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 June 30, 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 July 30, 2004 there were 91,525,059 shares of common stock, no par
value, outstanding.
MICREL, INCORPORATED
INDEX TO
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2004
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - June 30, 2004 and
December 31, 2003 3
Condensed Consolidated Statements of Operations - Three and Six
Months Ended June 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - Six
Months Ended June 30, 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 14
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 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 29
Signature 30
2
ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
June 30, December 31,
2004 2003 (1)
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 134,235 $ 140,059
Short term investments 9,162 --
Accounts receivable, net 40,720 33,084
Inventories 35,783 31,108
Other current assets 1,918 2,132
Deferred income taxes 27,121 34,294
---------- ----------
Total current assets 248,939 240,677
PROPERTY, PLANT AND EQUIPMENT, NET 87,645 87,993
LONG TERM INVESTMENTS 3,185 --
DEFERRED INCOME TAXES 1,955 2,483
INTANGIBLE ASSETS, NET 8,147 5,771
OTHER ASSETS 406 515
---------- ----------
TOTAL $ 350,277 $ 337,439
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 17,230 $ 12,897
Taxes payable 3,057 7,627
Deferred income on shipments to distributors 17,569 12,272
Other current liabilities 12,322 12,152
Current portion of long-term debt 453 703
---------- ----------
Total current liabilities 50,631 45,651
LONG-TERM DEBT 3,472 3,280
OTHER LONG-TERM OBLIGATIONS 2,222 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 - 91,970,493 shares;
2003 - 92,522,513 shares 150,019 160,015
Deferred stock compensation (2,215) (3,954)
Accumulated other comprehensive loss (48) (25)
Retained earnings 146,196 127,573
---------- ----------
Total shareholders' Equity 293,952 283,609
---------- ----------
TOTAL $ 350,277 $ 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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
NET REVENUES $ 68,996 $ 49,109 $ 130,257 $ 100,064
COST OF REVENUES(1) (NOTE 11) 34,618 30,880 68,335 61,291
--------- --------- --------- ---------
GROSS PROFIT 34,378 18,229 61,922 38,773
--------- --------- --------- ---------
OPERATING EXPENSES:
Research and development (NOTE 11) 9,689 12,136 20,245 24,825
Selling, general and
Administrative (NOTE 11) 8,573 6,582 17,439 13,574
Amortization of deferred stock
compensation(1) 577 915 1,172 1,681
Purchased in-process technology -- -- 480 --
--------- --------- --------- ---------
Total operating expenses 18,839 19,633 39,336 40,080
--------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 15,539 (1,404) 22,586 (1,307)
OTHER INCOME, NET 289 181 538 347
--------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 15,828 (1,223) 23,124 (960)
PROVISION (BENEFIT) FOR
INCOME TAXES (NOTE 11) 1,780 (310) 4,501 (221)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 14,048 $ (913) $ 18,623 $ (739)
========= ========= ========= =========
NET INCOME (LOSS) PER SHARE:
Basic $ 0.15 $ (0.01) $ 0.20 $ (0.01)
========= ========= ========= =========
Diluted $ 0.15 $ (0.01) $ 0.20 $ (0.01)
========= ========= ========= =========
WEIGHTED-AVERAGE SHARES USED IN
COMPUTING PER SHARE AMOUNTS:
Basic 92,259 92,171 92,387 92,105
========= ========= ========= =========
Diluted 94,074 92,171 94,666 92,105
========= ========= ========= =========
(1)Amortization of deferred stock
compensation:
Included in cost of revenues $ 177 $ 290 $ 370 $ 591
========= ========= ========= =========
Included in operating expenses
amortization of deferred stock
compensation related to:
Research and development $ 218 $ 500 $ 436 $ 1,009
Selling, general and
Administrative 359 415 736 672
--------- --------- --------- ---------
Total operating expenses $ 577 $ 915 $ 1,172 $ 1,681
========= ========= ========= =========
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)
Six Months Ended
June 30,
---------------------
2004 2003
--------- ---------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income (loss) $ 18,623 $ (739)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 12,704 15,087
Stock based compensation 1,542 2,272
Purchased in-process technology 480 --
(Gain) loss on disposal of assets 35 --
Deferred rent 3 15
Deferred income taxes 8,141 911
Changes in operating assets and liabilities,
net of effect of acquisition:
Accounts receivable (6,962) 921
Inventories (4,495) 1,947
Prepaid expenses and other assets 465 31
Accounts payable 3,922 (2,697)
Income taxes (4,238) (1,671)
Other accrued liabilities (3,903) (1,426)
Deferred income on shipments to distributors 5,297 1,133
--------- ---------
Net cash provided by operating activities 31,614 15,784
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (11,534) (11,547)
Purchase of intangible assets (1,030) --
Purchases of short-term investments (9,185) --
Purchases of long-term investments (3,185) --
Purchase of BlueChip Communications, net of
cash acquired (2,033) --
--------- ---------
Net cash used in investing activities (26,967) (11,547)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (340) (560)
Proceeds from the issuance of common stock, net 3,423 2,426
Repurchase of common stock (13,554) --
--------- ---------
Net cash provided by(used in) financing activities (10,471) 1,866
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (5,824) 6,103
CASH AND CASH EQUIVALENTS - Beginning of period 140,059 117,363
--------- ---------
CASH AND CASH EQUIVALENTS - End of period $ 134,235 $ 123,466
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 185 $ 365
========= =========
Income taxes $ 912 $ 549
========= =========
Non-cash transactions:
