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, 2004.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number 0-25236
M I C R E L, I N C O R P O R A T E D
(Exact name of Registrant as specified in its charter)
California 94-2526744
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2180 Fortune Drive, San Jose, CA 95131
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 944-0800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act. Yes [X] No [ ]
As of April 30, 2004 there were 92,322,402 shares of common stock, no par
value, outstanding.
MICREL, INCORPORATED
INDEX TO
REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2004
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - March 31, 2004 and
December 31, 2003 3
Condensed Consolidated Statements of Operations - Three Months
Ended March 31, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - Three Months
Ended March 31, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and Use of Proceeds 28
Item 6. Exhibits and Reports on Form 8-K 28
Signature 29
2
ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
March 31, December 31,
2004 2003 (1)
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 136,138 $ 140,059
Short term investments 7,000 --
Accounts receivable, net 38,133 33,084
Inventories 34,322 31,108
Other current assets 2,646 2,132
Deferred income taxes 32,449 34,294
---------- ----------
Total current assets 250,688 240,677
PROPERTY, PLANT AND EQUIPMENT, NET 87,904 87,993
DEFERRED INCOME TAXES 2,275 2,483
INTANGIBLE ASSETS, NET 8,606 5,771
OTHER ASSETS 393 515
---------- ----------
TOTAL $ 349,866 $ 337,439
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 16,331 $ 12,897
Taxes payable 7,603 7,627
Deferred income on shipments to distributors 14,435 12,272
Other current liabilities 16,536 12,152
Current portion of long-term debt 578 703
---------- ----------
Total current liabilities 55,483 45,651
LONG-TERM DEBT 3,519 3,280
OTHER LONG-TERM OBLIGATIONS 4,487 4,899
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:
2004 - 92,427,754 shares;
2003 - 92,522,513 shares 157,325 160,015
Deferred stock compensation (3,070) (3,954)
Accumulated other comprehensive loss (26) (25)
Retained earnings 132,148 127,573
---------- ----------
Total shareholders' equity 286,377 283,609
---------- ----------
TOTAL $ 349,866 $ 337,439
========== ==========
(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, 2003.
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,
-----------------------
2004 2003
---------- ----------
NET REVENUES $ 61,261 $ 50,955
COST OF REVENUES* 33,717 30,411
---------- ----------
GROSS PROFIT 27,544 20,544
---------- ----------
OPERATING EXPENSES:
Research and development 10,556 12,689
Selling, general and administrative 8,866 6,992
Amortization of deferred stock compensation* 595 766
Purchased in-process technology 480 --
---------- ----------
Total operating expenses 20,497 20,447
---------- ----------
INCOME FROM OPERATIONS 7,047 97
OTHER INCOME, NET 249 166
---------- ----------
INCOME BEFORE INCOME TAXES 7,296 263
PROVISION FOR INCOME TAXES 2,721 89
---------- ----------
NET INCOME $ 4,575 $ 174
========== ==========
NET INCOME PER SHARE:
Basic $ 0.05 $ 0.00
========== ==========
Diluted $ 0.05 $ 0.00
========== ==========
WEIGHTED AVERAGE SHARES USED IN
COMPUTING PER SHARE AMOUNTS:
Basic 92,518 92,039
========== ==========
Diluted 95,249 92,739
========== ==========
* Amortization of deferred stock compensation
related to:
Cost of revenues $ 193 $ 301
========== ==========
Research and development $ 218 $ 509
Selling, general and administrative 377 257
---------- ----------
Total $ 595 $ 766
========== ==========
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,
-----------------------
2004 2003
---------- ----------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 4,575 $ 174
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 6,441 7,593
Stock based compensation 788 1,067
Purchased in-process technology 480 --
Deferred income taxes 2,493 370
Changes in operating assets and liabilities:
Accounts receivable (4,375) (757)
Inventories (3,034) 1,035
Prepaid expenses and other assets (250) (1,072)
Accounts payable 3,023 134
Income taxes 185 (274)
Other accrued liabilities 2,579 1,962
Deferred income on shipments to distributors 2,163 1,857
---------- ----------
Net cash provided by operating activities 15,068 12,089
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (5,954) (5,779)
Purchase of intangible assets (1,030) --
Purchases of short-term investments (7,001) --
Purchase of BlueChip Communications, net of
cash acquired (2,033) --
---------- ----------
Net cash used by investing activities (16,018) (5,779)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (168) (308)
Proceeds from the issuance of common stock, net 1,406 535
Repurchase of common stock (4,209) --
---------- ----------
Net cash provided (used) by financing activities (2,971) 227
---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,921) 6,537
CASH AND CASH EQUIVALENTS - Beginning of period 140,059 117,363
---------- ----------
CASH AND CASH EQUIVALENTS - End of period $ 136,138 $ 123,900
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 98 $ 194
========== ==========
Income taxes $ 62 $ --
========== ==========
Non-cash transactions:
Deferred stock compensation (reversal) $ (96) $ (1,219)
========== ==========
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, 2004 and for the
three months ended March 31, 2004 and 2003 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 presentation of its financial position,
operating results and cash flows for the interim periods presented.
Operating results and cash flows for interim periods are not necessarily
indicative of results for the entire year.
This financial data should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003.
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, 2003.
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 earnings per
share is as follows (in thousands):
Three Months Ended
March 31,
-----------------------
2004 2003
---------- ----------
Weighted average common shares outstanding 92,518 92,039
Dilutive effect of stock options outstanding
using the treasury stock method 2,731 700
---------- ----------
Shares used in computing diluted net income
per share 95,249 92,739
========== ==========
For the three months ended March 31, 2004 and 2003, 2.4 million and 4.2
million stock options, respectively, have been excluded from the weighted-
average number of common shares outstanding for the diluted net income per
share computations as they were anti-dilutive.
Stock Based Awards - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees". Deferred stock compensation balances are recorded as a contra-
equity amount and amortized as a charge to operating results over the
applicable vesting periods. As of March 31, 2004 total unamortized stock
compensation was $3.1 million.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and earnings per share had the Company
applied the fair value method. Under SFAS 123, the fair value of stock-
based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value
of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option
awards. These models also require subjective assumptions, including future
stock volatility and expected time to exercise, which greatly affect the
calculated values. The Company's calculations for the fair value of stock
options were made using the Black-Scholes option pricing model with the
following weighted average assumptions for the three months ended March
31, 2004 and 2003, respectively: expected life, 60 months; stock
volatility, 81.7% and 85.8%; risk free interest rates, 2.8% and 2.92%; and
no dividends during the expected term. The Company's calculations are
based on a multiple option valuation approach and forfeitures are
recognized as they occur. The Company's calculations for the fair value
of stock issued under the employee stock purchase plan were made using the
Black-Scholes option pricing model with the following weighted average
assumptions: expected life, 6 months; stock volatility, 81.7% in 2004 and
86.1% in 2003; risk free interest rates, 1.98% in 2004 and 1.92% in 2003;
and no dividends during the term.
