UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number 0-25236
M I C R E L, I N C O R P O R A T E D
(Exact name of Registrant as specified in its charter)
California 94-2526744
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2180 Fortune Drive, San Jose, CA 95131
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 944-0800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act. Yes [X] No [ ]
As of April 29, 2005 there were 87,388,461 shares of common stock, no par
value, outstanding.
MICREL, INCORPORATED
INDEX TO
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - March 31, 2005 and
December 31, 2004 3
Condensed Consolidated Statements of Operations - Three Months
Ended March 31, 2005 and 2004 4
Condensed Consolidated Statements of Cash Flows - Three Months
Ended March 31, 2005 and 2004 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 6. Exhibits 26
Signature 27
2
ITEM 1. FINANCIAL STATEMENTS
MICREL, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
March 31, December 31,
2005 2004 (1)
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 113,814 $ 101,282
Short term investments 29,453 46,503
Accounts receivable, net 32,291 32,055
Inventories 33,569 35,744
Other current assets 2,441 2,488
Deferred income taxes 25,702 25,746
---------- ----------
Total current assets 237,270 243,818
PROPERTY, PLANT AND EQUIPMENT, NET 78,467 81,605
LONG TERM INVESTMENTS 1,981 2,012
DEFERRED INCOME TAXES 272 --
INTANGIBLE ASSETS, NET 5,969 6,375
OTHER ASSETS 383 457
---------- ----------
TOTAL $ 324,342 $ 334,267
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 13,704 $ 16,275
Taxes payable 6,501 4,960
Deferred income on shipments to distributors 13,356 13,648
Other current liabilities 13,690 12,165
Current portion of long-term debt 170 164
---------- ----------
Total current liabilities 47,421 47,212
LONG-TERM DEBT 27 83
DEFERRED INCOME TAXES -- 121
OTHER LONG-TERM OBLIGATIONS 1,533 1,964
SHAREHOLDERS' EQUITY:
Preferred stock, no par value -
authorized: 5,000,000 shares;
issued and outstanding: none -- --
Common stock, no par value -
authorized: 250,000,000 shares;
issued and outstanding:
2005 - 88,087,061 shares;
2004 - 89,825,994 shares 110,837 127,264
Deferred stock compensation (817) (1,118)
Accumulated other comprehensive loss (88) (85)
Retained earnings 165,429 158,826
---------- ----------
Total shareholders' equity 275,361 284,887
---------- ----------
TOTAL $ 324,342 $ 334,267
========== ==========
(1) Derived from the audited balance sheet included in the Annual Report on
Form 10-K of Micrel, Incorporated for the year ended December 31, 2004.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
MICREL, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
NET REVENUES $ 60,685 $ 61,261
COST OF REVENUES(1) 30,309 33,717
---------- ----------
GROSS PROFIT 30,376 27,544
---------- ----------
OPERATING EXPENSES:
Research and development 11,460 10,556
Selling, general and administrative 9,344 8,866
Amortization of deferred stock compensation(1) 250 595
Purchased in-process technology -- 480
---------- ----------
Total operating expenses 21,054 20,497
---------- ----------
INCOME FROM OPERATIONS 9,322 7,047
OTHER INCOME, NET 836 249
---------- ----------
INCOME BEFORE INCOME TAXES 10,158 7,296
PROVISION FOR INCOME TAXES 3,555 2,721
---------- ----------
NET INCOME $ 6,603 $ 4,575
========== ==========
NET INCOME PER SHARE:
Basic $ 0.07 $ 0.05
========== ==========
Diluted $ 0.07 $ 0.05
========== ==========
WEIGHTED AVERAGE SHARES USED IN
COMPUTING PER SHARE AMOUNTS:
Basic 89,102 92,518
========== ==========
Diluted 89,624 95,249
========== ==========
(1) Amortization of deferred stock compensation:
Included in cost of revenues $ 51 $ 193
========== ==========
Amortization of deferred stock compensation
included in operating expenses related to:
Research and development $ 64 $ 218
Selling, general and administrative 186 377
---------- ----------
Total operating expenses $ 250 $ 595
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
MICREL, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 6,603 $ 4,575
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,371 6,441
Stock based compensation 301 788
Purchased in-process technology -- 480
(Gain) loss on disposal of assets 102 --
Deferred rent (20) --
Deferred income taxes (349) 2,493
Changes in operating assets and liabilities,
net of effect of acquisition:
Accounts receivable (236) (4,375)
Inventories 2,175 (3,034)
Prepaid expenses and other assets 121 (250)
Accounts payable (2,571) 3,023
Income taxes 1,482 185
Other accrued liabilities 1,114 2,579
Deferred income on shipments to distributors (292) 2,163
---------- ----------
Net cash provided by operating activities 13,801 15,068
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,929) (5,954)
Purchase of intangible assets -- (1,030)
Purchases of short-term investments -- (7,001)
Proceeds from the sale of short-term investments 17,078 --
Purchase of BlueChip Communications, net of
cash acquired -- (2,033)
---------- ----------
Net cash provided by (used in) investing
activities 15,149 (16,018)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (50) (168)
Proceeds from the issuance of common stock, net 780 1,406
Repurchase of common stock (17,148) (4,209)
---------- ----------
Net cash used in financing activities (16,418) (2,971)
---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12,532 (3,921)
CASH AND CASH EQUIVALENTS - Beginning of period 101,282 140,059
---------- ----------
CASH AND CASH EQUIVALENTS - End of period $ 113,814 $ 136,138
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 49 $ 98
========== ==========
Income taxes $ 2,468 $ 62
========== ==========
Non-cash transactions:
Deferred stock compensation (reversal) $ -- $ (96)
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Information - The accompanying condensed consolidated
financial statements of Micrel, Incorporated and its wholly-owned
subsidiaries ("Micrel" or the "Company") as of March 31, 2005 and for the
three months ended March 31, 2005 and 2004 are unaudited. In the opinion of
management, the condensed consolidated financial statements include all
adjustments (consisting only of normal recurring accruals) that management
considers necessary for a fair statement of its financial position,
operating results and cash flows for the interim periods presented.
Operating results and cash flows for interim periods are not necessarily
indicative of results for the entire year.
This financial data should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004. This
financial data should also be read in conjunction with the Company's critical
accounting policies included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2004.
