidated statements of
operations. In addition, prior to adopting SFAS No. 123R, the Company
presented all tax benefits of deductions resulting from the exercise of
stock grants as operating cash flows in the consolidated statements of cash
flows. SFAS No. 123R requires the cash flows resulting from the tax benefits
from tax deductions in excess of the compensation cost recognized (excess
tax benefits) to be classified as financing cash flows.
The fair value of the Company's stock options granted under the Option
Plans was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions:
Three Months Ended
March 31,
-----------------------
2006 2005
---------- ----------
Expected term (years) 5.8 5
Stock volatility 59.5% 81.9%
Risk free interest rates 4.8% 4.2%
Dividends during expected terms none none
8
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Expected term is based on an analysis of historical exercises and the
remaining contractual life of options. The calculation of expected term
for previous SFAS No. 123 disclosure fair value estimates was based solely
on an analysis of historical exercises of stock options. The Company
believes that an analysis of historical exercises and remaining
contractual life of options provides a better estimate of future exercise
patterns.
Stock volatility is based upon a combination of both historical stock
price volatility and implied volatility derived from traded options on the
Company's stock in the marketplace. The calculation of expected
volatility for previous SFAS No. 123 fair value disclosure estimates was
based solely on historical stock price volatility. The Company believes
that the combination of historical volatility and implied volatility
provides a better estimate of future stock price volatility.
The Company continues to base the estimate of risk-free rate on the U.S.
Treasury yield curve in effect at the time of grant.
The Company has never paid cash dividends and does not currently intend to
pay cash dividends, thus has assumed a 0% dividend yield.
As part of the requirements of SFAS No. 123R, the Company is required to
estimate potential forfeitures of stock grants and adjust compensation
cost recorded accordingly. The estimate of forfeitures will be adjusted
over the requisite service period to the extent that actual forfeitures
differ, or are expected to differ, from such estimates. Changes in
estimated forfeitures will be recognized through a cumulative catch-up
adjustment in the period of change and will also impact the amount of
stock compensation expense to be recognized in future periods.
The following table shows total stock-based compensation expense recognized
in the Condensed Consolidated Statement of Operations for the three months
ended March 31, 2006, pursuant to SFAS No. 123R and for the three months
ended March 31, 2005 pursuant to APB 25 (in thousands):
Three Months Ended
March 31,
-----------------------
2006 2005
---------- ----------
Cost of revenues $ 182 $ 51
Research and development 1,065 64
Selling, general and administrative 1,109 186
---------- ----------
Pre-tax stock-based compensation expense 2,356 301
Less income tax effect (200) (116)
---------- ----------
Net stock-based compensation expense $ 2,156 $ 185
========== ==========
The Company's income before income taxes and net income for the three
months ended March 31, 2006 were lower by $2.4 million and $2.2 million,
respectively, than if the Company had continued to account for share-based
compensation under APB 25. Basic and diluted earnings per share for the
same period were each $0.03 lower due to the Company adopting SFAS No.
123R.
Total stock-based compensation cost capitalized as part of inventory for
the three months ended March 31, 2006 was $348,000.
At March 31, 2006, there was $18.5 million of total unrecognized
compensation cost related to non-vested stock option awards which is
expected to be recognized over a weighted-average period of 3.8 years.
9
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Pro Forma Information under SFAS No. 123 for Periods Prior to AFAS123 No. 123R
Adoption - As discussed above, results for prior periods have not been
restated to reflect the effects of implementing SFAS No. 123R. The following
table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to
stock options granted under the Company's stock option plans and shares issued
under the employee stock purchase plan for the three months ended March 31,
2005. For purposes of this pro forma disclosure, the value of the stock
options was estimated using a Black-Scholes option-pricing model using a
multiple option valuation approach with forfeitures recognized as they occur
(in thousands, except per-share amounts):
Three Months
Ended
March 31,
2005
----------
Net income as reported $ 6,603
Add: stock-based employee compensation expense
included in reported net income, net of tax effects 185
Deduct: stock-based employee compensation expense
determined under fair value based method,
net of tax effects (2,852)
----------
Pro forma net income $ 3,936
==========
Net income per share as reported:
Basic $ 0.07
==========
Diluted $ 0.07
==========
Pro forma net income per share:
Basic $ 0.04
==========
Diluted $ 0.04
==========
For the three months ended March 31, 2005, pro forma stock compensation
amounts have been revised to reflect the estimated tax effect of various
stock option grants. These revisions resulted in a decrease in pro forma
net income of $606,000 ($0.01 per diluted share).