6
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
SFAS No. 148 was issued in December 2002 and amended SFAS No. 123 to
require that disclosures of the pro forma effect of using the fair value
method of accounting for stock-based employee compensation be displayed
more prominently and in a tabular format. The following table illustrates
the effect on the Company's net income and net income per share if it had
recorded compensation costs based on the estimated grant date fair value
as defined by SFAS No. 123 for all granted stock-based awards. (in
thousands, except per share amounts):
Three Months Ended
March 31,
-----------------------
2004 2003
---------- ----------
Net income as reported $ 4,575 $ 174
========== ==========
Add: stock-based employee compensation
expense included in reported net income,
net of tax effects 479 649
Deduct: stock-based employee compensation
expense determined under fair value based
method, net of tax effects (3,035) (3,351)
---------- ----------
Pro forma net income (loss) $ 2,020 $ (2,528)
========== ==========
Net income per share as reported:
Basic $ 0.05 $ 0.00
========== ==========
Diluted $ 0.05 $ 0.00
========== ==========
Pro forma net income (loss) per share:
Basic $ 0.02 $ (0.03)
========== ==========
Diluted $ 0.02 $ (0.03)
========== ==========
2. RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board ("FASB" or the
"Board") issued Interpretation No. 46 ("FIN 46") "Consolidation of
Variable Interest Entities." FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional subordinated
financial support from other parties. FIN 46 is effective immediately for
all new variable interest entities created or acquired after January 31,
2003. In December 2003, the FASB issued a revision of FIN 46 that delays
the implementation date for certain interests created or acquired prior to
January 31, 2003 until the first interim or annual period ending after
March 15, 2004. The adoption of this statement had no material effect on
the Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Accounting Standards No. 150
("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS No. 150 changes the
accounting guidance for certain financial instruments that, under previous
guidance, could be classified as equity or "mezzanine" equity by now
requiring those instruments to be classified as liabilities (or assets in
some circumstances) in the statement of financial position. Further, SFAS
No. 150 requires disclosure regarding the terms of those instruments and
settlement alternatives. SFAS No. 150 is generally effective for all
financial instruments entered into or modified after May 31, 2003, and is
otherwise effective at the beginning of the first interim period beginning
after June 15, 2003. While the effective date of certain elements of SFAS
No. 150 have been deferred, the adoption of such elements when finalized
is not expected to have a material impact on the Company's financial
position, results of operations or cash flows.
7
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. INVENTORIES
Inventories consist of the following (in thousands):
March 31, December 31,
2004 2003
---------- ----------
Finished goods $ 12,063 $ 9,787
Work in process 21,490 20,425
Raw materials 769 896
---------- ----------
$ 34,322 $ 31,108
========== ==========
4. BORROWING ARRANGEMENTS
Borrowing arrangements consist of a $5 million revolving line of credit
from a commercial bank. The revolving line of credit agreement includes a
provision for the issuance of commercial or standby letters of credit by
the bank on behalf of the Company. The value of all letters of credit
outstanding reduces the total line of credit available. There were no
borrowings under the revolving line of credit at March 31, 2004, and there
were $550,000 in standby letters of credit outstanding. The revolving line
of credit agreement expires on June 30, 2005. Borrowings under the
revolving line of credit bear interest rates of, at the Company's
election, the prime rate (4.0% at March 31, 2004), or the bank's revolving
offshore rate, which approximates LIBOR (1.11% at March 31, 2004) 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, 2004.
In September 2002, the Company borrowed $10.7 million through a commercial
mortgage financing agreement which was associated with the purchase of its
previously leased manufacturing facilities in San Jose, CA. Borrowings
under this agreement bear interest, at the Company's election, at the
daily floating prime rate (4.0% at March 31, 2004), or adjustable monthly
LIBOR (1.11% at March 31, 2004) plus 1.5%. The principal balance of the
loan shall be paid in 59 consecutive monthly installments of $16,890 and
one final installment in the amount necessary to pay in full the remaining
outstanding principal balance, with no early payment penalty. In December
2003, the company repaid $7.0 million of loan, resulting in a remaining
loan balance of $3.4 million at March 31, 2004. The mortgage agreement
contains certain restrictive covenants with which the Company was in
compliance at March 31, 2004.
As of March 31, 2004, the Company had $3.6 million under term notes
outstanding.
5. SIGNIFICANT CUSTOMERS
During the three months ended March 31, 2004, two customers, a world wide
distributor and an Asian based stocking representative, accounted for $10.2
million (17%) and $6.1 million (10%) of net revenues, respectively. During
the three months ended March 31, 2003, the same two customers accounted for
$8.0 million (16%) and $5.1 million (10%) of net revenues, respectively.
No direct original equipment manufacturer ("OEM") accounted for more than
10% of net revenues.
As of March 31, 2004, one customer, an Asian based stocking representative,
accounted for 11% of net accounts receivable. At December 31, 2003, two
customers accounted for 19% and 13% of total accounts receivable.
6. 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
$4.6 million and $173,000 for the three months ended March 31, 2004 and
2003, respectively.
8
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. SEGMENT REPORTING
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information and operates in two
reportable segments: standard products and custom and foundry products. The
chief operating decision maker evaluates segment performance based
primarily on revenue. Accordingly, all expenses are not allocated to
segments. Therefore, it is not practical to show profit or loss by
operating segments. Also, the chief operating decision maker does not
assign assets to these segments. Consequently, it is not practical to show
assets by operating segments.
Net Revenues by Segment
(dollars in thousands)
Three Months Ended
March 31,
-----------------------
2004 2003
---------- ----------
Net Revenues:
Standard Products $ 58,634 $ 45,254
Custom and Foundry Products 2,627 5,701
---------- ----------
Total net revenues $ 61,261 $ 50,955
========== ==========
As a Percentage of Total Net Revenues:
Standard Products 96% 89%
Custom and Foundry Products 4 11
---------- ----------
Total net revenues 100% 100%
========== ==========
8. LITIGATION AND OTHER CONTINGENCIES
On February 26, 1999, the Lemelson Medical, Education & Research Foundation
(the "Lemelson Partnership") filed a complaint which was served on the
Company on June 15, 1999, entitled Lemelson Medical, Education & Research
Foundation, Limited Partnership v. Lucent Technologies Inc., et al. in the
United States District Court in Phoenix, Arizona, against eighty-eight
defendants, including the Company, alleging infringement of Lemelson
Foundation patents. The complaint in the lawsuit seeks unspecified
compensatory damages, treble damages and attorneys' fees, as well as
injunctive relief against further infringement of the Lemelson patents at
issue. The case is currently in the motion and hearing phase. The Company
intends to continue to defend itself against these claims.
On May 9, 1994, Linear Technology Corporation ("Linear" or "LTC"), a
competitor of the Company, filed a complaint against the Company, entitled
Linear Technology Corporation v. Micrel, Incorporated, in the United States
District Court in San Jose, California, alleging patent and copyright
infringement and unfair competition. All claims, except the patent
infringement claim, have been settled or dismissed. The complaint in the
lawsuit seeks unspecified compensatory damages, treble damages and
attorneys' fees as well as preliminary and permanent injunctive relief
against infringement of the Linear patent at issue. On August 20, 1999, the
United States District Court in San Jose adjudicated in favor of the
Company on a motion, finding the patent to be invalid under the "on sale
bar" defense as the plaintiff had placed ICs containing the alleged
invention on sale more than a year before filing its patent application.