Deferred stock compensation (reversal) $ (197) $ (1,318)
========= =========
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 June 30, 2004 and for the
three and six months ended June 30, 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(Loss) Per Common and Equivalent Share - Basic net income (loss)
per share is computed by dividing net income (loss) by the number of
weighted-average common shares outstanding. Diluted net income per share
reflects potential dilution from outstanding stock options using the
treasury stock method. Reconciliation of weighted average shares used in
computing net income (loss) per share is as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Weighted-average common shares
outstanding 92,259 92,171 92,387 92,105
Dilutive effect of stock options
outstanding using the treasury
stock method 1,815 -- 2,279 --
--------- --------- --------- ---------
Shares used in computing diluted
net income (loss) per share 94,074 92,171 94,666 92,105
========= ========= ========= =========
For the three and six months ended June 30, 2004, 4.9 million and 3.3
million stock options, respectively, have been excluded from the weighted-
average number of common shares outstanding for the diluted net income per
share computations as they were anti-dilutive. For the three and six
months ended June 30, 2003, all stock options outstanding, 11.6 million as
of June 30, 2003, have been excluded from the weighted-average number of
common shares outstanding for the diluted net loss per share computations
as they are anti-dilutive in loss periods.
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 June 30, 2004 total unamortized
stock compensation was $2.2 million.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income (loss) and net income (loss) 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.
6
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company's calculations for the fair value of stock options were made
using the Black-Scholes option pricing model. Calculations are based on a
multiple option valuation approach with forfeitures recognized as they
occur and the following weighted average assumptions:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Expected life (months) 60 60 60 60
Stock volatility 84.7% 85.8% 83.2% 85.8%
Risk free interest rates 3.8% 2.3% 3.3% 2.6%
Dividends during expected terms none none none none
The Company's calculations for the fair value of stock issued under the
employee stock purchase plan were made using the Black-Scholes option
pricing model with the following weighted average assumptions:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Expected life (months) 6 6 6 6
Stock volatility 84.7% 85.8% 83.2% 85.8%
Risk free interest rates 1.6% 1.0% 1.3% 1.0%
Dividends during expected terms none none none none
SFAS No. 148 was issued in December 2002 and amended SFAS No. 123 to
require that disclosures of the pro forma effect of using the fair value
method of accounting for stock-based employee compensation be displayed
more prominently and in a tabular format. The following table illustrates
the effect on the Company's net income (loss) and net income (loss) 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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net income (loss) as reported $ 14,048 $ (913) $ 18,623 $ (739)
Add: stock-based employee
compensation expense included
in reported net income (loss),
net of tax effects 458 733 938 1,381
Deduct: stock-based employee
compensation expense determined
under fair value based method,
net of tax effects (3,000) (3,571) (6,035) (6,866)
--------- --------- --------- ---------
Pro forma net income (loss) $ 11,506 $ (3,751) $ 13,526 $ (6,224)
========= ========= ========= =========
Net income (loss) per share
as reported:
Basic $ 0.15 $ (0.01) $ 0.20 $ (0.01)
========= ========= ========= =========
Diluted $ 0.15 $ (0.01) $ 0.20 $ (0.01)
========= ========= ========= =========
Pro forma net income (loss)
per share:
Basic $ 0.12 $ (0.04) $ 0.15 $ (0.07)
========= ========= ========= =========
Diluted $ 0.12 $ (0.04) $ 0.15 $ (0.07)
========= ========= ========= =========
7
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on recognition and measurement guidance previously discussed under EITF
Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." ("EITF 03-01"). The consensus
clarifies the meaning of other-than-temporary impairment and its
application to investments in debt and equity securities, in particular
investments within the scope of FASB Statement No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," and investments
accounted for under the cost method. This consensus is to be applied to
other-than-temporary impairment evaluations in reporting periods beginning
after June 15, 2004. We do not believe that this consensus will have a
material impact on the Company's consolidated results of operations.
In April 2004, the Emerging Issues Task Force issued Statement No. 03-06
"Participating Securities and the Two-Class Method Under FASB Statement No.
128, Earnings Per Share" ("EITF 03-06"). EITF 03-06 addresses a number of
questions regarding the computation of earnings per share by companies that
have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when,
and if, it declares dividends on its common stock. The issue also provides
further guidance in applying the two-class method of calculating earnings
per share, clarifying what constitutes a participating security and how to
apply the two-class method of computing earnings per share once it is
determined that a security is participating, including how to allocate
undistributed earnings to such a security. EITF 03-06 became effective
during the quarter ended June 30, 2004, the adoption of which did not have
any impact on the Company's calculation of net income per share.