4. 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 March 31, 2006 is as follows (in thousands):
Unrealized Unrealized
Amortized Market Holding Holding
Cost Value Gains Losses
---------- ---------- ---------- -----------
Short-term investments $ 29,570 $ 29,532 $ -- $ 38
10
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. INVENTORIES
Inventories consist of the following (in thousands):
March 31, December 31,
2006 2005
---------- ----------
Finished goods $ 13,891 $ 12,472
Work in process 18,152 17,044
Raw materials 1,095 903
---------- ----------
$ 33,138 $ 30,419
========== ==========
6. OTHER CURRENT LIABILITES
Other current liabilities consist of the following (in thousands):
March 31, December 31,
2006 2005
---------- ----------
Accrued current restructuring expenses $ 1,473 $ 1,759
Accrued workers compensation and health insurance 1,327 1,343
Accrued litigation 9,282 9,282
Accrued compensation 5,184 6,951
Accrued commissions 1,638 1,480
All other current accrued liabilities 1,016 857
---------- ----------
Total other current liabilities $ 19,920 $ 21,672
========== ==========
7. 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
direct borrowings under the revolving line of credit at March 31, 2006, 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 (7.75% at March 31, 2006), or the bank's revolving
offshore rate, which approximates LIBOR (5.0% at March 31, 2006) 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
March 31, 2006.
On February 23, 2006, the Company posted a surety bond in the amount of
$10.5 million in the United States District Court, Northern District of
Ohio, to stay payment of potential damages and interest arising from a
judgment awarded to TRW by a jury on July 26, 2005 (see Note 11). The
Company is currently appealing the verdict. As collateral for the surety
bond, the Company placed $2.6 million in a registered pledge account. The
amount pledged is classified as Restricted Cash in the Company's Condensed
Consolidated Balance Sheet (see Note 1).
Associated with the acquisition of BlueChip Communications, the Company has
$113,000 outstanding in term notes payable to the Norwegian Industrial and
Regional Development Fund.
8. SIGNIFICANT CUSTOMERS
During the three months ended March 31, 2006, two customers, an Asian based
stocking representative and a world wide distributor, accounted for $8.6
million (13%) and $8.3 million (12%) of net revenues, respectively. During
the three months ended March 31, 2005, three customers, an Asian based OEM,
11
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
a world wide distributor and an Asian based stocking representative,
accounted for $9.7 million (16%), $7.2 million (12%) and $6.5 million (11%)
of net revenues, respectively.
At March 31, 2006, three customers, an Asian based stocking representative
and two world wide distributors accounted for 18%, 16% and 13%,
respectively, of total accounts receivable. As of December 31, 2005, three
customers, an Asian based stocking representative and two world wide
distributors accounted for 18%, 15% and 15%, respectively, of total accounts
receivable.
9. COMPREHENSIVE INCOME
Comprehensive income, which was comprised of the Company's net income for
the periods and changes in unrealized gains or losses on investments, was
$8.7 million and $6.6 million for the three months ended March 31, 2006 and
2005, respectively.
10. 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.
Net Revenues by Segment
(dollars in thousands)
Three Months Ended
March 31,
-----------------------
2006 2005
---------- ----------
Net Revenues:
Standard Products $ 65,007 $ 58,587
Custom and Foundry Products 3,144 2,098
---------- ----------
Total net revenues $ 68,151 $ 60,685
========== ==========
As a Percentage of Total Net Revenues:
Standard Products 95% 97%
Custom and Foundry Products 5 3
---------- ----------
Total net revenues 100% 100%
========== ==========
11. 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
a number 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. Based on a recent court ruling in another case
brought by the Lemelson Foundation against another set of defendants, the
Foundation has filed a motion to dismiss with prejudice 14 barcode and
machine vision patents asserted in the current case against the Company.