Net Income Per Common and Equivalent Share - Basic net income per share is
computed by dividing net income by the number of weighted-average common
shares outstanding. Diluted net income per share reflects potential dilution
from outstanding stock options using the treasury stock method.
Reconciliation of weighted average shares used in computing net income per
share is as follows (in thousands):
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
Weighted average common shares outstanding 89,102 92,518
Dilutive effect of stock options outstanding
using the treasury stock method 522 2,731
---------- ----------
Shares used in computing diluted net income per share 89,624 95,249
========== ==========
For the three months ended March 31, 2005 and 2004, 9.5 million and 2.4
million stock options, respectively, have been excluded from the weighted-
average number of common shares outstanding for the diluted net income per
share computations as they were anti-dilutive.
Stock Based Awards - The Company accounts for stock-based awards to employees
using the intrinsic value method in accordance with Accounting Principles
Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees".
During the years 1996 through December 2001, certain of the Company's option
pricing practices resulted in stock compensation expense under APB 25 (for a
further discussion, see Stock-based Awards included in Note 1 of Notes to
Consolidated Financial Statements in the Company's Annual Report on Form 10-K
for the year ended December 31, 2004). Deferred stock compensation expense
balances are recorded as a contra-equity amount and amortized as a charge to
operating results over the applicable vesting periods. As of March 31, 2005
total unamortized stock compensation was $817,000 with an anticipated
remaining future amortization schedule of $521,000 in 2005 and $296,000 in
2006.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and earnings per share had the Company
applied the fair value method as of the beginning of fiscal 1995. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require subjective
assumptions, including future stock volatility and expected time to exercise,
which greatly affect the calculated values. The Company's calculations for
the fair value of stock options were made using the Black-Scholes option
pricing model. Calculations are based on a multiple option valuation
approach with forfeitures recognized as they occur and the following weighted
average assumptions:
6
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
Expected life (months) 60 60
Stock volatility 81.9% 81.7%
Risk free interest rates 4.2% 2.8%
Dividends during expected terms 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
March 31,
-----------------------
2005 2004
---------- ----------
Expected life (months) 6 6
Stock volatility 81.9% 81.7%
Risk free interest rates 3.0% 2.0%
Dividends during expected terms none none
SFAS No. 148 was issued in December 2002 and amended SFAS No. 123 to require
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. The following table illustrates the
effect on the Company's net income and net income per share if it had
recorded compensation costs based on the estimated grant date fair value as
defined by SFAS No. 123 for all granted stock-based awards. (in thousands,
except per share amounts):
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
Net income as reported $ 6,603 $ 4,575
========== ==========
Add: stock-based employee compensation expense
included in reported net income, net of tax effects 183 479
Deduct: stock-based employee compensation expense
determined under fair value based method, net
of tax effects (2,244) (3,034)
---------- ----------
Pro forma net income $ 4,542 $ 2,020
========== ==========
Net income per share as reported:
Basic $ 0.07 $ 0.05
========== ==========
Diluted $ 0.07 $ 0.05
========== ==========
Pro forma net income per share:
Basic $ 0.05 $ 0.02
========== ==========
Diluted $ 0.05 $ 0.02
========== ==========
7
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2004, the Financial Accounting Standards Board ("FASB") Emerging
Issues Task Force ("EITF") reached a consensus on recognition and measurement
guidance previously discussed under EITF Issue No. 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
("EITF 03-01"). The consensus clarifies the meaning of other-than-temporary
impairment and its application to investments in debt and equity securities,
in particular investments within the scope of FASB Statement No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," and
investments accounted for under the cost method. In September 2004, the FASB
delayed the accounting provisions of EITF Issue No 03-01; however the
disclosure requirements remain effective and were adopted by the Company as
of the year ended December 31, 2004. The Company will evaluate the effect, if
any, of EITF Issue No. 03-01 when final guidance is issued.
In November 2004, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 151, "Inventory Costs," which clarifies the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and
wasted material. Companies will no longer be permitted to capitalize
inventory costs on their balance sheets when the production defect rate
varies significantly from the expected rate as SFAS No. 151 requires that
those items be recognized as current-period charges regardless of whether
they meet the criterion of "so abnormal". It also makes clear that fixed
overhead should be allocated based on "normal capacity" of the production
facilities. SFAS No. 151 will be effective for inventory costs incurred
during fiscal years beginning after June 15, 2005, which is 2006 for calendar
year companies. The Company is currently evaluating the potential impacts, if
any, that the adoption of SFAS No. 151 may have on the Company's consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions.
SFAS 153 requires exchanges of productive assets to be accounted for at fair
value, rather than at carryover basis, unless (1) neither the asset received
nor the asset surrendered has a fair value that is determinable within
reasonable limits or (2) the transactions lack commercial substance. SFAS No.
153 is effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. We do not expect the adoption of this standard
to have a material effect on the Company's consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." SFAS
No. 123R is a revision of SFAS No. 123, and supersedes APB 25. Among other
items, SFAS No. 123R eliminates the use of APB 25 and the intrinsic value
method of accounting, and requires companies to recognize the cost of
employee services received in exchange for awards of equity instruments,
based on the fair value of those awards as of the grant date, in the
financial statements. As a result of the SEC's April 2005 deferral of the
effective date of SFAS No. 123R, the Company will be required to adopt SFAS No.
123R effective January 1, 2006., although early adoption is allowed. SFAS No.
123R permits companies to adopt its requirements using either a "modified
prospective" method, or a "modified retrospective" method. Under the "modified
prospective" method, compensation cost is recognized in the financial
statements beginning with the effective date, based on the requirements of
SFAS No. 123R for all share-based payments granted after that date, and based
on the requirements of SFAS No. 123 for all unvested awards granted prior to
the effective date of SFAS No. 123R. Under the "modified retrospective"
method, the requirements are the same as under the "modified prospective"
method, but also permits entities to restate financial statements of previous
periods based on proforma disclosures made in accordance with SFAS No. 123.
The Company currently utilizes a standard option pricing model (Black-
Scholes) to measure the fair value of stock options granted to employees.
While SFAS No. 123R permits entities to continue to use such a model, the
standard also permits the use of a "lattice" model. The Company has not yet
determined which model it will use to measure the fair value of employee
stock options upon the adoption of SFAS No. 123R.