The United States District Court in San Jose dismissed the plaintiff's
complaint on the merits of the case and awarded the Company its legal
costs. Linear appealed the trial Court's decision to the United States
Court of Appeal for the Federal Circuit ("CAFC") on September 17, 1999. On
December 28, 2001, the CAFC reversed the District Court's judgment of
invalidity and remanded the case to the District Court. After the Company's
Petition for Rehearing En Banc by the Court of Appeal was denied, the
Company filed a Petition for Writ of Certiorari with the Supreme Court of
the United States, which Linear opposed. On May 19, 2003, the Supreme Court
denied the Petition for Writ of Certiorari. The District Court subsequently
determined a schedule for further discovery and hearing matters before the
Court. A claim construction hearing (also called a "Markman" hearing) was
held before the District Court on December 16, 2003. The Court issued its
ruling on January 24, 2004, interpreting the claims at issue in the
litigation. Furthermore, the parties have attended three settlement
conferences before the District Court. The Company intends to continue to
defend itself against the claims alleged in this litigation.
9
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. The Company intends to vigorously
defend itself against these counterclaims. The case is currently in the
motion and discovery phase.
On April 21, 2003, the Company filed a complaint against its former
principal accountants Deloitte & Touche LLP ("Deloitte") entitled Micrel,
Incorporated v. Deloitte & Touche LLP in the Superior Court of the State of
California, County of Santa Clara, alleging various causes of action
relating to certain professional advice received by Micrel from Deloitte.
In this lawsuit, Micrel is alleging that Deloitte negligently rendered
services as accountants to Micrel, breached certain agreements with Micrel
by failing to perform services using ordinary skill and competence and in
conformance with generally accepted principles for such work and made
certain false representations upon which Micrel justifiably relied. As a
direct result of Deloitte's actions, Micrel alleges damages including:
expenses incurred in the form of payments to various professionals to
address the impact on Micrel's financial statements and other effects of
the wrongful conduct; loss of cash as well as equity from stock options;
additional charges to earnings that Micrel would not incur but for the
wrongful advice; additional potential liability for taxes; potential
liability for tax penalties; 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 phase.
The Company believes that the ultimate outcome of the legal actions
discussed above will not result in a material adverse effect on the
Company's financial condition, results of operation or cash flows. 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, 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.
Certain additional claims and lawsuits 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.
10
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. STOCK REPURCHASE PROGRAM
On March 11, 2004 Micrel's Board of Directors amended the Company's common
stock repurchase program and authorized the repurchase of common stock up
to a maximum value of $25 million during the year 2004. 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 Company
repurchased 285,050 shares of its common stock for $4.2 million during the
quarter ended March 31, 2004.
10. CLOSURE OF WAFER FABRICATION FACILITY
In September 2002, the Company approved a plan to close its Santa Clara,
California wafer fabrication facility to reduce costs and improve
operating efficiencies. The Company accrued $5.5 million in restructuring
expenses associated with the facility closure which consisted of $1.0
million for equipment disposal costs and $4.5 million in net contractual
building lease costs, excluding estimated sublease income, that will
provide no future benefit. During July 2003, the Company ceased all
manufacturing processes within the Santa Clara facility and completed the
relocation of all employees to its San Jose, CA facilities.
During the third quarter of 2003, the Company also incurred and paid
severance costs of $320,000 related to the termination of 46 employees
associated with the wafer fabrication facility closure. The affected
employees consisted primarily of wafer fabrication operators and
maintenance technicians. These termination costs have been reported as
restructuring expense in the statement of operations.
A summary of restructuring expense accrual is as follows: ($000)
Contractual
Severance Facility Equipment
Costs Costs Disposal Total
--------- ----------- --------- ---------
Balance December 31, 2002 $ -- $ 4,536 $ 1,000 $ 5,536
2003 Charges 320 466 (500) 286
Uses (320) (883) (89) (1,292)
--------- --------- --------- ---------
Balance December 31, 2003 $ -- $ 4,119 $ 411 $ 4,530
2004 Charges -- -- -- --
Uses -- (416) (43) (459)
--------- --------- --------- ---------
Balance March 31, 2004 $ -- $ 3,703 $ 368 $ 4,071
========= ========= ========= =========
Of the $4.1 million in accrued restructuring costs, $2.0 million has been
classified as other current liabilities and the remaining $2.1 million has
been classified as other long-term obligations as of March 31, 2004. These
restructuring costs are expected to be paid in cash over the remaining
facility lease term, which expires in October 2006. Actual future costs or
actual sublease income may be different than these estimates and could
require an adjustment to restructuring expense in the period such
determination is made.
11. ACQUISITION
On March 3, 2004, Micrel acquired a controlling interest in BlueChip
Communications AS ("BlueChip") of Oslo, Norway. BlueChip is a fabless
semiconductor company that designs, develops and markets high performance
Radio Frequency integrated circuits and modules for the actuation and
connectivity markets. Micrel acquired approximately 94% of the outstanding
BlueChip securities and options to purchase BlueChip securities in a cash-
for-stock transaction. Under the terms of the agreement, Micrel paid
approximately $2 million and incurred approximately $300,000 in direct
acquisition costs for the outstanding BlueChip securities and options.
Also, Micrel will pay additional consideration of approximately $1 million
if certain revenue and gross profit targets are met by the BlueChip
operation during calendar year 2004. The acquisition was accounted for as
a purchase under SFAS 141 "Business Combinations" and, accordingly, the
results of operations of BlueChip from the date of acquisition forward
11
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
have been included in the Company's condensed consolidated financial
statements.
An amount of $480,000 was allocated to purchased in-process technology,
which has not reached technological feasibility and has no alternative
future use, for which the Company recorded a charge to the line item
purchased in-process technology in the condensed consolidated statement of
operations for the three months ended March 31, 2004. In addition, $1.7
million was allocated to existing technology and $450,000 was allocated to
customer relationships and are included in intangible assets in the
accompanying condensed consolidated balance sheet. These intangible assets
are expected to be amortized over their useful lives of five and three
years, respectively. The amounts assigned to existing technology,
customer relationships and purchased in-process technology were valued by
an independent appraisal firm based on management's forecast of future
revenues, cost of revenues and operating expenses related to the purchased
technologies. The calculation gave consideration to relevant market sizes
and growth factors, expected industry trends, the anticipated nature and
timing of new product introductions, individual product cycles, and the
estimated lives of each of the products underlying the technology. In-
process research and development costs consist of five research and
development projects that had not yet reached technological feasibility at
the time of acquisition.
The Company has not presented supplemental pro-forma results of operations
reflecting the impact of the BlueChip acquisition as the effect is not
material.
In addition, Micrel has recorded an intangible asset of $800,000 for the
license of certain developed technology pursuant to a pre-acquisition
development and license agreement which was entered into with BlueChip in
2001. This intangible asset is being amortized over its estimated useful
life of five years.
12
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, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. Forward-looking statements
include: statements regarding future products or product development;
statements regarding future research and development spending and the
Company's product development strategy; statements regarding the levels of
international sales; statements regarding future expansion or utilization of
manufacturing capacity; statements regarding future expenditures; and
statements regarding current or future acquisitions. 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. It is important to note that our actual
results could differ materially from those in such forward-looking statements.
Some of the factors that could cause actual results to differ materially are
set forth below. Additional factors that may affect operating results are
contained within the Company's Form 10-K for the year ended December 31, 2003.