Otherwise, the case continues to move very slowly through the motion and
hearing phase. The Court has proposed a preliminary claim construction,
12
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
to which each party has filed objections. The Court has not yet ruled on
the parties objections. The Company intends to continue to defend itself
against the claims in suit.
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. A bench trial on the merits was
commenced on November 30, 2005 and concluded on December 16, 2005. The
parties filed post-trial briefs on January 20, 2006 and are awaiting
issuance of the Court's ruling.
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
counterclaim 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 February 23, 2006, the Company
posted a surety bond in the amount of $10.5 million in the United States
District Court, Northern District of Ohio, to stay payment of damages and
potential interest awarded to TRW (see Notes 1 and 7). The Company is
currently appealing the verdict. 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, which Motion was denied by the Court. On
January 13, 2006, the Company filed a notice of its intent to appeal the
jury's verdict. The appeal and response briefs are due to be filed in the
next few months.
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.
Specifically, beginning in 1996, the Company began to follow a practice of
granting employee stock options on the date with the lowest closing price
within the thirty-day period subsequent to the employee's date of hire
(the "Thirty-Day Method"). The Company began this practice after
receiving advice from Deloitte that options granted using the Thirty-Day
Method would not be compensatory under APB No 25. The Company
subsequently determined that options granted using the Thirty-Day Method
were compensatory under APB No 25, and discontinued use of the Thirty-Day
Method thereafter. 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. The parties have
stipulated to continuation of initial and subsequent trial dates. No new
trial date has been set.
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
13
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. On December 9, 2005, the
Court issued an order granting MPS' Motion to Dismiss with regard to the
statutory and common law misappropriation of trade secrets claims, but
denying the Motion with regard to the Company's claims of breach of
confidentiality agreements and violation of California Business and
Professions Code Section 17200. The case is in the discovery phase.
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. 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.
14
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. STOCK REPURCHASE PROGRAM
On November 17, 2005 the Company's Board of Directors authorized the
repurchase of common stock up to a maximum value of $75 million during the
period from January 1, 2006 through December 31, 2006. 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
three months ended March 31, 2006, the Company repurchased, 1,202,900
shares of its common stock for $15.3 million.
13. 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 $21.6 million and net long-term deferred tax assets of $12.1
million as of March 31, 2006. 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.
The income tax provision for the three months ended March 31, 2006 and
2005 is based on the Company's estimated annual effective tax rate of
40.8% and 35% of pretax income, respectively. 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 non-deductible stock-based expense, state
income taxes, state research and development credits, federal qualified
production activity deductions.
14. 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 Other
Facility Disposal
Costs Costs Total
----------- --------- ---------
Balance December 31, 2004 $ 3,049 $ 360 $ 3,409
2005 Uses (1,650) -- (1,650)
-------- -------- --------
Balance December 31, 2005 1,399 360 1,759
2006 Uses (259) (27) (286)
-------- -------- --------
Balance March 31, 2006 $ 1,140 $ 333 $ 1,473
======== ======== ========
All of the $1.5 million in accrued restructuring costs has been included
within other current liabilities as of March 31, 2006. In February 2006,
the company terminated the lease under the terms of the lease agreement
due to major vandalism rendering the building unusable. The Lessor has
notified the company that it is disputing the termination of the lease.
Even though the Company is no longer making payments to the Lessor, the
restructuring costs shown above represent the total potential amount owed
under the lease prior to termination. Other disposal costs include
estimated costs associated with the final closing of the facility.
Actual future costs may be different than these estimates and could
require an adjustment to the restructuring accrual in the period such
determination is made.
15
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 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 the ability to meet
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. Additional factors that may affect operating
results are contained within the Company's Form 10-K for the year ended
December 31, 2005.