The Company currently expects to adopt SFAS 123R in the quarter and year
beginning January 1, 2006; however, the Company has not yet determined which
of the aforementioned adoption methods it will use. Subject to a complete
review of the requirements of SFAS 123R, the Company expects that the
adoption of SFAS 123R may have a material adverse impact on its results of
operations.
8
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS
Short-term and long-term investments consist primarily of liquid debt
instruments and are classified as available-for-sale securities and are
stated at market value with unrealized gains and losses included in
shareholders' equity. Unrealized losses are charged against income when a
decline in the fair market value of an individual security is determined to
be other than temporary. Realized gains and losses on investments are
included in other income or expense. Investments purchased with remaining
maturity dates of greater than three months and less than 12 months are
classified as short-term. Investments purchased with remaining maturity dates
of 12 months or greater are classified either as short-term or as long-term
based on maturities and the Company's intent with regards to those securities
(expectations of sales and redemptions). A summary of investments at March
31, 2005 is as follows (in thousands):
Unrealized Unrealized
Amortized Market Holding Holding
Cost Value Gains Losses
---------- ---------- ---------- -----------
Short-term investments $ 29,511 $ 29,453 $ -- $ 58
Long-term investments $ 2,011 $ 1,981 $ -- $ 30
As of March 31, 2005, all investments with unrealized loss positions have been
in such positions for twelve months or less.
4. INVENTORIES
Inventories consist of the following (in thousands):
March 31, December 31,
2005 2004
---------- ----------
Finished goods $ 15,460 $ 15,912
Work in process 16,427 18,585
Raw materials 1,682 1,247
---------- ----------
$ 33,569 $ 35,744
========== ==========
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 March 31, 2005, and there
were $875,000 in standby letters of credit outstanding. In December 2004,
the expiration date of the revolving line of credit agreement was extended to
June 30, 2006. Borrowings under the revolving line of credit bear interest
rates of, at the Company's election, the prime rate (5.75% at March 31,
2005), or the bank's revolving offshore rate, which approximates LIBOR (3.1%
at March 31, 2005) plus 2.0%. The agreement contains certain restrictive
covenants that include a restriction on the declaration and payment of
dividends without the lender's consent. The Company was in compliance with
all such covenants at March 31, 2005.
Associated with the acquisition of BlueChip Communications, the Company has
$197,000 outstanding in term notes payable to the Norwegian Industrial and
Regional Development Fund.
9
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. SIGNIFICANT CUSTOMERS
During the three months ended March 31, 2005, three customers, an Asian
based OEM, a world wide distributor and an Asian based stocking
representative, accounted for $9.7 million (16%), $7.2 million (12%) and
$6.5 million (11%) of net revenues, respectively. During the three months
ended March 31, 2004, two customers, a world wide distributor and an Asian
based stocking representative, accounted for $10.2 million (17%) and $6.1
million (10%) of net revenues, respectively.
At March 31, 2005, three customers accounted for 17%, 13% and 12% of total
accounts receivable. As of March 31, 2004, one customer accounted for 11% of
net accounts receivable.
7. COMPREHENSIVE INCOME
Comprehensive income, which was comprised of the Company's net income for the
periods and changes in unrealized gains or losses on investments, was $6.6
million and $4.6 million for the three months ended March 31, 2005 and 2004,
respectively.
8. SEGMENT REPORTING
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for reporting information regarding operating segments in annual
financial statements and requires selected information for those segments to
be presented in interim financial reports issued to stockholders. Operating
segments are identified as components of an enterprise about which separate
discrete financial information is available for evaluation by the chief
operating decision maker. The Company has two reportable segments: standard
products and custom and foundry products. The chief operating decision maker
evaluates segment performance based on revenue. Accordingly, all expenses are
considered corporate level activities and are not allocated to segments.
Therefore, it is not practical to show profit or loss by reportable segments.
Also, the chief operating decision maker does not assign assets to these
segments. Consequently, it is not practical to show assets by reportable
segments.
Net Revenues by Segment
(dollars in thousands)
Three Months Ended
March 31,
-----------------------
2005 2004
---------- ----------
Net Revenues:
Standard Products $ 58,587 $ 58,634
Custom and Foundry Products 2,098 2,627
---------- ----------
Total net revenues $ 60,685 $ 61,261
========== ==========
As a Percentage of Total Net Revenues:
Standard Products 97% 96%
Custom and Foundry Products 3 4
---------- ----------
Total net revenues 100% 100%
========== ==========
10
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. After many years of
motions and appeals, a claim construction hearing (also called a "Markman"
hearing) was held before the District Court on December 16, 2003. The Court
issued its ruling on January 24, 2004, interpreting the claims at issue in
the litigation. Furthermore, the parties have attended three settlement
conferences before the District Court. A trial date has been set for
November 28, 2005. The Company intends to continue to defend itself against
the claims alleged in this litigation
On December 27, 2002, the Company filed a complaint against TRW, Inc.
("TRW") entitled Micrel, Incorporated v. TRW, Inc., dba TRW Automotive
Electronics Group, in the United States District Court, Northern District of
Ohio, Eastern Division, alleging various causes of action relating to breach
of a relationship surrounding the development of certain custom products by
Micrel for TRW. In this lawsuit, Micrel is alleging that TRW breached
various agreements to assist in Micrel's development of, and to purchase,
certain Application Specific Integrated Circuits. The complaint seeks
compensatory damages, attorneys' fees and costs of suit. On February 24,
2003, TRW filed an answer to the Company's complaint and a counterclaim
alleging various causes of action relating to breach of the above-mentioned
relationship concerning ASIC development. The Company intends to vigorously
defend itself against these counterclaims. The case is currently in the
pretrial phase. Case management and settlement conferences were conducted
with the Court on December 7, 2004 and February 17, 2005. A trial date has
been set for July 12, 2005.
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 and
pre-trial phase. A trial date has been set for September 19, 2005.
On November 11, 2004, the Company filed a complaint against Monolithic Power
Systems ("MPS"), entitled Micrel, Inc. v. Monolithic Power Systems, in the
United States District Court, Northern District of California (the "Court")
alleging two causes of action for infringement by MPS of certain patents
owned by Micrel. In the complaint, the Company alleges that MPS has been
and is infringing U.S. patent no. 5,517,046 (the " '046 patent") and U.S.