Micrel designs, develops, manufactures and markets a range of high-
performance analog power integrated circuits ("ICs"), mixed-signal and
digital ICs. These circuits are used in a wide variety of electronics
products, including those in the computer, telecommunications, industrial and
networking markets. In addition to standard products, the Company
manufactures custom analog and mixed-signal circuits and provides wafer
foundry services.
Rapid growth in dollar shipments of semiconductors of 38% in 2000 was
followed by the most severe downturn in the history of the semiconductor
industry in 2001. Customer demand for the Company's products declined sharply
in 2001 as customers reacted to the economic recession in the United States
and high inventory levels of semiconductor components by reducing order
rates. The resulting environment, which continued from the beginning of 2001
through the second quarter of 2003, was characterized by reduced demand for
the Company's products, especially from customers serving the high speed
communications market, and by poor visibility into future customer demand.
The Company's gross profit and net income declined in 2001 and 2002 due to
lower unit volume, declining selling prices for the Company's products and an
increased level of unabsorbed fixed costs due to lower utilization levels of
the Company's wafer fabrication lines. In response to this environment, the
Company focused on reducing costs in 2001, 2002 and 2003.
The Company's objective was to align its cost structure with the reduced
revenue levels while retaining sufficient manufacturing capacity, and
sustaining a level of research and development investment that should
facilitate future growth. In addition to reducing discretionary spending and
payroll costs, the Company sought to significantly reduce its manufacturing
costs. One of the Company's most significant cost reduction actions was the
consolidation of its Santa Clara, California wafer fabrication operation into
its San Jose, California wafer fabrication facility. This action commenced in
2002 and was completed in 2003. By the end of 2003, the Company's
manufacturing cost reduction efforts had offset a substantial portion of the
erosion in gross profit resulting from the decline in average selling prices.
The Company continued to invest in research and development at a rate in
excess of 20% of revenues while selling, general and administrative spending
was reduced to a level in 2003 which approached 1999 spending. Throughout the
2001 to 2003 period the Company continued to generate positive cash flows
from operations.
As a result of its cost reduction actions, the Company returned to
profitability in 2003 after recording a loss on an annual basis for the first
time in its history in 2002 primarily due to the effect of charges related to
the manufacturing consolidation and from the one time acceleration of stock
compensation expense due to the Company's stock option exchange offer. The
first half of 2003 was characterized by the continuation of limited
visibility into, and uncertainty of, customer demand. The uncertainty of
demand was compounded in the first half of 2003 by events such as the war in
Iraq and the outbreak of severe acute respiratory syndrome in Asia ("SARS").
The Company's quarterly revenues remained relatively flat, averaging $50
million per quarter for the first half of 2003. The Company recorded a small
net loss for this period. In the second half of 2003, customer demand
increased as the United States' and Asian economies began to grow more
rapidly. The Company's new order rates, or bookings, grew faster than revenue
in the third and fourth quarter of 2003, resulting in sequential growth in
both revenues and order backlog. The growth in new orders and revenues in the
second half of 2003 was driven by demand for the Company's standard products
from customers serving the communications, computing, industrial and wireless
handset end markets. Gross margins and net income increased in the second
half of 2003.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
In the first quarter of 2004, demand for the Company's products continued
to grow. New order rates increased compared with both the first and fourth
quarters of 2003. Since new order rates in the first quarter were greater
than revenues, the backlog of orders at the end of March was at its highest
level in over three years. Strength in demand from customers serving the
industrial and wireline communications end markets offset seasonal slowness
in demand from customers in the computing and wireless handset markets,
resulting in higher revenues on both a sequential and year-over-year basis.
The combination of higher revenues, a richer, higher margin sales mix and
lower manufacturing costs led to an improved gross profit margin of 45% in
the first quarter. Operating expenses were essentially level with the first
quarter of 2003, which resulted in almost 100% of the year-over-year increase
in gross profit falling through to increase operating profit. The Company
expects that future revenue increases would result in increased operating
expenses and that there can be no assurance that future revenue increases
would result in the same high rate of incremental operating profit increases.
On March 3, 2004, Micrel acquired a controlling interest in BlueChip
Communications AS ("BlueChip") of Oslo, Norway. BlueChip is a fabless
semiconductor company that designs, develops and markets high performance
Radio Frequency integrated circuits and modules for the actuation and
connectivity markets. The acquisition was accounted for as a purchase under
SFAS 141 "Business Combinations" and, accordingly, the results of operations
of BlueChip from the date of acquisition forward have been included in the
Company's condensed consolidated financial statements. In addition, $480,000
was expensed to purchased in-process technology in the three months ended
March 31, 2004 (see Note 11 of Notes to Condensed Consolidated Financial
Statements).
The Company derives a substantial portion of its net revenues from
standard products. For the three months ended March 31, 2004 and 2003 the
Company's standard products sales accounted for 96% and 89%, respectively, of
the Company's net revenues. 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. 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. 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, 2003.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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, significant return rights, price protection and pricing adjustments
subsequent to the initial product shipment. Micrel 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. Sales to OEM customers and stocking representatives, primarily
located in Asia, which have limited return rights and pricing adjustments,
are recognized upon shipment and a related returns allowance is established
based upon historical return rates. Actual future returns could be different
than the returns allowance established.
The Company also maintains an allowance for doubtful accounts for
estimated uncollectible accounts receivables. This estimate is based on an
analysis of specific customer creditworthiness and historical bad debts
experience. Actual future uncollectible amounts could exceed the doubtful
accounts allowance established.
Inventory Valuation. Inventories are stated at the lower of cost (first-
in, first-out method) or market. The Company records adjustments to write
down the cost of obsolete and excess inventory to the estimated market value
based on historical and forecasted demand for its products. If actual future
demand for the Company's products is less than currently forecasted,
additional inventory adjustments may be required. Once a reserve is
established, it is maintained until the product to which it relates is sold
or otherwise disposed of. This treatment is in accordance with Accounting
Research Bulletin 43 and SEC Staff Accounting Bulletin 100 "Restructuring and
Impairment Charges."
Income Taxes. Deferred tax assets and liabilities result primarily from
temporary timing differences between book and tax valuation of assets and
liabilities, state and federal research and development credit carryforwards
and state manufacturers credit carryforwards. The Company had net deferred
tax assets of $34.7 million as of March 31, 2004. The Company must 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.
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 8 of Notes to Condensed Consolidated Financial Statements) and has not
accrued a liability for such litigation. The Company regularly evaluates
current information available to determine whether such accruals should be
made. An estimated liability would be accrued when it is determined to be
probable that a liability has been incurred and the amount of loss can be
reasonably estimated. If the Company were to determine that such a liability
was probable and could be reasonable estimated, the adjustment would be
charged to income in the period such determination was made.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Results of Operations
The following table sets forth certain operating data as a percentage of
total net revenues for the periods indicated:
Three Months Ended
March 31,
-----------------------
2004 2003
------- -------
Net revenues 100.0% 100.0%
Cost of revenues 55.0 59.7
------- -------
Gross profit 45.0 40.3
------- -------
Operating expenses:
Research and development 17.2 24.9
Selling, general and administrative 14.5 13.7
Amortization of deferred stock compensation 1.0 1.5
Purchased in-process technology 0.8 --
------- -------
Total operating expenses 33.5 40.1
------- -------
Income from operations 11.5 0.2
Other income, net 0.4 0.3
------- -------
Income before income taxes 11.9 0.5
Provision for income taxes 4.4 0.2
------- -------
Net income 7.5% 0.3%
======= =======
Net Revenues. For the three months ended March 31, 2004, net revenues
increased 20% to $61.3 million from $51.0 million for the same period in the
prior year. This increase was primarily due to increased standard products
revenues, which were partially offset by decreased custom and foundry products
revenues. The Company derives a substantial portion of its net revenues from
standard products, which represented 96% and 89%, respectively, of net
revenues for the three months ended March 31, 2004 and 2003.