Micrel designs, develops, manufactures and markets a range of high-
performance analog power integrated circuits ("ICs"), mixed-signal and
digital ICs. These products address a wide range of end markets including
cellular handsets, portable computing, enterprise and home networking, wide
area and metropolitan area networks and industrial equipment. The Company
also manufactures custom analog and mixed-signal circuits and provides wafer
foundry services for customers who produce electronic systems for
communications, consumer and military applications.
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. 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 Micrel's customers
continued to average two to three weeks. First quarter 2005 gross margin
improved to 50.1%, 3.8 percentage points higher than the fourth quarter of
2004 and more than 5 percentage points above 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 cause 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
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 the 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% less than
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
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 short delivery
requirements, even as the aggregate order level increased. Order levels from
the Company's distributors increased in the third quarter, returning to a
level consistent with sales of Micrel's products to their end customers. 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 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 49% in the year ago period and 52% in the second
quarter. The increase in gross margin was primarily a result of ongoing
manufacturing cost reductions and an improved sales mix of higher margin
products.
Continued broad based demand, combined with lean channel inventories and
short lead times, resulted in higher order rates for the Company in the fourth
quarter of 2005. Order strength in the quarter from customers serving the
industrial and communications end markets, and from the Company's major
distributors, resulted in the second highest quarterly booking level since
calendar year 2000. Revenues increased 4% on a sequential basis in the fourth
quarter to $65.1 million and were 10% above the revenues in the year ago
period. Gross margin increased by 3.4 percentage points to 57.5% from the
third to the fourth quarter and was 11.2 percentage points higher than the
fourth quarter of 2004 primarily due to a higher mix of sales with higher
gross margins, and increased factory utilization. The fourth quarter gross
margin was the third highest quarterly gross margin in the Company's history
and has returned to levels recorded in the year 2000. This is notable since
the revenues and capacity utilization in the fourth quarter of 2005 were
approximately one-third lower than comparable peak levels in 2000. Despite an
increase in legal expenses associated with an atypically high level of
litigation activity, the Company's operating income and operating margin
increased on both a sequential and year-over-year basis in the fourth quarter.
Although order rates increased in the fourth quarter, customer lead times
remained short, averaging three to four weeks.
In the first quarter of 2006, broad based strength in customer demand,
combined with continued lean channel inventories resulted in the highest
quarterly booking level for Micrel since calendar year 2000. Orders from
customers serving the communications and industrial end markets strengthened
in the first quarter. Bookings from Micrel's major sell-through distributors
also increased sequentially in the first quarter. Increased end customer
demand led these distributors to extend their order backlog with Micrel during
the quarter. This resulted in a distributor book-to-bill substantially above
one as our distributors attempted to increase their inventories and ensure
availability of supply for Q2. Bookings from our direct OEM customers and
sell-in stocking representatives also increased on a sequential basis, despite
typical seasonal slowness in the handset and personal computing end markets.
Revenues increased 5% on a sequential basis to $68.2 million and were 12%
above the revenues of the year-ago period. The sequential growth in
revenues was primarily the result of increased demand from customers serving
the wireline communications end market and higher resales of the Company's
products through its distributors. The first quarter strength in sales to the
communications and industrial end markets was partially offset by seasonal
declines in sales to the wireless handset (primarily in Korea) and computing
end markets.
The Company's gross margin increased for the fifth consecutive quarter. In
the first quarter of 2006, the Company recorded the highest quarterly gross
margin in its history. The first quarter gross margin of 58.5% exceeded the
previous peak gross margins recorded in the year 2000, when revenue levels
were substantially higher. The sequential improvement in gross margin was
primarily the result of a richer sales mix driven by increased sales of higher
margin wireline communications products. Despite an increase of $2.0 million
in equity-based compensation as a result of the adoption of SFAS No. 123R, the
Company's operating profit increased on both a sequential and year-over-year
basis. Operating margin improved to 20% of revenues in the first quarter of
2006 from 19% in the fourth quarter of 2005 and 15% in the year-ago period.