11
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
patent no. 5,556,796 (the " '796 patent"). Micrel alleges damages
attributable to MPS' infringement of the '046 and '796 patents as a direct
result of MPS' actions, including treble damages for wanton, deliberate,
malicious and willful conduct. Subsequently, on November 29, 2004 the
Company filed an amended complaint adding Michael R. Hsing, MPS' President
and Chief Executive Officer ("Hsing"), and James C. Moyer, MPS' Chief Design
Engineer ("Moyer") as defendants. Hsing and Moyer are both former employees
of Micrel. In addition to the original two causes of action against MPS for
infringement of the '046 and '796 Patents, the amended complaint adds causes
of action for statutory and common law misappropriation of Micrel's trade
secrets, breach of confidentiality agreements by Hsing and Moyer, and
violation of California's Unfair Competition Law. The amended complaint
seeks compensatory damages, costs of suit and such other relief that the
Court may deem proper. On December 16, 2004, MPS filed a Motion to Dismiss
the Company's claims for statutory and common law misappropriation of
Micrel's trade secrets. On April 8, 2005, the Court granted MPS' Motion to
Dismiss with leave to amend the complaint. On May 2, 2005, Micrel filed a
second amended complaint for patent infringement, misappropriation of trade
secrets, common law misappropriation, breach of confidentiality agreement,
and statutory unfair competition.
Based on the status to date of the above litigation, 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, and the Company believes it is not
reasonably possible that a material loss has been incurred. However,
litigation is subject to inherent uncertainties, and no assurance can be
given that the Company will prevail in these lawsuits. Accordingly, the
pending lawsuits, as well as potential future litigation with other
companies, could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
The semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights. To the extent that the
Company becomes involved in such intellectual property litigation, in
addition to litigation mentioned herein, it could result in substantial
costs and diversion of resources to the Company and could have a material
adverse effect on the Company's financial condition, results of operation or
cash flows.
In the event of an adverse ruling in any intellectual property litigation
that now exists or might arise in the future, the Company might be required
to discontinue the use of certain processes, cease the manufacture, use and
sale of infringing products, expend significant resources to develop non-
infringing technology or obtain licenses to the infringing technology.
There can be no assurance, however, that under such circumstances, a license
would be available under reasonable terms or at all. In the event of a
successful claim against the Company and the Company's failure to develop or
license substitute technology on commercially reasonable terms, the
Company's financial condition, results of operations, or cash flows could be
adversely affected. Based on the status of the litigation described above,
the Company does not believe that any material and specific risk exists
related to the loss of use of patents, products or processes.
Certain additional claims have been filed by or have arisen against the
Company in its normal course of business. The Company believes that these
claims and lawsuits will not have a material adverse effect on the Company's
financial condition, results of operation or cash flows.
10. STOCK REPURCHASE PROGRAM
In March 2005, Micrel's Board of Directors approved a $75 million share
repurchase program for calendar year 2005. Shares of common stock purchased
pursuant to the repurchase program are cancelled upon repurchase, and are
intended to offset dilution from the Company's stock option plans, employee
stock purchase plans and 401(k) plan. During the three months ended March
31, 2005, the Company repurchased 1,838,200 shares of its common stock for
$17.1 million.
12
MICREL, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11. INCOME TAXES
Deferred tax assets and liabilities result primarily from temporary
differences between book and tax bases of assets and liabilities, state and
federal research and development credit carryforwards and state
manufacturers credit carryforwards. The Company had net current deferred
tax assets of $25.7 million and net long-term deferred tax liabilities of
$272,000 as of March 31, 2005. The Company must regularly assess the
likelihood that future taxable income levels will be sufficient to ultimately
realize the tax benefits of these deferred tax assets. The Company currently
believes that future taxable income levels will be sufficient to realize the
tax benefits of these deferred tax assets and has not established a valuation
allowance. Should the Company determine that future realization of these
tax benefits is not likely, a valuation allowance would be established,
which would increase the Company's tax provision in the period of such
determination.
The calculation of the Company's tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. The Company
records liabilities for anticipated tax audit issues based on its estimate
of whether, and the extent to which, additional taxes may be due. Actual
tax liabilities may be different than the recorded estimates and could
result in an additional charge or benefit to the tax provision in the
period when the ultimate tax assessment is determined.
The income tax provision for the three months ended March 31, 2005 and 2004
is based on the Company's estimated annual effective tax rate of 35% and
37% of pretax income, respectively.
12. RESTRUCTURING AND MANUFACTURING FACILITY IMPAIRMENT
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 2004, the Company
increased its accrued restructuring expenses for contractual building lease
costs by $584,000 to eliminate remaining estimated future sub-lease income
as efforts to sub-lease the facility have been unsuccessful to date and the
estimated probability of future sub-lease has been reduced to less than
probable.
A summary of restructuring expense accrual is as follows: ($000)
Contractual
Facility Equipment
Costs Disposal Total
----------- --------- ---------
Balance December 31, 2003 $ 4,119 $ 411 $ 4,530
2004 Charges 584 -- 584
Uses (1,654) (51) (1,705)
--------- --------- ---------
Balance December 31, 2004 $ 3,049 $ 360 $ 3,409
2005 Charges -- -- --
Uses (410) -- (410)
--------- --------- ---------
Balance March 31, 2005 $ 2,639 $ 360 $ 2,999
========= ========= =========
Of the $3.0 million in accrued restructuring costs, $2.0 million has been
classified as other current liabilities and the remaining $1.0 million has
been classified as other long-term obligations as of March 31, 2005. These
restructuring costs are expected to be paid in cash over the remaining
facility lease term, which expires in October 2006. Actual future costs or
actual sublease income may be different than these estimates and could
require an adjustment to the restructuring accrual in the period such
determination is made.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934,as amended, including statements regarding the Company's expectations,
hopes, intentions or strategies regarding the future. Forward-looking
statements include, but are not limited to: statements regarding future
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. In some
cases, forward-looking statements can be identified by the use of forward-
looking terminology such as "believe," "estimate," "may," "can," "will,"
"intend," "objective," "plan," "expect" or "anticipate" or the negative of
these terms or other comparable terminology. All forward-looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward-looking statements. These statements are subject to risks and
uncertainties that could cause actual results and events to differ materially
from those expressed or implied by such forward-looking statements. Some of the
factors that could cause actual results to differ materially are set forth
below. Additional factors that may affect operating results are contained
within the Company's Form 10-K for the year ended December 31, 2004.