Standard products revenues increased 29% to $58.6 million, for the three
months ended March 31, 2004, from $45.3 million for the same period in the
prior year. The increase resulted primarily from increased unit shipments of
industrial, high bandwidth communications and network communications products.
Custom and foundry products revenues decreased 54% to $2.6 million
representing 4% of net revenues, for the three months ended March 31, 2004,
from $5.7 million or 11% of net revenues for the same period in the prior
year. The decrease resulted primarily from the cessation of low margin
foundry business with a single customer, Lexmark.
Customer demand for semiconductors can change quickly and unexpectedly. As
a result of the slowing global economy, a rapid build-up of semiconductor
inventories in global sales channels occurred during 2001, causing lead times
for components to fall precipitously. Although it is generally believed that
industry wide channel inventories have decreased substantially since 2001,
the short lead time environment continued from the middle of 2001 through the
end of 2003 as a result of underutilization of manufacturing capacity and
relatively high levels of work-in-process inventories within the
semiconductor industry. From the middle of 2001 through 2003, customers
perceived that semiconductor components were readily available and ordered
only for their short-term needs, resulting in historically low order backlog
levels. 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% turns fill per quarter during 2003.
The turns fill for the first quarter of 2004 was approximately 45%. The
Company experienced an increase in order rates and backlog in the second half
of 2003 which continued in the first quarter of 2004, indicating that demand
for semiconductors may be increasing and that customers may be becoming more
concerned about product availability. When lead times, order backlog and
industry-wide capacity utilization increase, as they have since the fourth
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
quarter of 2003, the semiconductor industry historically has experienced four
to six quarters of growth. However, the sustainability of improved customer
demand is uncertain and highly dependent on economic conditions. Although
the Company's order backlog at the end of March was at the highest level in
over three years, the turns fill requirement, together with the uncertainty
of product mix and pricing, make it difficult to predict future levels of
sales and profitability and may require the Company to continue to carry
higher levels of inventory.
International sales represented 76% and 68% of net revenues for the three
months ended March 31, 2004 and 2003, respectively. On a dollar basis,
international sales increased 34% to $46.6 million for the three months ended
March 31, 2004 from $34.8 million for the comparable period in 2003. This
increase resulted primarily from increased shipments of industrial, high
bandwidth communications and network communications products, primarily in
Asia and to a lesser extent 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.
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
45% for the three months ended March 31, 2004 from 40% for the comparable
period in 2003. This increase in gross margin resulted primarily from a
greater sales mix of higher margin products. During the quarter the company
reduced sales of low margin foundry products and increased sales of higher
margin high bandwidth communications products. In addition, the Company
benefited from decreased wafer fabrication costs resulting from the Company's
wafer fabrication consolidation project (see Note 10 of Notes to Condensed
Consolidated Financial Statements) and lower costs for external assembly and
test manufacturing services and the sale of approximately $1 million of
previously reserved inventory. Facility and equipment capacity utilization of
the Company's San Jose, CA wafer fabrication facility was approximately 50%
for the three months ended March 31, 2004 and 2003.
If the global economy continues to expand, resulting in continued
increases in demand for the Company's products, the Company believes that
gross margin should increase in future periods. The Company currently has
the ability to increase manufacturing output in response to higher customer
demand. Should this occur, the Company's fixed cost will be spread over a
larger sales volume which should result in a higher gross margin.
Research and Development Expenses. Research and development expenses
include costs associated with the development of new processes and the
definition, design and development of new products. The Company also expenses
prototype wafers and new production mask sets related to new products as
research and development costs until products based on new designs are fully
characterized by the Company and are demonstrated to support published data
sheets and satisfy reliability tests.
Research and development expenses represented 17% and 25% as a percentage
of net revenues, for the three months ended March 31, 2004 and 2003,
respectively. On a dollar basis, research and development expenses decreased
$2.1 million or 17% to $10.6 million for the three months ended March 31, 2004
from $12.7 million for the comparable period in 2003. The decrease was
primarily due to decreased prototype fabrication costs combined with reduced
staffing costs and reduced mask 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 15% and 14%
for the three months ended March 31, 2004 and 2003, respectively. On a dollar
basis, selling, general and administrative expenses increased $1.9 million or
27% to $8.9 million for the three months ended March 31, 2004 from $7.0
million for the comparable period in 2003. The dollar increases were
principally attributable to increased commissions related to higher revenues,
increased outside legal costs and increased staffing costs.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Purchased in-process technology. Associated with the acquisition of
BlueChip, Micrel allocated $2.6 million of the total purchase cost to
intangible assets. Of that amount, $480,000 was expensed to purchased in-
process technology, which has not reached technological feasibility and has no
alternative future use, in the three months ended March 31, 2004. The
remaining intangible assets of $2.1 million, consisting of $1.7 million
existing technology and $450,000 customer relationships, are included in
intangible assets in the accompanying balance sheets and are being amortized
over their useful lives of three to five years (see Note 11 of Notes to
Condensed Consolidated Financial Statements). The amortization of these
intangible assets included in the three months ended March 31, 2004 was
$36,000 and is estimated to be $143,000 in each remaining quarter of 2004.
Other Income, Net. Other income, net reflects interest income from
investments in short-term, investment-grade, securities and money market funds
offset by interest expense incurred on term notes, combined with other non-
operating income or expenses. Other income, net increased $83,000 to $249,000
for the three months ended March 31, 2004 from $166,000 for the comparable
period in 2003. The increase was primarily due to decreased interest expense
resulting from a decrease in average debt.
Provision for Income Taxes. For the three months ended March 31, 2004, the
provision for income taxes was 37% of pretax income, as compared to 34% for
the comparable period in 2003. The income tax provision for the three months
ended March 31, 2004 is based on the Company's estimated annual effective tax
rate of 35%, but includes an adjustment for the purchased in-process
technology charge which is non-deductible for income tax purposes. The
estimated provision for income taxes differs from taxes computed at the
federal statutory rate primarily due to the effect of state income taxes and
state research and development credits.
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, 2004, consisted of cash and short-term
investments of $143 million and a $5 million revolving line of credit from a
commercial bank. The revolving line of credit agreement includes a provision
for the issuance of commercial or standby letters of credit by the bank on
behalf of the Company. The value of all letters of credit outstanding reduces
the total line of credit available. There were no borrowings under the
revolving line of credit at March 31, 2004 and there were $550,000 in standby
letters of credit outstanding. The revolving line of credit agreement expires
on June 30, 2005. Borrowings under the revolving line of credit bear interest
rates of, at the Company's election, the prime rate (4.0% at March 31, 2004),
or the bank's revolving offshore rate, which approximates LIBOR (1.11% at
March 31, 2004) 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, 2004.