The Company's inventory increased on a sequential basis in response to higher
demand and in order to provide competitive lead times to our customers. The
sequential increase in inventory added approximately one percentage point to
first quarter gross margin, about the same as that experienced in the fourth
quarter of 2005.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company derives a substantial portion of its net revenues from
standard products. For the three month periods ended March 31, 2006 and 2005
the Company's standard products sales accounted for 95% and 97% of the
Company's net revenues, respectively. The Company believes that a
substantial 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, share-based compensation, 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, 2005.
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, where revenue is deferred upon shipment and recognized on a sell-
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
through basis, the Company may offer price adjustments to its distributors 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.
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."
Share-Based Compensation. Prior to fiscal 2006, the Company accounted for
stock-based compensation plans under the recognition and measurement
provisions of APB Opinion No. 25. Effective January 1, 2006, Micrel adopted
the provisions of SFAS No. 123R using the modified-prospective transition
method. Under SFAS No. 123R share-based compensation cost is measured at the
grant date based on the fair value of the award and is recognized as expense
in the statement of operations. To determine fair value, the Company uses the
Black-Scholes valuation model which requires input factors such as expected
term, stock price volatility, dividend rate and risk free interest rate. In
addition, SFAS No. 123R requires an estimate of expected forfeiture rates of
stock grants and stock-based compensation expense is to be only recognized for
those shares expected to vest. Determining the input factors, such as expected
term, expected volatility and estimated forfeiture rates, requires significant
judgment based on subjective future expectations.
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 March 31, 2006, 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 11 of Notes to Condensed Consolidated Financial Statements). An
estimated liability is accrued when it is determined to be probable that a
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
liability has been incurred and the amount of loss can be reasonably
estimated. The liability accrual is charged to income in the period such
determination is made. The Company regularly evaluates current information
available to determine whether such accruals should be made.
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
March 31,
-----------------------
2006 2005
---------- ----------
Net revenues 100.0% 100.0%
Cost of revenues 41.5 49.9
----- -----
Gross profit 58.5 50.1
----- -----
Operating expenses:
Research and development 19.1 19.0
Selling, general and administrative 19.7 15.7
----- -----
Total operating expenses 38.8 34.7
----- -----
Income from operations 19.7 15.4
Other income, net 1.9 1.4
----- -----
Income before income taxes 21.6 16.8
Provision for income taxes 8.8 5.9
----- -----
Net income 12.8% 10.9%
===== =====
Net Revenues. For the three months ended March 31, 2006, net revenues
increased 12% to $68.2 million from $60.7 million for the same period in the
prior year. This increase was primarily due to increased standard products
revenues and to a lesser extent increased custom and foundry revenues.
Standard products revenues for the three months ended March 31, 2006
increased 11% to $65.0 million from $58.6 million for the same period in the
prior year. This increase resulted primarily from increased unit shipments of
standard products to the industrial, computer products, networking and high-
speed communications end markets.
Custom and foundry products revenues for the three months ended March 31,
2006 increased 50% to $3.1 million from $2.1 million for the same period in
the prior year. This increase resulted primarily from increased unit shipments
of custom products to the industrial end market.
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. The
Company averaged approximately 55% to 60% turns fill per quarter during 2005.
The first quarter 2006 turns fill rate for OEM and stocking representatives
remained in this same range.
Throughout 2005 customers maintained a focus on inventory control,
continuing the trend that began in the second half of 2004. Overall
semiconductor industry channel inventories remained near historical low
levels throughout 2005. Nevertheless, customers were cautious about
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 stayed relatively short throughout 2005. When demand
for the Company's products increased in the third and fourth quarter, order
backlog increased and lead times from the Company's customers grew modestly
to three to four weeks, from approximately two to three weeks in the first
nine months of 2005. In the first quarter of 2006, the order lead time once
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
again increased to approximately five to six weeks as a result of increased
demand from the Company's distributors and from customers serving the
wireline communications end market. Although higher backlog and slightly
longer order lead times provide modestly improved visibility into end demand,
the ongoing 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 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 73% and 76% of net revenues for the three
months ended March 31, 2006 and 2005, respectively. On a dollar basis,
international sales increased 7% to $49.6 million for the three months ended
March 31, 2006 from $46.3 million for the comparable period in 2005. This
increase resulted primarily from increased shipments of standard products to
the industrial end markets, primarily in Europe.