Micrel designs, develops, manufactures and markets a range of high-
performance analog power integrated circuits ("ICs"), mixed-signal and digital
ICs. These circuits are used in a wide variety of electronics products,
including those in the computer, telecommunications, industrial and networking
markets. In addition to standard products, the Company manufactures custom
analog and mixed-signal circuits and provides wafer foundry services.
The Company's 2004 revenues grew to the highest level since 2000, increasing
22 percent over 2003. The strength in customer order rates that began in the
second half of 2003 continued through most of the first half of 2004. The
increase in customer demand caused lead times for semiconductor components,
including Micrel's, to expand during the first and second quarters of 2004 as
customers and distributors became concerned about availability of supply. The
Company's revenues continued to grow in the first half of the year and gross
margin, operating margin and net income increased on a sequential basis in both
the first and second quarters. By the end of the second quarter, customers
began to perceive that the supply of semiconductor components was generally
sufficient and lead times for certain components began to shrink.
In the third and fourth quarter of 2004, demand was below normal seasonal
levels as customers reacted quickly to uncertain demand for their products,
decreasing semiconductor lead times and uncertain economic conditions by
reducing their order rates. Because of the lessons learned from the painful
excess inventory situation that occurred in 2001, the Company's customers
appear to be more sensitive to change in end demand for their products and
supplier lead times. Customers in certain end markets such as networking,
enterprise computing and high speed communications experienced lower demand for
their end products than they had anticipated. This factor, combined with
rapidly shrinking lead times from most semiconductor suppliers, led to lower
order rates for the Company's products in the second half of 2004 as customers
attempted to control their inventory levels. Semiconductor distributors also
reacted to decreasing lead times by reducing order rates. Inventories at the
Company's distributors, after increasing during the first half of 2004,
declined throughout the second half of the year and ending 2004 levels were
slightly higher than 2003 ending inventories. Inventory levels at the Company's
stocking representatives, after growing significantly during the first nine
months of 2004, remained flat during the fourth quarter of 2004 and ended 2004
with levels significantly higher than 2003 ending inventories. The proportion
of the Company's total sales to China, Taiwan and Southeast Asia, which are
primarily served by stocking representatives, continued to grow in 2004 due to
the continued shift in electronics manufacturing to China and Southeast Asia
from North America and Europe. The Company's level of on hand inventory
remained above prior year levels to provide a high level of customer service in
response to shorter customer lead times. As a result of lower order rates, the
Company's backlog and revenues declined in both the third and fourth quarter of
2004. At the end of 2004, lead times for the Company's products remained low,
at approximately two to three weeks, and visibility into customer demand was
poor.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Despite reduced revenues in the second half of 2004 the Company's gross
margin declined only slightly and operating margins remained above 10% in both
the third and fourth quarter. For the year, gross margin improved by over 8%
to 48%, operating margin increased to 16% in 2004 from 2% in 2003, and the
Company's net income per diluted share increased substantially to $0.34 in 2004
from $0.05 in 2003. Included in net income for 2004 were $6.3 million in
reversals of income and payroll tax liabilities associated with the conclusion
of a tax audit (see Note 8 of Notes to Consolidated Financial Statements). The
Company generated the second highest level of operating cash flow in the
Company's history in 2004 and repaid almost all of its outstanding debt during
the year. Operating cash flow less cash used for the purchase of property,
plant and equipment (commonly referred to as "free cash flow") was the highest
in the Company's history.
In the first quarter of 2005, demand as measured by order rates, improved
substantially over fourth quarter of 2004 levels. First quarter bookings
increased by 40% over fourth quarter 2004 levels. After a weak December,
average daily order rates increased at the beginning of January and remained
steady through the end of March. The improvement in order rates was driven by
customers serving the industrial, computing and communications end markets.
Orders from customers serving the wireless handset end market were slightly
less than fourth quarter levels, which is normal for the first calendar
quarter. Bookings from Micrel's major distributors increased in the first
quarter after falling sharply in the second half of 2004 as distributors
adjusted to shorter industry lead times and reduced their inventory levels.
Despite increased bookings during the first quarter and lean supply chain
inventory levels, order lead times from our customers continued to average two
to three weeks. This suggests that the Company's customers continue to believe
that there is sufficient capacity to meet demand on relatively short notice.
Although order backlog increased modestly in the first quarter, there continues
to be limited visibility into customer demand which makes it difficult to
accurately predict future revenue levels.
The increase in demand in the first quarter of 2005 resulted in an
increased level of orders booked and shipped during the quarter, known as
"turns fill". As a result of the increased demand, first quarter sales
increased sequentially by 2% after declining the previous two quarters, but
were 1% below the revenue from the year ago period. Despite relatively flat
revenues, the Company continued to improve gross margin. First quarter of 2005
gross margin of 50.1% was the highest quarterly gross margin for Micrel since
the first quarter of 2001. First quarter of 2005 gross margin improved by 376
basis points from the fourth quarter of 2004 and was more than 500 basis points
higher than the year ago period on approximately the same level of revenues.
Operating profit and net income in the first quarter of 2005 also increased
from both the first and fourth quarters of 2004.
In 2004, Micrel completed the acquisition of BlueChip Communications AS
("BlueChip") of Oslo, Norway. BlueChip is a fabless semiconductor company that
designs, develops and markets high performance RF ICs and modules for the
actuation and connectivity markets. The acquisition was accounted for as a
purchase under SFAS No. 141 "Business Combinations" and, accordingly, the
results of operations of BlueChip from the date of acquisition forward have
been included in the Company's consolidated financial statements. (see Note 13
of Notes to Condensed Consolidated Financial Statements).
The Company derives a substantial portion of its net revenues from standard
products. For the three month periods ended March 31, 2005 and 2004 the
Company's standard products sales accounted for 97% and 96%, of the Company's
net revenues, respectively. The Company believes that a substantial portion of
its net revenues in the future will depend upon standard products sales,
although such sales as a proportion of net revenues may vary as the Company
adjusts product output levels to correspond with varying economic conditions
and demand levels in the markets which it serves. The standard products
business is characterized by short-term orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without significant
penalty to the customer. Since most standard products backlog is cancelable
without significant penalty, the Company typically plans its production and
inventory levels based on internal forecasts of customer demand, which is
highly unpredictable and can fluctuate substantially. In addition, the Company
is limited in its ability to reduce costs quickly in response to any revenue
shortfalls.