3. INVESTMENTS
Short-term and long-term investments consist primarily of liquid debt
instruments and are classified as available-for-sale securities and are
stated at market value with unrealized gains and losses included in
shareholders' equity. Investments purchased with remaining maturity dates
of greater than three months and less than 12 months are classified as
short-term. Investments purchased with remaining maturity dates of 12
months or greater are classified as long-term. A summary of investments at
June 30, 2004 is as follows (in thousands):
8
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Unrealized Unrealized
Amortized Market Holding Holding
Cost Value Gains Losses
---------- ---------- ---------- -----------
Short-term investments $ 9,199 $ 9,162 $ - $ 37
Long-term investments $ 3,196 $ 3,185 $ - $ 11
4. INVENTORIES
Inventories consist of the following (in thousands):
June 30, December 31,
2004 2003
------------ ------------
Finished goods $ 14,341 $ 9,787
Work in process 20,587 20,425
Raw materials 855 896
---------- ----------
$ 35,783 $ 31,108
========== ==========
5. 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 June 30, 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 June 30, 2004), or the bank's revolving offshore
rate, which approximates LIBOR (1.6% at June 30, 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 June 30, 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 June 30, 2004), or adjustable monthly LIBOR
(1.6% at June 30, 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 June 30, 2004. The mortgage agreement
contains certain restrictive covenants with which the Company was in
compliance at June 30, 2004.
As of June 30, 2004, the Company had $3.9 million under term notes
outstanding, including the commercial mortgage loan.
6. SIGNIFICANT CUSTOMERS
During the six months ended June 30, 2004, three customers, a world wide
distributor, an Asian based stocking representative, and a direct original
equipment manufacturer ("OEM") accounted for $19.4 million (15%), $16.4
million (13%) and $13.5 million (10%) of net revenues, respectively. During
the six months ended June 30, 2003, the same world wide distributor and
Asian based stocking representative accounted for $12.9 million (13%) and
$10.6 million (10%) of net revenues, respectively, and no direct OEM
accounted for 10% or more of net revenues.
9
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
As of June 30, 2004, one customer, an Asian based stocking representative,
accounted for 20% of net accounts receivable. At December 31, 2003, two
customers accounted for 19% and 13% of total accounts receivable.
7. COMPREHENSIVE INCOME
Comprehensive income or loss, which was comprised of the Company's net
income or loss for the periods and changes in unrealized gains or losses on
investments, was a net income of $14.0 million and $18.6 million for the
three and six months ended June 30, 2004, respectively, and a net loss of
$913,000 and a net loss of $740,000 for the three and six months ended June
30, 2003, respectively.
8. 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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net Revenues:
Standard Products $ 66,118 $ 43,580 $ 124,752 $ 88,834
Custom and Foundry Products 2,878 5,529 5,505 11,230
--------- --------- --------- ---------
Total net revenues $ 68,996 $ 49,109 $ 130,257 $ 100,064
========= ========= ========= =========
As a Percentage of Total Net Revenues:
Standard Products 96% 89% 96% 89%
Custom and Foundry Products 4% 11% 4% 11%
--------- --------- --------- ---------
Total net revenues 100% 100% 100% 100%
========= ========= ========= =========
9. 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
10
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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, in
addition to litigation mentioned herein, it could result in substantial
costs and diversion of resources to the Company and could have a material
adverse effect on the Company's financial condition, results of operation or
cash flows.
11
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 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. 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. During the
six months ended June 30, 2004, the Company repurchased 1,003,100 shares of
its common stock for $13.6 million.
11. INCOME TAXES
Deferred tax assets and liabilities result primarily from temporary
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 $29.1 million as of June 30, 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.
The calculation of the Company's tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. The Company
records liabilities for anticipated tax audit issues based on its estimate
of whether, and the extent to which, additional taxes may be due. Actual
tax liabilities may be different than the recorded estimates and could
result in an additional charge or benefit to the tax provision in the
period when the ultimate tax assessment is determined.
During the quarter ended June 30, 2004, the Company reversed $3.8 million
of accrued income tax liabilities as a result of the completion of a
federal income tax audit which covered the tax years 1994 through 2001. In
addition, related to the federal tax audit completion, the Company also
reversed $3.9 million in accrued payroll tax liabilities. The effects of
these accrued tax liability reversals on the below-noted items in the Company's
statement of operations is summarized as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Cost of revenues $ (1,111) $ -- $ (1,111) $ --
Research and development (1,697) -- (1,697) --
Selling, general and
Administrative (1,140) -- (1,140) --
Provision (benefit) for
income taxes (2,378) -- (2,378) --
--------- --------- --------- ---------
Total $ (6,326) $ -- $ (6,326) $ --
========= ========= ========= =========
12
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The income tax provision for the three and six months ended June 30, 2004
is based on the Company's estimated annual effective tax rate of 35% of
pretax income, reduced by the $3.8 million reversal of accrued income tax
liabilities recorded in the quarter ended June 30, 2004 and increased by
$168,000 as a result of $480,000 of non-deductible purchased in-process
technology charges recorded in the three months ended March 31, 2004.
12. 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 -- (828) (51) (879)
--------- --------- --------- ---------
Balance June 30, 2004 $ -- $ 3,291 $ 360 $ 3,651
========= ========= ========= =========
Of the $3.7 million in accrued restructuring costs, $2.0 million has been
classified as other current liabilities and the remaining $1.7 million has
been classified as other long-term obligations as of June 30, 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 the restructuring accrual in the period such
determination is made.