In September 2002, the Company borrowed $10.7 million through a commercial
mortgage financing agreement which was associated with the purchase of its
previously leased manufacturing facilities in San Jose, CA. Borrowings under
this agreement bear interest, at the Company's election, at the daily floating
prime rate (4.0% at March 31, 2004), or adjustable monthly LIBOR (1.11% at
March 31, 2004) plus 1.5%. The principal balance of the loan shall be paid in
59 consecutive monthly installments of $16,890 and one final installment in
the amount necessary to pay in full the remaining outstanding principal
balance, with no early payment penalty. In December 2003, the company repaid
$7.0 million of the loan, resulting in a remaining loan balance of $3.4
million at March 31, 2004. The mortgage agreement contains certain restrictive
covenants with which the Company was in compliance at March 31, 2004.
The Company generated $15.1 million in cash flows from operating
activities for the three months ended March 31, 2004 as compared to $12.1
million for the same period in the prior year. This cash flow increase
resulted primarily from an increase in net income adjusted for non-cash
activities combined with an increase in current liabilities, which were
partially offset by an increase in current assets.
The $15.1 million in cash flows from operating activities generated by the
Company, during the three months ended March 31, 2004, were primarily
attributable to a net income of $4.6 million plus additions for non-cash
activities of $10.2 million combined with a $7.9 million increase in current
liabilities, which was partially offset by a $4.4 million increase in
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
accounts receivables, as a result of increased revenues and increased
shipments of product in the last month of the quarter and a $3.0 million
increase in inventories.
The cash flows from operating activities generated by the Company in the
three months ended March 31, 2003 were primarily attributable to a net income
of $174,000 plus additions for non-cash activities of $9.0 million combined
with a $3.7 million increase in current liabilities, which was partially
offset by a $794,000 increase in current assets.
The Company's investing activities during the three months ended March 31,
2004 used cash of $16.0 million for $7.0 million in purchases of short term
investments, $6.0 million in purchases of property, plant and equipment, $2.0
million for the purchase of BlueChip and $1.0 million for the purchase of
intangible assets. Cash used by investing activities during the three months
ended March 31, 2003 resulted from the purchase of $5.8 in net purchases of
property, plant and equipment.
The Company's financing activities during the three months ended March 31,
2004 used $3.0 million in cash primarily for the repurchase of $4.2 million
of the Company's common stock, which was partially offset by $1.4 million in
proceeds form employee stock transactions. Cash provided by financing
activities during the three months ended March 31, 2003 was $227,000 and
resulted from $535,000 in proceeds from employee stock transactions, which
was partially offset by $308,000 in repayments of long-term debt.
The Company currently intends to purchase approximately $20 million to $30
million in capital equipment and improvements during 2004 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 $25.0
million of its common stock through December 31, 2004. The Company expects
that its cash requirements through 2004 will be met by its cash from
operations, existing cash balances and short-term investments, and its credit
facility. In the longer term, the Company believes future cash requirements
will continue to be met by its cash from operations, and future debt or
equity financings as required.
Recently Issued Accounting Standards
Please refer to Note 2 of Notes to Condensed Consolidate Financial
Statements for a discussion of the expected impact of recently issued
accounting standards.
Contractual Obligations and Commitments
The Company's contractual obligations disclosure in its Annual Report on
Form 10-K for the year ended December 31, 2003 has not materially changed
since that report was filed. During the three months ended March 31, 2004
payments of $639,000 were made under previously existing operating leases and
repayments of $168,000 were made under previously existing long-term debt
agreements. Open purchase orders were approximately $21 million and are all
due within one year. These obligations primarily relate to future purchases
of wafer fabrication raw materials, foundry wafers, assembly and testing
services and manufacturing equipment.
Borrowing agreements consisted of a $5 million revolving line of credit
from a commercial bank. The revolving line of credit agreement includes a
provision for the issuance of commercial or standby letters of credit by the
bank on behalf of the Company. The value of all letters of credit outstanding
reduces the total line of credit available. There were no borrowings under
the revolving line of credit at December 31, 2003 and there were $550,000 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.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Factors That May Affect Operating Results
The Company's operating results may fluctuate because of a number of factors,
many of which are beyond its control.
If the Company's operating results are below the expectations of public
market analysts or investors, then the market price of its Common Stock could
decline. Some of the factors that affect or may affect the Company's quarterly
and annual results, but which are difficult for the Company to control or
predict are:
- - the volume and timing of orders received
- - changes in the mix of products sold
- - market acceptance of the Company's products and its customers' products
- - competitive pricing pressures
- - cyclical semiconductor industry conditions
- - dependence on third-party suppliers
- - the ability to introduce new products on a timely basis
- - the timing of new product announcements and introductions by the Company or
its competitors
- - the timing and extent of research and development expenses
- - fluctuations in manufacturing yields
- - the ability to hire and retain key technical and management personnel
- - access to advanced process technologies
- - the timing and extent of new process development costs
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.
Customer demand for the Company's products is volatile and difficult to
predict.
The Company's customers continuously adjust their inventories in response
to changes in end market demand for their products and the availability of
semiconductor components. This results in frequent changes in demand for the
Company's products. The volatility of customer demand limits the Company's
ability to predict future levels of sales and profitability. The supply of
semiconductors can quickly and unexpectedly match or exceed demand because end
customer demand can change very quickly. Also, semiconductor suppliers can
rapidly increase production output. This can lead 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 the Company's products can result in excess quantities of
certain of the Company's 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 weakness in the global economy in 2001, 2002, and most of 2003 has
caused the end markets that the Company's customers serve to grow less
rapidly, or in some cases, contract. The resulting uncertainty of demand has
caused most of the Company's customers to err on the side of caution until
they see signs of order strength for their end products. In this environment,
customers are not making large purchase commitments, instead, ordering modest
quantities to fill known short-term requirements, greatly reducing the
Company's visibility into customer demand. As a result, the Company's
quarterly revenues remain highly dependent upon turns fill orders (orders
booked and shipped in the same quarter). Although the level of order backlog
has increased since the beginning of 2004, the short-term and volatile nature
of customer demand makes it extremely difficult to predict near term revenues
and profits.
The short lead time environment has allowed many end consumers of the
Company's products to rely on stocking representatives and distributors to
carry inventory to meet short term requirements and minimize their investment
in on-hand inventory. As a result the Company may carry a higher level of
inventory at some of its stocking representatives and distributors to service
the volatile short-term demand of the end customer. Should the relationship
with a distributor or stocking representative be terminated, 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.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The semiconductor industry is highly competitive.
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
- - price
- - timing of product introductions
- - emergence of new computer and communications standards
- - quality and customer support
In times when economic growth and customer demand is less certain, both the
semiconductor industry and the Company have experienced significant price
erosion since the beginning of 2001. If this price erosion continues, it will
have the effect of reducing revenue levels and gross margins in future
periods.
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. Increased competition could adversely affect the Company's financial
condition or results of operations. 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 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.
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 Company's product offering, while diversified, is highly dependent on
certain select end markets.