The Company may experience significant fluctuations in its results of
operations. Factors that affect the Company's results of operations include
the volume and timing of orders received, changes in the mix of products sold,
the utilization level of manufacturing capacity, competitive pricing pressures
and the successful development of new products. These and other factors are
described in further detail later in this discussion. As a result of the
foregoing or other factors, there can be no assurance that the Company will not
experience material fluctuations in future operating results on a quarterly or
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
annual basis, which could materially and adversely affect the Company's
business, financial condition, results of operations or cash flows.
Critical Accounting Policies and Estimates
The financial statements included in this Form 10-Q and discussed within
this Management's Discussion and Analysis of Financial Condition and Results of
Operations have been prepared in accordance with accounting principles
generally accepted in the United States of America. Preparation of these
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. On an on-going basis, management evaluates its estimates
and judgments. Management bases its estimates and judgments on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The Company considers
certain accounting policies related to revenue recognition, inventory
valuation, income taxes, and litigation to be critical to the fair presentation
of its financial statements. For a detailed discussion of the Company's
significant accounting policies, see Note 1 of Notes to Consolidated Financial
Statements in Item 14 of the Company's Annual Report on Form 10 K for the year
ended December 31, 2004.
Revenue Recognition and Receivables. Micrel generates revenue by selling
products to original equipment manufacturers ("OEM"s), distributors and
stocking representatives. Stocking representative firms may buy and stock the
Company's products for resale or may act as the Company's sales representative
in arranging for direct sales from the Company to an OEM customer. The
Company's policy is to recognize revenue from sales to customers when the
rights and risks of ownership have passed to the customer, when persuasive
evidence of an arrangement exists, the product has been delivered, the price is
fixed or determinable and collection of the resulting receivable is reasonably
assured.
Micrel allows certain distributors, primarily located in North America and
Europe, and in certain countries in Asia, significant return rights, price
protection and pricing adjustments subsequent to the initial product shipment.
As these returns and price concessions have historically been significant, and
future returns and price concessions are difficult to reliably estimate, the
Company defers recognition of revenue and related cost of sales (in the balance
sheet line item "deferred income on shipments to distributors") derived from
sales to these distributors until they have resold the Company's products to
their customers. Although revenue recognition and related cost of sales are
deferred, the Company records an accounts receivable and relieves inventory at
the time of initial product shipment. As standard terms are FOB shipping
point, payment terms are enforced from shipment date and legal title and risk
of inventory loss passes to the distributor upon shipment. In addition, the
Company may offer to its distributors, where revenue is deferred upon shipment
and recognized on a sell-through basis, price adjustments to allow the
distributor to price the Company's products competitively for specific resale
opportunities. The Company estimates and records an allowance for distributor
price adjustments for which the specific resale transaction has been completed,
but the price adjustment claim has not yet been received and recorded by the
Company.
Sales to OEM customers and Asian based stocking representatives are
recognized upon shipment. The Company does not grant return rights, price
protection or pricing adjustments to OEM customers. The Company offers limited
contractual stock rotation rights to stocking representatives. In addition,
the Company is not contractually obligated to offer, but may infrequently
grant, price adjustments or price protection to certain stocking
representatives on an exception basis. At the time of shipment to OEMs and
stocking representatives, an allowance for returns and price adjustments is
established based upon historical return rates. Actual future returns and price
adjustments could be different than the allowance established.
The Company also maintains an allowance for doubtful accounts for estimated
uncollectible accounts receivable. This estimate is based on an analysis of
specific customer creditworthiness and historical bad debts experience. Actual
future uncollectible amounts could exceed the doubtful accounts allowance
established.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Inventory Valuation. Inventories are stated at the lower of cost (first-in,
first-out method) or market. The Company records adjustments to write down the
cost of obsolete and excess inventory to the estimated market value based on
historical and forecasted demand for its products. If actual future demand for
the Company's products is less than currently forecasted, additional inventory
adjustments may be required. Once a reserve is established, it is maintained
until the product to which it relates is sold or otherwise disposed of. This
treatment is in accordance with Accounting Research Bulletin 43 and SEC Staff
Accounting Bulletin 100 "Restructuring and Impairment Charges."
Income Taxes. Deferred tax assets and liabilities result primarily from
temporary timing differences between book and tax valuation of assets and
liabilities, state and federal research and development credit carryforwards
and state manufacturers credit carryforwards.
The Company must regularly assess the likelihood that future taxable income
levels will be sufficient to ultimately realize the tax benefits of these
deferred tax assets. As of March 31, 2005, the Company believes that future
taxable income levels will be sufficient to realize the tax benefits of these
deferred tax assets and has not established a valuation allowance. Should the
Company determine that future realization of these tax benefits is not likely,
a valuation allowance would be established, which would increase the Company's
tax provision in the period of such determination.
In addition, the calculation of the Company's tax liabilities involves
dealing with uncertainties in the application of complex tax regulations. The
Company records liabilities for anticipated tax audit issues based on its
estimate of whether, and the extent to which, additional taxes may be due.
Actual tax liabilities may be different than the recorded estimates and could
result in an additional charge or benefit to the tax provision in the period
when the ultimate tax assessment is determined.
Litigation. The semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. The
Company is currently involved in such intellectual property litigation (see
Note 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 reasonable 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
March 31,
-----------------------
2005 2004
---------- ----------
Net revenues 100.0% 100.0%
Cost of revenues 49.9 55.0
----- -----
Gross profit 50.1 45.0
----- -----
Operating expenses:
Research and development 18.9 17.2
Selling, general and administrative 15.4 14.5
Amortization of deferred stock compensation 0.4 1.0
Purchased in-process technology -- 0.8
----- -----
Total operating expenses 34.7 33.5
----- -----
Income from operations 15.4 11.5
Other income, net 1.4 0.4
----- -----
Income before income taxes 16.8 11.9
Provision for income taxes 5.9 4.4
----- -----
Net income 10.9% 7.5%
===== =====
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Net Revenues. For the three months ended March 31, 2005, net revenues
decreased 1% to $60.7 million from $61.3 million for the same period in the
prior year. This decrease was primarily due to decreased custom and foundry
products revenues.
Standard products revenues for the three months ended March 31, 2005, and
2004 were constant at $58.6 million, representing 97% and 96% of net revenues,
respectively.