13. 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 ultimately acquired 100% of the outstanding
BlueChip common stock and options to purchase BlueChip common stock 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 have
been included in the Company's condensed consolidated financial statements.
13
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 determined by
management, based in part on a valuation 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.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 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 (see Note 12 of Notes to Condensed Consolidated
Financial Statements). 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
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
customers serving the communications, computing, industrial and wireless
handset end markets. Gross margins and net income increased in the second half
of 2003.
In the first quarter of 2004, demand for the Company's products increased.
New order rates increased compared with both the first and fourth quarters of
2003. Customers increased order lead times in response to general concern
about the availability of semiconductor component supply. 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.
In the second quarter of 2004, revenues, gross margin, operating margin and
net income continued to increase. Demand for the Company's products remained
solid with new order levels approximately equal to the level of revenue for the
quarter. Order lead times exiting the second quarter remained about the same
as the end of the first quarter. Gross profit margin increased on both a
sequential and year-over-year basis. The improvement in gross margin was due
primarily due to higher sales volume combined with higher factory utilization
which spread fixed costs over higher unit volume, and a more favorable product
mix compared with the second quarter of 2003. Second quarter and year-to-date
operating expenses were approximately $800 thousand less than the year ago
period due to the reversal of $2.8 million of accrued payroll tax liabilities
associated with the conclusion of a tax audit (see Note 11 of Notes to
Condensed Consolidated Financial Statements). Operating profit and net income
increased for the fourth consecutive quarter. The Company is making progress
toward its goal of returning to quarterly profit margin levels that were
achieved prior to the year 2000.
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 13 of Notes to Condensed Consolidated Financial Statements).
The Company derives a substantial portion of its net revenues from standard
products. For each of the three and six month periods ended June 30, 2004 the
Company's standard products sales accounted for 96%, of the Company's net
revenues as compared to 89% for the comparable periods in 2003. 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.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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.
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 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
$29.1 million as of June 30, 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
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
when the ultimate tax assessment is determined. During the quarter ended June
30, 2004, the Company reversed $3.8 million of accrued income tax liabilities
as a result of the completion of a federal income tax audit which covered the
tax years 1994 through 2001. This reversal of accrued income tax liabilities
has been recorded as a reduction to provision for income taxes in the three
months ended June 30, 2004. In addition, related to the federal tax audit
completion, the Company also reversed $3.9 million in accrued payroll tax
liabilities. This reduction in accrued payroll tax liabilities has been
recorded as a $1.1 million reduction in cost of revenues, a $1.7 million
reduction in research and development expense and a $1.1 million reduction in
selling, general and administrative expense in the three months ended June 30,
2004.
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 9 of Notes to Condensed Consolidated Financial Statements) and has not
accrued a liability for such litigation. The Company regularly evaluates
current information available to determine whether such accruals should be
made. An estimated liability would be accrued when it is determined to be
probable that a liability has been incurred and the amount of loss can be
reasonably estimated. If the Company were to determine that such a liability
was probable and could be reasonably estimated, the adjustment would be charged
to income in the period such determination was made.
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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 50.2 62.9 52.5 61.3
--------- --------- --------- ---------
Gross profit 49.8 37.1 47.5 38.7
--------- --------- --------- ---------
Operating expenses:
Research and development 14.0 24.7 15.5 24.8
Selling, general and
Administrative 12.4 13.4 13.3 13.5
Amortization of deferred
stock compensation 0.9 1.9 0.9 1.7
Purchased in-process technology - - 0.4 -
--------- --------- --------- ---------
Total operating expenses 27.3 40.0 30.1 40.0
--------- --------- --------- ---------
Income (loss) from operations 22.5 (2.9) 17.4 (1.3)
Other income (loss), net 0.4 0.4 0.4 0.4
--------- --------- --------- ---------
Income (loss) before income taxes 22.9 (2.5) 17.8 (0.9)
Provision (benefit) for
income taxes 2.5 (0.6) 3.5 (0.2)
--------- --------- --------- ---------
Net income(loss) 20.4% (1.9)% 14.3% (0.7)%
========= ========= ========= =========
Net Revenues. For the three months ended June 30, 2004, net revenues
increased 40% to $69.0 million from $49.1 million for the same period in the
prior year. For the six months ended June 30, 2003, net revenues increased 30%
to $130.3 million from $100.1 million for the same period in the prior year.
These increases were primarily due to increased standard products revenues,
which were partially offset by decreased custom and foundry products revenues.
Standard products revenues increased 52% to $66.1 million, for the three
months ended June 30, 2004, from $43.6 million for the same period in the prior
year. For the six months ended June 30, 2004, standard products revenues
increased 40% to $124.8 million from $88.8 for the same period in the prior
year. These increases resulted primarily from increased unit shipments of
standard products to the industrial, telecommunications and high bandwidth
communications products end markets.