The Company currently sells a significant portion of its products in the
high-speed communications, computer, networking and wireless handset markets.
These markets are characterized by short product life cycles, rapidly changing
customer demand, evolving and competing industry standards and seasonal demand
trends. Additionally, there can be no assurance that these markets will
continue to grow. If the markets for high speed communications, computers,
networking or wireless handsets that the Company serves fail to grow, or grow
more slowly than it currently anticipates, or if there is increased
competition in these markets, the Company's business, results of operations
and financial condition could be adversely affected.
An important part of the Company's strategy is to continue to focus on the
market for high-speed communications ICs. If the recovery in the
telecommunications infrastructure and wire line networking markets is not
sustainable, resulting in reduced demand for the Company's high bandwidth
products, the Company's future revenue growth and profitability could be
adversely affected.
The Company's Ethernet products have become an important portion of the
Company's revenues. If the Company fails to develop new products to serve this
market in a timely manner, or if the market acceptance of the Company's new
Ethernet products is poor, if a competitor's products unfavorably affect
pricing or demand for the Company's products, the Company's revenues and
results of operations could be adversely affected.
The Company currently derives the majority of its product revenues from
sales of standard analog and mixed-signal ICs and expects these products to
continue to account for the majority of its revenues for the foreseeable
future. As a result, factors adversely affecting the pricing of or demand for
standard analog integrated and mixed-signal circuits, such as competition,
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
product performance or technological change, could have a material adverse
effect on the Company's business and consolidated results of operations and
financial condition.
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.
Dependence on third-party manufacturing and supply relationships increases the
risk that the Company will not have an adequate supply of products to meet
demand or that its cost of materials will be higher than expected.
The Company faces many risks associated with its dependence upon third
parties that manufacture, assemble or package certain of its products. These
risks include:
- - reduced control over delivery schedules and quality
- - risks of inadequate manufacturing yields and excessive costs
- - the potential lack of adequate capacity during periods of excess demand
- - difficulties selecting and integrating new subcontractors
- - limited warranties on wafers or products supplied to the Company
- - potential increases in prices
- - potential misappropriation of the Company's intellectual property
Any of these risks may lead to increased costs or delay delivery of the
Company's products, which would harm its profitability and customer
relationships.
Additionally, the Company's wafer and product requirements typically
represent a relatively small portion of the total production of the third-
party foundries and outside assembly, testing and packaging contractors. As a
result, Micrel is subject to the risk that a foundry will provide delivery or
capacity priority to other larger customers at the expense of Micrel,
resulting in an inadequate supply to meet customer demand or higher costs to
obtain the necessary product supply. Also, there is a risk that a third-party
manufacturer will cease production on an older or lower volume process that it
uses to produce the Company's products. The Company cannot be certain that its
outside manufacturers will continue to devote resources to the production of
its products or continue to advance the process design technologies on which
the manufacturing of its products are based. Each of these events could
increase the Company's costs and harm its ability to deliver its products on
time.
The Company's gross margin is dependent upon a number of factors, including
the level of capacity utilization.
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 level of new customer order
rates over the past three years combined with increased efficiencies has
resulted in lower capacity utilization of the Company's factories as it has
attempted to match production with anticipated customer demand. The Company's
gross margins have declined as a result of this reduced utilization of
production capacity. Increased order rates in the second half of 2003 and the
first quarter of 2004 indicate that demand for the Company's products is
beginning to grow. If higher levels of demand continue for the remainder of
2004 the Company's factory utilization should increase. The Company's ability
to improve gross margins as capacity utilization increases will be dependent
upon the Company's ability to successfully control expenses and maintain
efficiencies as production activities increase. If the recent improvement in
customer demand is not sustained, or declines, and production activity is
reduced in response to lower demand in the future, gross margins may
deteriorate.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The cost reduction actions the Company has initiated may not be sustainable as
business improves.
The Company has implemented or initiated a variety of cost reduction
actions. Although business conditions have improved in recent quarters, as
customer demand continues to improve and revenues increase, it is unclear
whether the Company will continue to benefit from all of the cost reduction
actions that have been implemented.
The semiconductor industry experiences seasonal fluctuations in demand.
Customer demand for semiconductor products typically fluctuates based on
seasonal patterns. Demand in the third and fourth quarter of the calendar
year is typically higher due to the seasonal buying patterns related to the
Christmas period. Demand in the first calendar quarter is typically lower due
to the post-Christmas decline in consumption. Should actual seasonal demand
patterns be different than historical patterns, the Company's revenues and
financial results may be adversely affected.
The Company encounters risks associated with its international operations,
including geopolitical risks.
Reduced levels of economic activity, or disruptions of international
transportation, could adversely affect the Company's sales on either a global
basis or in specific geographic regions. Three of the Company's top ten direct
customers are located in South Korea. In the event that current political
tensions surrounding North Korea evolve into military or social conflict, the
Company's revenues, results of operations, cash flow and financial condition
could be adversely affected.
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. International markets are subject to a variety of
risks, including changes in policy by foreign governments, 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. 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 in Asia or
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.
The Company's international sales are denominated in U.S. currency.
Consequently, 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.
The Company's operating results substantially depend on manufacturing output
and yields, which may not meet expectations.
The Company manufactures most of its semiconductors at its San Jose,
California fabrication facilities. 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.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company's future success depends in part on the continued service of its
key design engineering, sales, marketing and executive personnel and its
ability to identify, hire and retain additional personnel.
There is intense competition for qualified personnel in the semiconductor
industry, in particular design engineers, and 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.
Changes in accounting standards regarding employee stock option plans could
reduce the Company's profitability, limit the desirability of granting stock
options and harm the Company's ability to attract and retain employees.
The Financial Accounting Standards Board ("FASB") has issued a proposed
accounting standard which would require all companies to treat the value of
stock options granted to employees as an expense in the Company's Consolidated
Statement of Operations .. Should the proposal become effective, Micrel and
other companies that have issued stock options would be required to record a
compensation expense equal to the value of each stock option granted, which
would negatively impact GAAP profitability. In addition, the FASB has proposed
a choice of valuation models to estimate the fair value of employee stock
options. These models, including the Black-Scholes and Binomial option-pricing
models, use varying methods and inputs and may yield significantly different
results.
The Company does not agree with the FASB proposal to treat employee stock
options as compensation expense and has stated so in writing to the FASB. The
Company believes that employee stock option transactions are not consistent
with or comparable to other forms of employee compensation but are consistent
with and comparable to an equity investment and therefore should continue to be
recorded as such. The Company believes that employee stock options do not meet
that part of the legal definition of compensation as payment for services
rendered, since stock options are offered as an inducement prior to service.
Unlike most other employee benefits, stock options are not a controllable
expense, since the Company has no control over the market value of its stock
and therefore has no control over the ultimate value, if any, received by the
employee. Expensing a calculated value of stock options will negatively distort
the Company's financial performance in a way it cannot control unless the
Company ceases to issue stock options. In addition, the estimated value of
employee stock options, using option-pricing models, is currently disclosed
annually and quarterly in the notes to the Company's consolidated financial
statements. Therefore for those investors who are concerned about the effect of
employee stock options on the Company, the effect of expensing employee stock
options is already reported.