Custom and foundry products revenues for the three months ended March 31,
2005, decreased 20% to $2.1 million from $2.6 million for the same period in
the prior year. The decrease resulted primarily from decreased unit shipments
of custom products.
Customer demand for semiconductors can change quickly and unexpectedly. The
Company's revenue levels have been highly dependent on the amount of new orders
that are received for which product is requested to be delivered to the
customer within the same quarter. Within the semiconductor industry these
orders that are booked and shipped within the quarter are called "turns fill"
orders. When the turns fill level exceeds approximately 35% of quarterly
revenue, it makes it very difficult to predict near term revenues and income.
Because of the long cycle time to build its products, the Company's lack of
visibility into demand when turns fill is high makes it difficult to predict
what product to build to match future demand.
As lead times and backlog increased during the first half of 2004 the
turns fill requirement declined to 35% by the second quarter. After
experiencing an increase in order rates and backlog in the first six months of
2004, order rates in the second half declined as customers quickly reduced new
orders in an attempt to control their inventories in response to uncertain
demand for their end products and declining supplier lead times. The Company's
lead times decreased during the fourth quarter to less than four weeks at the
end of December, compared with average lead times of seven to eight weeks
during the first half of 2004. This resulted in an increased turns fill
requirement in the fourth quarter to approximately 45%.
Although overall semiconductor industry channel inventories appear to be
equal to or below long term historical trends, customers perceive that
semiconductor components are readily available. Customers are cautious in
committing new orders, relying instead on short lead times and the willingness
of semiconductor manufacturers to hold inventory and react quickly to supply
their short term needs. As a result, order lead times from the Company's
customers remained in the two to three week range in the first quarter of 2005.
The short lead times combined with a sequential increase in customer order
rates continued to drive a high level of turns fill, which rose to 58% for the
first quarter of 2005. The higher overall level of orders in the first quarter
suggests that customers have reduced their inventories to a level where they
are now purchasing components at about the same rate at which they are
consuming them. The low backlog level, increased reliance on turns fill
orders, and the uncertain growth rate of the world economy make it difficult to
predict near term demand. Although the Company has reduced production levels
in response to lower order rates, the uncertainty in demand arising from these
factors, 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, its stocking representatives and distributors to continue to carry
higher levels of inventory.
International sales remained constant at 76% of net revenues for the three
months ended March 31, 2005 and 2004, respectively.
The trend for the Company's customers to move their electronics
manufacturing to Asian countries has brought increased pricing pressure for
Micrel and other semiconductor manufacturers. Asian based manufacturers are
typically more concerned about cost and less concerned about the capability of
the integrated circuits they purchase. This can make it more difficult for
United States based companies to differentiate themselves except by price. The
increased concentration of electronics procurement and manufacturing in the
Asia Pacific region has led, and may continue to lead, to continued price
pressure for the Company's products in the future.
Gross Profit. Gross profit is affected by a variety of factors including
the volume of product sales, product mix, manufacturing utilization, product
yields and average selling prices. The Company's gross margin increased to 50%
for the three months ended March 31, 2005 from 45% for the comparable period in
2004. These increases in gross margin resulted primarily from decreased
depreciation and other manufacturing cost reductions. Depreciation and
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
amortization (excluding amortization of deferred stock compensation) as a
percent of sales declined to 9% for the three months ended March 31, 2005 from
11% for the same period in 2004. This reduction in depreciation was primarily
due to existing equipment becoming fully depreciated, which was partially
offset by additional depreciation on new equipment purchases.
Research and Development Expenses. Research and development expenses as a
percentage of net revenues represented 19% and 17%, for the three months ended
March 31, 2005 and 2004, respectively. On a dollar basis, research and
development expenses increased $904,000 or 9% to $11.4 million for the three
months ended March 31, 2005 from $10.6 million for the comparable period in
2004. This increase was primarily due to increased prototype fabrication
costs. The Company believes that the development and introduction of new
products is critical to its future success and expects to continue its
investment in research and development activities in the future.
Selling, General and Administrative Expenses. As a percentage of net
revenues, selling, general and administrative expenses represented 15% and 14%
for the three months ended March 31, 2005 and 2004, respectively. On a dollar
basis, selling, general and administrative expenses increased $478,000 or 5% to
$9.3 million for the three months ended March 31, 2005 from $8.9 million for
the comparable period in 2004. This dollar increase was principally
attributable to increased profit sharing accruals, increased accounting and
auditing costs associated with implementation of the requirements of Section
404 of the Sarbanes-Oxley Act and increased outside legal costs.
Amortization of Deferred Stock Compensation. The Company accounts for
stock-based awards to employees using the intrinsic value method in accordance
with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees". During the years 1996 through December 2001, certain of
the Company's option pricing practices resulted in stock compensation expense
under APB 25. As of March 31, 2005 total unamortized stock compensation was
$817,000 with an anticipated remaining future amortization schedule of $521,000
in 2005 and $296,000 in 2006.
In December 2004, the Financial Accounting Standards Board ("FASB" or the
"Board") issued Statement of Accounting Standards ("SFAS") No. 123R, "Share-
Based Payment". SFAS No. 123R is a revision of SFAS No. 123, and supersedes APB
25 (see Note 2 of Notes to Condensed Consolidated Financial Statements for more
discussion of SFAS No. 123R).
Purchased in-process technology. Associated with the acquisition of
BlueChip, Micrel allocated $2.6 million of the total purchase cost to
intangible assets. Of that amount, $480,000 was expensed to purchased in-
process technology, which had not reached technological feasibility and had no
alternative future use, in the three months ended March 31, 2004. This amount
was adjusted and reversed in part as of December 31, 2004 to reflect the final
determination of conditional consideration that had previously been allocated
in part to purchased in-process technology.
Other Income, Net. Other income, net reflects interest income from
investments in short-term and long-term investment grade securities and money
market funds and other non-operating income, offset by interest expense
incurred on term notes. Other income, net increased $587,000 to $836,000 for
the three months ended March 31, 2005 from $249,000 for the comparable period
in 2004. The increase was primarily due to an increase in interest rates and
returns on investment balances and decreased interest expense resulting from a
decrease in average debt.
Provision for Income Taxes. The income tax provision for the three months
ended March 31, 2005 and 2004 represented 35% and 37% of pretax income,
respectively. The income tax provision for such interim periods reflects the
Company's estimated annual income tax rate and differs from taxes computed at
the federal statutory rate primarily due to the effect of state income taxes,
state research and development credits, federal extraterritorial income
exclusion and federal qualified production activity deductions.