Custom and foundry products revenues decreased 48% to $2.9 million
representing 4% of net revenues, for the three months ended June 30, 2004, from
$5.5 million or 11% of net revenues for the same period in the prior year. For
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
the six months ended June 30, 2004, custom and foundry products revenues
decreased 51% to $5.5 million from $11.2 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 and second quarters of 2004 was approximately
45% and 35% respectively. The Company experienced an increase in order rates
and backlog in the six months ended June 30, 2004 as compared to the same
period in 2003, which may indicate that demand for semiconductors is increasing
and that customers may be becoming more concerned about product availability.
When lead times, order backlog and industry-wide capacity utilization increase,
the semiconductor industry historically has experienced growth. However, the
sustainability of improved customer demand is uncertain and highly dependent on
economic conditions. Lead times and order backlog for the Company's products
stabilized in the second quarter after increasing in the first quarter of 2004
which may indicate that customers are becoming more comfortable with the
available supply of semiconductor components. As a result, turns fill may need
to increase in order for the Company to grow revenues in future periods. 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 June 30 2004 and 2003, respectively. On a dollar basis,
international sales increased 56% to $52.1 million for the three months ended
June 30, 2004 from $33.3 million for the comparable period in 2003. For the
six months ended June 30, 2004 and 2003, international sales represented 76%
and 68% of net revenues, respectively. On a dollar basis, international sales
increased 45% to $98.7 million for the six months ended June 30, 2004 from
$68.2 million for the comparable period in 2003. These increases resulted
primarily from increased shipments of industrial, telecommunications and high
bandwidth 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 50%
for the three months ended June 30, 2004 from 37% for the comparable period in
2003. For the six months ended June 30, 2004, gross margin increased to 48%
from 39% for the comparable period in 2003. These increases in gross margin
resulted primarily from a greater sales mix of higher margin products,
decreased wafer fabrication costs, decreased external assembly and test costs,
and the reversal of $1.1 million of accrued payroll tax liabilities associated
with the conclusion of a tax audit (see Note 11 of Notes to Condensed
Consolidated Financial Statements). During the three and six months ended June
30, 2004, the company reduced sales of low margin foundry products and
increased sales of higher margin analog and high bandwidth communications
standard products as compared to the same periods in 2003. In addition, the
Company benefited from decreased wafer fabrication costs resulting from the
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Company's wafer fabrication consolidation project (see Note 12 of Notes to
Condensed Consolidated Financial Statements) and lower costs for external
assembly and test manufacturing services. The Company's gross profit margin
has also benefited from spreading fixed costs over a higher sales volume.
Depreciation and amortization (excluding deferred stock compensation) as a
percent of sales has declined from 15% in the first half of 2003 to 10% in the
first half of 2004.
If the global economy continues to expand, and demand for the Company's
products continues to grow, 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 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 14% and 25% as a percentage
of net revenues, for the three months ended June 30, 2004 and 2003,
respectively. On a dollar basis, research and development expenses decreased
$2.5 million or 20% to $9.7 million for the three months ended June 30, 2004
from $12.2 million for the comparable period in 2003. For the six months ended
June 30, 2004 and 2003, research and development expenses represented 16% and
25% as a percentage of net revenues, respectively. On a dollar basis, research
and development expenses decreased $4.6 million or 18% to $20.2 million for the
six months ended June 30, 2004 from $24.8 million for the comparable period in
2003. These decreases were primarily due to decreased prototype fabrication
costs combined with reduced staffing costs, reduced mask costs and the reversal
of $1.7 million of accrued payroll tax liabilities associated with the
conclusion of a tax audit (see Note 11 of Notes to Condensed Consolidated
Financial Statements). The Company believes that the development and
introduction of new products is critical to its future success and expects to
continue its investment in research and development activities in the future.
Selling, General and Administrative Expenses. As a percentage of net
revenues, selling, general and administrative expenses represented 12% and 13%
for the three months ended June 30, 2004 and 2003, respectively. On a dollar
basis, selling, general and administrative expenses increased $2.0 million or
30% to $8.6 million for the three months ended June 30, 2004 from $6.6 million
for the comparable period in 2003. For the six months ended June 30, 2004 and
2003, selling, general and administrative expenses represented 13% and 14% as a
percentage of net revenues, respectively. On a dollar basis, selling, general
and administrative expenses increased $3.9 million or 28% to $17.4 million for
the six months ended June 30, 2004 from $13.7 million for the comparable period
in 2003. These dollar increases were principally attributable to increased
commissions related to higher revenues, increased outside legal costs and
increased staffing costs which were partially offset by the reversal of $1.1
million of accrued payroll tax liabilities associated with the conclusion of a
tax audit (see Note 11 of Notes to Condensed Consolidated Financial
Statements).
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 13 of Notes to
Condensed Consolidated Financial Statements).
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 $108,000 to
$289,000 for the three months ended June 30, 2004 from $181,000 for the
comparable period in 2003. Other income, net increased $191,000 to $538,000
for the six months ended June 30, 2004 from $347,000 for the comparable period
in 2003. These increases were primarily due to increased interest income on
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
increased cash and investment balances and decreased interest expense resulting
from a decrease in average debt.