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.
Stock-Based Compensation. Effective January 1, 2006, the Company adopted
the fair value recognition provisions of SFAS No. 123R using the modified
prospective transition method and therefore has not restated results for
prior periods. The Company's results of operations for the three months ended
March 31, 2006 were impacted by the recognition of non-cash expense related
to the fair value of stock-based compensation awards. During the three months
ended March 31, 2006, Micrel recorded $2.4 million in pre-tax stock-based
compensation expense, of which $182,000 is included in cost of revenues, $1.1
million is included in research and development expense and $1.1 million is
included in sales, general and administrative expense. Total impact of stock-
based compensation expense, net of tax, for the three months ended March 31,
2006 was $2.2 million.
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
58.5% for the three months ended March 31, 2006 from 50.1% for the comparable
period in 2005. The increase in gross margin resulted primarily from a greater
sales mix of higher margin products combined with decreased depreciation,
decreased wafer fabrication costs and decreased external assembly and test
costs. Depreciation and amortization as a percent of sales declined to 6% for
the three months ended March 31, 2006 from 9% for the same period in 2005.
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 19.1% and 19%, for the three months
ended March 31, 2006 and 2005, respectively. On a dollar basis, research and
development expenses increased $1.5 million or 13% to $13.0 million for the
three months ended March 31, 2006 from $11.5 million for the comparable period
in 2005. This increase was primarily due to $1.0 million in increased stock-
based compensation costs due to the adoption of SFAS No. 123R (See Note 3 of
Notes to Condensed Consolidated Financial Statements) combined with increased
prototype fabrication costs. 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 19.7% and
15.7% for the three months ended March 31, 2006 and 2005, respectively. On a
dollar basis, selling, general and administrative expenses increased $3.9
million or 41% to $13.4 million for the three months ended March 31, 2006 from
$9.5 million for the comparable period in 2005. This increase was primarily
due to a $1.1 million increase in outside legal costs, $923,000 in increased
stock-based compensation costs due to the adoption of SFAS No. 123R (See Note
3 of Notes to Condensed Consolidated Financial Statements) and increased
staffing costs, including salaries, sales commissions and profit sharing
accruals.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 $416,000 to $1.3 million for the
three months ended March 31, 2006 from $836,000 for the comparable period in
2005. The increase was primarily due to an increase in average interest rates
and returns on investment balances.
Provision for Income Taxes. The income tax provision for the three months
ended March 31, 2006 and 2005 is based on the Company's estimated annual
effective tax rate of 40.8% and 35% of pretax income, respectively. 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 non-deductible stock-based expense, state
income taxes, state research and development credits, 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 March 31, 2006, consisted of cash and short-term
investments of $129.1 million and a $6 million revolving line of credit from a
commercial bank (see Note 7 of Notes to Condensed Consolidated Financial
Statements).
The Company generated $12.2 million in cash flows from operating activities
for the three months ended March 31, 2006, primarily attributable to net
income of $8.7 million plus additions for non-cash activities of $5.6 million
combined with $4.8 million increase in income taxes payable and a $3.4 million
increase in deferred income on shipments to distributors, which was partially
offset by a $4.5 million increase in accounts receivables, a $2.4 million
increase in inventories, a $1.8 million decrease in other current liabilities
and a $1.6 million decrease in accounts payables.
For the three months ended March 31, 2005, the Company generated $13.8
million in cash flows from operating activities, primarily attributable to net
income of $6.6 million plus additions for non-cash activities of $5.4 million
and a $2.2 million decrease in inventories, which was partially offset by a
$2.6 million decrease in accounts payable.
The Company generated $13.0 million of cash from investing activities
during the three months ended March 31, 2006 comprised of $18.9 million in
proceeds from the sales of short-term investments which was partially offset
by $3.3 million in purchases of property, plant and equipment and $2.6
million increase in restricted cash (see Note 7 of Notes to Condensed
Consolidated Financial Statements).