The Company is subject to the risk of litigation and regulatory action in
connection with the restatement of its financial statements, and the potential
liability from any such litigation or regulatory action could harm its
business.
On January 28, 2002, the Company announced that it would restate its
consolidated financial statements for the fiscal years ended December 31,
1998, 1999, and 2000, and the fiscal quarters ended March 31, 2001, June 30,
2001, and September 30, 2001. As a result of this restatement, the Company
could become subject to litigation or regulatory proceedings, or both. As of
the date hereof, the Company is not aware of any litigation or regulatory
action having been commenced against it related to this restatement. However,
such litigation or regulatory action could be commenced against the Company in
the future and, if so, the Company cannot predict the outcome of any such
litigation or regulatory action at this time. However, if an unfavorable
result occurred in any such action, the Company's business and financial
condition could be harmed.
The restatement also involves certain tax issues that need to be resolved
with the appropriate taxing authorities. The Company has recorded a liability
in its financial statements with respect to these tax issues. The Company
cannot predict the results of its discussions with the appropriate tax
authorities regarding the tax implications of its restatement and accordingly,
the amount of actual financial impact may differ from the amount recorded in
the Company's financial statements.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company may not be able to protect its intellectual property adequately,
or could be harmed by litigation involving its patents and proprietary rights.
The Company's future success depends in part upon its intellectual
property, including patents, trade secrets, know-how and continuing technology
innovation. There can be no assurance that the steps taken by the Company to
protect its intellectual property will be adequate to prevent misappropriation
or that others will not develop competitive technologies or products. There
can be no assurance that any patent owned by the Company will not be
invalidated, circumvented or challenged, that the rights granted thereunder
will provide competitive advantages or that any of its pending or future
patent applications will be issued with the scope of the claims sought, if at
all. Furthermore, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology,
duplicate technology or design around the patents owned by the Company.
Additionally, the semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. There can
be no assurance that existing claims or any other assertions or claims for
indemnity resulting from infringement claims will not adversely affect the
Company's business, financial condition, results of operations, or cash flows.
The Company faces risks associated with acquisitions it has completed and will
face risks associated with any future acquisitions.
The Company has made acquisitions in the past and may make acquisitions in
the future. The risks involved with acquisitions include:
- diversion of management's attention
- failure to retain key personnel
- amortization of acquired intangible assets
- customer dissatisfaction or performance problems with the acquired
company
- the cost associated with acquisitions and the integration of acquired
operations
- assumption of unknown liabilities
Any of these risks could materially harm the Company's business, financial
condition and results of operations. Additionally, any acquisition involves a
significant amount of integration of two companies that have previously
operated independently. No assurance can be given that difficulties will not
be encountered in integrating certain products, technologies or operations of
the acquired companies or that the benefits expected from such integration
will be realized. There can be no assurance that any of the acquired companies
will retain its key personnel, that the engineering teams of Micrel and the
acquired companies will successfully cooperate and realize any technological
benefits or that Micrel or the acquired companies will realize any of the
other anticipated benefits of the acquisitions. In addition, the consummation
of an acquisition could result in the cancellation, termination or non-renewal
of arrangements with the acquired company by suppliers, distributors or
customers, or the termination of negotiations or delays in ordering by
prospective customers as a result of uncertainties that may be perceived as a
result of the acquisition. Any significant amount of cancellations,
terminations, delays or non-renewals of arrangements with the acquired company
or loss of key employees or termination of negotiations or delays in ordering
could have a material adverse effect on the business, operating results or
financial condition of the acquired company and Micrel after the acquisition.
Market conditions may lead the Company to initiate additional cost reduction
plans, which may negatively affect near term operating results.
As a result of weak customer demand, competitive pricing pressures, excess
capacity, weak economic conditions or other factors, the Company may decide 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
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
An increase in interest rates in the United States could slow economic growth
which may result in slower growth in Company revenues.
On May 4, 2004, the Federal Open Market Committee indicated in its Press
Release that "the Committee believes that policy accommodation can be
removed at a pace that is likely to be measured. "The financial press has
interpreted this to mean that continued growth in the U.S. economy will likely
cause the Federal Reserve Bank to raise interest rates. The effect of
increasing interest rates can have both a positive and negative impact on the
Company's financial performance. Because the Company's cash position is
substantially higher than its debt level, higher interest rates can result in
a higher level of net interest income. Higher interest rates can have a
negative effect on the Company if higher interest rates result in slower, or
negative, economic growth. Slower economic growth could cause the Company's
customers to reduce the amount of product purchased form the Company.
The November 2004 election in the United States creates uncertainty for the
financial markets and world economy which could negatively affect economic
growth.
A presidential and congressional election, such as the upcoming November
2004 election, can create uncertainty regarding the future of government
policies which can have a direct effect on the economy in the United States.
Given the influence of the U.S. economy on the global economy and the
Company's customer base, concern or uncertainty arising from the 2004 election
could result in a lack of confidence about the future direction of government
policies. While the impact of the 2004 election on economic growth is unknown
at this time, this uncertainty could result in slower economic growth and
greater caution in the purchasing behavior of the Company's customers. This
could lead to slower than expected growth for the Company's revenues.
The Company's ability to manufacture sufficient wafers to meet demand could be
severely hampered by natural disasters.
The Company's existing wafer fabrication facility is located in Northern
California and this facility 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.
The Company could incur substantial fines or litigation costs associated with
its storage, use and disposal of hazardous materials.
The Company is 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 the
Company's manufacturing processes or a cessation of operations. In addition,
these regulations could restrict the Company's ability to expand its
facilities at their present locations or construct or operate a new wafer
fabrication facility or could require us 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.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk disclosures set forth in the Company's 2003
Form 10-K for the year ended December 31, 2003 have not changed significantly
during the three months ended March 31, 2004.
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 concluded that
the Company's disclosure controls and procedures appear to be effective at
the reasonable assurance level.
There has been no change in the Company's internal controls over financial
reporting during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information included in Note 8 of Notes to Condensed Consolidated
Financial Statements under the caption "Litigation and Other Contingencies"
in Item 1 of Part I is incorporated herein by reference.
ITEM 2. CHANGES IN 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
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 2004 42,550 $ 16.70 42,550 $ 8,670
February 2004 75,350 $ 15.91 75,350 $ 7,471
March 2004 167,150 $ 13.75 167,150 $ 20,792
--------- ---------
Total 285,050 $ 14.76 285,050
========= =========
In February 2002, the Company's Board of Directs 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 Company has
previously disclosed purchase activity and amendments to this plan in its
Annual and Quarterly Reports on Form 10-K and Form 10-Q in the Notes to
Consolidated Financial Statements. In March 11, 2004 the Board of Directors
amended the repurchase program and authorized the repurchase of common stock
up to a maximum value of $25 million during the year 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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
(b) Reports on Form 8-K. During the quarter ended March 31, 2004, the
Company furnished a Current Report on Form 8-K, dated January 29,
2004 announcing its financial results for the three and twelve month
periods ended December 31, 2003. In addition, the Company filed a
Current report on Form 8-K, dated March 3, 2004 announcing the
closing of the acquisition of BlueChip Communications AS.
28
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICREL, INCORPORATED
--------------------
(Registrant)
Date: May 10, 2004 By /s/ Richard D. Crowley, Jr.
----------------------------
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
29