Provision (benefit) for Income Taxes. The income tax provision for the
three and six months ended June 30, 2004 is based on the Company's estimated
annual effective tax rate of 35% of pretax income, reduced by a $3.8 million
reversal of accrued income tax liabilities as a result of the completion of a
federal income tax audit (see Note 11 of Notes to Condensed Consolidated
Financial Statements) and increased by $168,000 as a result of $480,000 of non-
deductible purchased in-process technology charges recorded in the quarter
ended March 31, 2004. For the three and six months ended June 30, 2003, the
benefit for income taxes was 25% and 23% of pretax loss, respectively. The
income tax provision (benefit) for such interim periods reflects the Company's
estimated annual income tax rate. The estimated provision (benefit) 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 June 30, 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 June 30, 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 June 30, 2004), or
the bank's revolving offshore rate, which approximates LIBOR (1.6% at June 30,
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
June 30, 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 June 30, 2004), or adjustable monthly LIBOR (1.6% at June
30, 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
June 30, 2004. The mortgage agreement contains certain restrictive covenants
with which the Company was in compliance at June 30, 2004.
The Company generated $31.6 million in cash flows from operating activities
for the six months ended June 30, 2004 as compared to $15.8 million for the
same period in the prior year. The $31.6 million in cash flows from operating
activities generated by the Company, during the six months ended June 30, 2004,
were primarily attributable to net income of $18.6 million plus additions for
non-cash activities of $22.9 million, which was partially offset by a $7.0
million increase in accounts receivables, as a result of increased revenues and
a $4.5 million increase in inventories.
The $15.8 million in cash flows from operating activities generated by the
Company in the six months ended June 30, 2003 were primarily attributable to
additions for non-cash activities of $18.3 million combined with a $1.9 million
decrease in inventory and a $921,000 decrease in accounts receivable, which was
partially offset by a net loss of $739,000 plus a $2.1 million decrease in
current liabilities and a $2.5 million decrease in other non-current
obligations.
The Company used $27.0 million of cash in investing activities during the
six months ended June 30, 2004 comprised of $11.5 million in purchases of
property, plant and equipment, $12.4 million in purchases of short term and
long-term investments, $2.0 million for the purchase of BlueChip and $1.0
million for the purchase of intangible assets. Cash used in investing
activities during the six months ended June 30, 2003 resulted from $11.5 in net
purchases of property, plant and equipment.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company used $10.5 million of cash in financing activities during the
six months ended June 30, 2004 primarily for the repurchase of $13.6 million of
the Company's common stock, which was partially offset by $3.4 million in
proceeds from employee stock transactions. Cash provided by financing
activities during the six months ended June 30, 2003 was $1.9 million and
resulted from $2.4 million in proceeds from employee stock transactions, which
was partially offset by $560,000 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 six months ended June 30, 2004 payments of
$1.3 million were made under previously existing operating leases, repayments
of $340,000 were made under previously existing long-term debt agreements and a
$2.0 payment was made for other long-term liabilities. Open purchase orders
were approximately $30 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 June 30, 2004 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.
Factors That May Affect Operating Results
If a company's operating results are below the expectations of public
market analysts or investors, then the market price of its Common Stock could
decline. Many factors that can affect a company's quarterly and annual results
are difficult to control or predict. Some of the factors which can affect a
multinational semiconductor business such as the Company are described below.
Geopolitical and Macroeconomic Risks That May Affect Multinational Enterprises
Demand for semiconductor components is increasingly dependent upon the rate
of growth of the global economy. If the rate of global economic growth slows,
or contracts, customer demand for products could be adversely affected, which
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
in turn could negatively affect revenues, results of operations and financial
condition. Many factors could adversely affect regional or global economic
growth. Some of the factors that could slow global economic growth include:
rising interest rates in the United States, a slowdown in the rate of growth of
the Chinese economy, a significant act of terrorism which disrupts global trade
or consumer confidence, uncertainty over the outcome of the November 2004
elections in the United States, geopolitical tensions including war and civil
unrest. Reduced levels of economic activity, or disruptions of international
transportation, could adversely affect sales on either a global basis or in
specific geographic regions
The Company has generated a substantial portion of its net revenues from
export sales. The Company believes that a substantial portion of its future net
revenues will depend on export sales to customers in international markets,
including Asia. International markets are subject to a variety of risks,
including changes in policy by foreign governments, acts of terrorism, 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 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. 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 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 this 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 upon exercise. 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.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Market conditions may lead the Company to initiate additional cost reduction
plans, which may negatively affect near term operating results. Weak customer
demand, competitive pricing pressures, excess capacity, weak economic
conditions or other factors, may cause the Company to initiate additional
actions to reduce the Company's cost structure and improve the Company's future
operating results. The cost reduction actions may require incremental costs to
implement, which could negatively affect the Company's operating results in
periods when the incremental costs or liabilities are incurred.
Semiconductor Industry Specific Risks
The volatility of customer demand in the semiconductor industry limits a
company's ability to predict future levels of sales and profitability.
Semiconductor suppliers can rapidly increase production output, leading to a
sudden oversupply situation and a subsequent reduction in order rates and
revenues as customers adjust their inventories to true demand rates. A rapid
and sudden decline in customer demand for products can result in excess
quantities of certain products relative to demand. Should this occur the
Company's operating results may be adversely affected as a result of charges to
reduce the carrying value of the Company's inventory to the estimated demand
level or market price. The Company's quarterly revenues are highly dependent
upon turns fill orders (orders booked and shipped in the same quarter).