For the three months ended March 31, 2005, the Company generated $15.1
million of cash from investing activities comprised of $17.0 million in
proceeds from the sales of short-term investments which was partially offset
by $1.9 million in purchases of property, plant and equipment.
The Company used $13.7 million of cash in financing activities during the
three months ended March 31, 2006 primarily for the repurchase of $15.3
million of the Company's common stock, which was partially offset by $1.5
million in proceeds from employee stock transactions.
For the three months ended March 31, 2005, the Company used $16.4 million
of cash in financing activities primarily for the repurchase of $17.1 million
of the Company's common stock, which was partially offset by $780,000 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 remainder of 2006 primarily for manufacturing equipment for wafer
fabrication and product testing and additional research and development
related software and equipment. The Company is currently authorized by its
Board of Directors to repurchase an additional $60 million of its common
stock through December 31, 2006. 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 2006. In the longer
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 March 31, 2006, 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 $ 113 $ 113 $ -- $ -- $ --
Operating leases 8,065 2,710 2,856 2,403 96
Open purchase orders 20,000 20,000 $ -- $ -- $ --
-------- -------- -------- -------- --------
Total $ 28,178 $ 22,823 $ 2,856 $ 2,403 $ 96
======== ======== ======== ======== ========
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.
Borrowing agreements consisted 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 direct
borrowings under the revolving line of credit at March 31, 2006 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.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At March 31, 2006, the Company held $29.5 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). The
short-term investments held at March 31, 2006 are primarily fixed rate
securities. 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 100 basis points
from levels at March 31, 2006, 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 March 31, 2006, the Company held an insignificant amount of 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 March 31, 2006.
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.
24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information included in Note 11 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 1A. RISK FACTORS
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, 2005.
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, and 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 2005, 75% of the Company's revenues were derived
from export shipments. In addition, 65% of the Company's revenues were derived
from export shipments to customers in Asia. 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.
25
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 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. The occurrence of any of these events
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.
Customers are requiring that the Company offer its products in lead-free
packages. Governmental regulations in certain countries and 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 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.
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. Over the past three months, the
orders and revenues for the Company's high-speed communications products have
26
increased. If the growth 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.
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 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.
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
27
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.
The Statement of Accounting Standards No.123R, "Share-Based Payment" requires
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 3 of the Notes to
Consolidated Financial Statements, the effect of the adoption of this
accounting standard in 2006 has significantly increased stock based
compensation expense in the current period and such expense is expected to
continue in future periods. 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 and 10-Q filings and is
contained in Note 3 of the Notes to Consolidated Financial Statements of this
form 10-Q. The requirement to recognize the cost of stock option awards as an
expense in the financial statements has and will continue to reduce net income
and earnings per share and 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 employees to minimize the cost associated with share based incentive
awards, it will most likely be more difficult for the Company to hire and
retain employees.
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 four years, growing from less than 20% of
worldwide sales in 2001 to approximately 25% in 2004 and 26% in 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. One case was tried in the fourth quarter of
2005, and the parties are awaiting the Court's ruling. Two cases have not yet
been set for trial, but it is likely that one case will be tried in the second
half of 2006 and another will be tried in 2007. In the fourth case, the
Company has filed a notice of its intent to appeal an adverse jury verdict.
The Company currently expects that outside legal expenses will continue to be
substantial in 2006. If the level of effort required to prosecute or defend
the Company's position in any of the lawsuits increases significantly, or if a
judgment is entered against the Company, the resulting expense could adversely
affect the Company's financial condition, results of operations and 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.
28
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 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 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
In November 2005, 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. The plan
authorized the repurchase of common stock up to a maximum value of $75 million
during the period from January 1, 2006 through December 31, 2006.
Repurchases of the Company's common stock during 2006 were as follows:
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 2006 570,800 $ 11.63 570,800 $ 68,360
February 2006 297,500 $ 13.76 297,500 $ 64,267
March 2006 334,600 $ 13.71 334,600 $ 59,678
--------- ---------
Total 1,202,900 $12.74 1,202,900
========= =========
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
29
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: May 9, 2006 By /s/ Richard D. Crowley, Jr.
--------------------------------
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
30