Although the level of order backlog has increased since the end of 2003, 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 in the semiconductor industry has allowed
many end consumers to rely on stocking representatives and distributors to
carry inventory to meet short term requirements and minimize their investment
in on-hand inventory. Since the end of 2003 some of the Company's stocking
representatives and distributors have increased their inventory levels to
service the volatile short-term demand of the end customer. Should the
relationship with a distributor or stocking representative be terminated, the
future level of product returns could be higher than the returns allowance
established, which could negatively affect the Company's revenues and results
of operations.
The semiconductor industry is highly competitive and subject to rapid
technological change, price-erosion and increased international competition.
Significant competitive factors include product features, performance and
price; timing of product introductions; emergence of new computer and
communications standards; quality and customer support.
In times when economic growth and customer demand are less certain, both the
semiconductor industry and the Company have experienced significant price
erosion since the beginning of 2001. If price erosion continues, it will have
the effect of reducing revenue levels and gross margins in future periods.
Furthermore, the trend for the Company's customers to move their electronics
manufacturing to Asian countries has brought increased pricing pressure for
Micrel and the semiconductor industry. Asian based manufacturers are typically
more concerned about cost and less concerned about the capability of the
integrated circuits they purchase. The increased concentration of electronics
procurement and manufacturing in the Asia Pacific region may lead to continued
price pressure and additional product advertising costs for the Company's
products in the future.
The wireless handset market comprises a significant portion of the Company's
standard product revenues. Due to the highly competitive and fast changing
environment in which the Company's wireless handset customers operate, demand
for the product the Company sells into this end market can change rapidly and
unexpectedly. If the Company's wireless handset customers lose market share,
or accumulate too much inventory of completed handsets, the demand for the
Company's products can decline sharply which could adversely affect the
Company's revenues and results of operations.
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.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The markets that the Company serves frequently undergo transitions in which
products rapidly incorporate new features and performance standards on an
industry-wide basis. If the Company's products are unable to support the new
features or performance levels required by OEMs in these markets, it would
likely lose business from existing or potential customers and would not have
the opportunity to compete for new design wins until the next product
transition. If the Company fails to develop products with required features or
performance standards, or experiences even a short delay in bringing a new
product to market, or if its customers fail to achieve market acceptance of
their products, its revenues could be significantly reduced for a substantial
period of time.
Because the standard products market for ICs is diverse and highly
fragmented, the Company encounters different competitors in various market
areas. Most of these competitors have substantially greater technical,
financial and marketing resources and greater name recognition than the
Company. There can be no assurance that the Company will be able to compete
successfully in either the standard products or custom and foundry products
business in the future or that competitive pressures will not adversely affect
the Company's financial condition, results of operations, or cash flows.
The significant investment in semiconductor manufacturing capacity and the
rapid growth of circuit design centers in China may present a competitive
threat to established semiconductor companies due to the current low cost of
labor and capital in China. The emergence of low cost competitors in China
could reduce the revenues and profitability of established semiconductor
manufacturers.
Many semiconductor companies face risks associated with a dependence upon
third parties that manufacture, assemble or package certain of its products.
These risks include reduced control over delivery schedules and quality;
inadequate manufacturing yields and excessive costs; the potential lack of
adequate capacity during periods of excess demand; difficulties selecting and
integrating new subcontractors; potential increases in prices; disruption in
supply due to civil unrest, terrorism or other events which may occur in the
countries in which the subcontractors operate; and potential misappropriation
of the Company's intellectual property. Any of these risks may lead to
increased costs or delay delivery of the Company's products, which would harm
its profitability and customer relationships. Additionally, the Company's
wafer and product requirements typically represent a relatively small portion
of the total production of the third-party foundries and outside assembly,
testing and packaging contractors. As a result, Micrel is subject to the risk
that a foundry will provide delivery or capacity priority to other larger
customers at the expense of Micrel, resulting in an inadequate supply to meet
customer demand or higher costs to obtain the necessary product supply.
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, revenues and financial results
may be adversely affected.
There is intense competition for qualified personnel in the semiconductor
industry, in particular design engineers. The Company may not be able to
continue to attract and train engineers or other qualified personnel necessary
for the development of its business or to replace engineers or other qualified
personnel who may leave its employ in the future. Loss of the services of, or
failure to recruit, key design engineers or other technical and management
personnel could be significantly detrimental to the Company's product and
process development programs.
The success of companies in the semiconductor industry depends in part upon
intellectual property, including patents, trade secrets, know-how and
continuing technology innovation. There can be no assurance that the steps
taken by the Company to protect its intellectual property will be adequate to
prevent misappropriation or that others will not develop competitive
technologies or products. There can be no assurance that any patent owned by
the Company will not be invalidated, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages or that any of
its pending or future patent applications will be issued with the scope of the
claims sought, if at all. Furthermore, there can be no assurance that others
will not develop technologies that are similar or superior to the Company's
technology, duplicate technology or design around the patents owned by the
Company. Additionally, the semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. There can
be no assurance that existing claims or any other assertions or claims for
indemnity resulting from infringement claims will not adversely affect the
Company's business, financial condition, results of operations, or cash flows.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Companies in the semiconductor industry are subject to a variety of federal,
state and local governmental regulations related to the use, storage, discharge
and disposal of toxic, volatile or otherwise hazardous chemicals used in its
manufacturing process. Any failure to comply with present or future
regulations could result in the imposition of fines, the suspension of
production, alteration of manufacturing processes or a cessation of operations.
In addition, these regulations could restrict the Company's ability to expand
its facilities at their present locations or construct or operate a new wafer
fabrication facility or could require 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.
Company-Specific Risks
In addition to the risks that affect multinational semiconductor companies
listed above, there are additional risks which are more specific to the Company
such as:
The Company's gross margin, operating margin and net income are highly
dependent on the level of revenue and capacity utilization that the Company
experiences. Semiconductor manufacturing is a capital-intensive business
resulting in high fixed costs. If the Company is unable to utilize its
installed wafer fabrication or test capacity at a high level, the costs
associated with these facilities and equipment would not be fully absorbed,
resulting in higher average unit costs and lower profit margins. Increased
customer demand has led to increasing levels of capacity utilization through
the first half of 2004. 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 margin 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 margin,
operating margin and net income may deteriorate.
The Company derives a significant portion of its revenues from customers
located in certain geographic regions or countries. Three of the Company's
top ten direct customers are located in South Korea. In the event that
political tensions surrounding North Korea evolve into military or social
conflict, or other factors disrupt the Korean economy, the Company's revenues,
results of operations, cash flow and financial condition could be adversely
affected. A significant portion of the Company's revenues come from customers
located in Taiwan and China. In the event that economic activity in these two
countries declines, or is disrupted by geopolitical events, the Company's
revenues and results of operations could be adversely affected.
The Company manufactures most of its semiconductors at its San Jose,
California fabrication facilities. The Company's existing wafer fabrication
facility, located in Northern California, may be subject to natural disasters
such as earthquakes. A significant natural disaster, such as an earthquake or
prolonged drought, could have a material adverse impact on the Company's
business, financial condition and operating results. Furthermore,
manufacturing semiconductors requires manufacturing tools that are unique to
each product being produced. If one of these unique manufacturing tools was
damaged or destroyed, the Company's ability to manufacture the related product
would be impaired and its business would suffer until the tool was repaired or
replaced. Additionally, the fabrication of ICs is a highly complex and precise
process. Small impurities, contaminants in the manufacturing environment,
difficulties in the fabrication process, defects in the masks used to print
circuits on a wafer, manufacturing equipment failures, wafer breakage or other
factors can cause a substantial percentage of wafers to be rejected or numerous
die on each wafer to be nonfunctional. The Company maintains approximately two
to three months of inventory that has completed the wafer fabrication
manufacturing process. This inventory is generally located offshore at third
party subcontractors and can act to buffer some of the adverse impact from a
disruption to the Company's San Jose wafer fabrication activity arising from a
natural disaster such as an earthquake.
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 six months ended June 30, 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
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
April 2004 138,850 $ 13.11 138,850 $ 18,972
May 2004 96,600 $ 12.83 96,600 $ 17,733
June 2004 482,600 $ 13.03 482,600 $ 11,447
--------- ------- ---------
Total 1,003,100 $ 13.01 1,003,100
In February 2002, the Company's Board of Directors approved a plan to
repurchase shares of the Company's common stock in the open market. Shares of
common stock purchased pursuant to the repurchase program are cancelled upon
repurchase, and are intended to offset dilution from the Company's stock
option plans, employee stock purchase plans and 401(k) plan. 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, 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders (the "Annual Meeting") was held
on May 27, 2004. At the Annual Meeting, shareholders voted on two matters:
(a) the election of the Board of Directors, and (b) ratification of the
appointment of PricewaterhouseCoopers LLP as the independent auditor of the
Company for its fiscal year ending December 31, 2004 All nominees for
directors were elected and the selection of the independent auditor was
ratified. The proposals were voted upon and approved in the manner set forth
below:
28
Proposal No. 1 - Election of members of the Board of Directors:
The following persons were duly elected to the Board of Directors by the
shareholders for a one year term and until their successors are elected and
qualified:
NOMINATION FOR ABSTAINED
---------- --- ---------
Raymond D. Zinn 85,812,522 2,064,892
Warren H. Muller 85,462,301 2,415,113
Donald H. Livingstone 85,064,820 2,812,594
Larry L. Hansen 85,016,277 2,861,137
George Kelly 85,123,327 2,754,087
Proposal No. 2 - Ratification of the appointment PricewaterhouseCoopers LLP as
the independent auditor of the Company for its fiscal year ending December 31,
2004:
NOMINATION FOR ABSTAINED
---------- --- ---------
PricewaterhouseCoopers LLP 86,849,481 1,016,764
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 June 30, 2004, the
Company furnished a Current Report on Form 8-K, dated April 22, 2004
announcing its financial results for the three month period ended
March 31, 2004.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICREL, INCORPORATED
--------------------
(Registrant)
Date: August 9, 2004 By /s/ Richard D. Crowley, Jr.
---------------------------
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
30