Liquidity and Capital Resources
Since inception, the Company's principal sources of funding have been its
cash from operations, bank borrowings and sales of common stock. Principal
sources of liquidity at March 31, 2005, consisted of cash and short-term
investments of $143 million and a $5 million revolving line of credit from a
commercial bank (see Note 5 of Notes to Condensed Consolidated Financial
Statements).
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company generated $13.8 million in cash flows from operating activities
for the three months ended March 31, 2005, primarily attributable to net income
of $6.6 million plus additions for non-cash activities of $5.4 million and a
$2.2 million decrease in inventories, which was partially offset by a $2.6
million decrease in accounts payable.
For the three months ended March 31, 2004, the Company generated $15.1
million in cash flows from operating activities, primarily attributable to a
net income of $4.6 million plus additions for non-cash activities of $10.2
million combined with a $7.9 million increase in current liabilities, which was
partially offset by a $4.4 million increase in accounts receivables.
The Company generated $15.1 million of cash from investing activities
during the three months ended March 31, 2005 comprised of $17.0 million in
proceeds from the sales of short-term investments which was partially offset by
$1.9 million in purchases of property, plant and equipment.
For the three months ended March 31, 2004, the Company used $16.0 million in
cash for investing activities for the purchases of $7.0 million in short term
investments, $6.0 million in purchases of property, plant and equipment, $2.0
million for the purchase of BlueChip and $1.0 million for the purchase of
intangible assets.
The Company used $16.4 million of cash in financing activities during the
three months ended March 31, 2005 primarily for the repurchase of $17.1 million
of the Company's common stock, which was partially offset by $780,000 in
proceeds from employee stock transactions.
For the three months ended March 31, 2004, the Company used cash in
financing activities of $3.0 million which was primarily the result of the
repurchase of $4.2 million of the Company's common stock, which was partially
offset by $1.4 million in proceeds from employee stock transactions.
The Company currently intends to spend approximately $12 million to $18
million to purchase capital equipment and make facility improvements during the
next twelve months primarily for manufacturing equipment for wafer fabrication
and product testing and additional research and development related software
and equipment. In March 2005, the Company announced that its Board of Directors
had approved a $75 million stock repurchase program and the Company is
currently authorized by its Board of Directors to repurchase an additional
$57.9 million of its common stock through December 31, 2005. Since inception,
the Company's principal sources of funding have been its cash from operations,
bank borrowings and sales of common stock. The Company believes that its cash
from operations, existing cash balances and short-term investments, and its
credit facility will be sufficient to meet its cash requirements for 2005. In
the longer term, the Company believes future cash requirements will continue to
be met by its cash from operations, credit arrangements and future debt or
equity financings as required.
Recently Issued Accounting Standards
Please refer to Note 2 of Notes to Condensed Consolidated Financial
Statements for a discussion of the expected impact of recently issued
accounting standards.
Contractual Obligations and Commitments
The Company's contractual obligations disclosure in its Annual Report on
Form 10-K for the year ended December 31, 2004 has not materially changed since
that report was filed. During the three months ended March 31, 2005 payments
of $801,000 were made under previously existing operating leases and repayments
of $50,000 were made under previously existing long-term debt agreements. Open
purchase orders were approximately $26 million and are primarily due within one
year. These obligations primarily relate to future purchases of production
equipment, wafer fabrication raw materials, foundry wafers, assembly and
testing services, insurance services and advertising services.
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
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
behalf of the Company. The value of all letters of credit outstanding reduces
the total line of credit available. There were no borrowings under the
revolving line of credit at March 31, 2005 and there were $875,000 in standby
letters of credit outstanding. The letters of credit are issued to guarantee
payments for the Company's workers compensation program.
The Company has no other off-balance sheet arrangements and has not entered
into any transactions involving unconsolidated, limited purpose entities or
commodity contracts.
Factors That May Affect Operating Results
If a company's operating results are below the expectations of public
market analysts or investors, then the market price of its common stock could
decline. Many factors that can affect a company's quarterly and annual results
are difficult to control or predict. Some of the factors which can affect a
multinational semiconductor business such as the Company are described below.
Additional factors that may affect the Company and its operating results are
contained within the Company's Form 10-K for the year ended December 31, 2004.
Geopolitical and Macroeconomic Risks That May Affect Multinational Enterprises
- -------------------------------------------------------------------------------
Demand for semiconductor components is increasingly dependent upon the rate
of growth of the global economy. If the rate of global economic growth slows,
or contracts, customer demand for products could be adversely affected, which
in turn could negatively affect revenues, results of operations and financial
condition. Many factors could adversely affect regional or global economic
growth. Some of the factors that could slow global economic growth include:
rising interest rates in the United States, increased price inflation for
goods, services or materials, a slowdown in the rate of growth of the Chinese
economy, a significant act of terrorism which disrupts global trade or consumer
confidence, geopolitical tensions including war and civil unrest. Reduced
levels of economic activity, or disruptions of international transportation,
could adversely affect sales on either a global basis or in specific geographic
regions. Recent economic trends include slower economic growth in first
quarter 2005 U.S. gross domestic product, rising interest rates and higher
energy prices. As a result of these unfavorable economic trends, the Company
has lowered its growth estimates for 2005 global semiconductor shipments to an
increase of 8% to 10% from its previous projection of 12% to 15% growth.
The Company has generated a substantial portion of its net revenues from
export sales. The Company believes that a substantial portion of its future net
revenues will depend on export sales to customers in international markets,
including Asia. In 2004 and the first quarter of 2005, 66% of the Company's
revenues were derived from shipments to customers in Asia, an increase from 32%
in 2000 and 60% in 2003. International markets are subject to a variety of
risks, including changes in policy by the U.S. or foreign governments, acts of
terrorism, foreign government instability, social conditions such as civil
unrest, economic conditions including high levels of inflation, fluctuation in
the value of foreign currencies and currency exchange rates and trade
restrictions or prohibitions. Changes in exchange rates that strengthen the
U.S. dollar could increase the price of the Company's products in the local
currencies of the foreign markets it serves. This would result in making the
Company's products relatively more expensive than its competitors' products
that are denominated in local currencies, leading to a reduction in sales or
profitability in those foreign markets. The Company has not taken any
protective measures against exchange rate fluctuations, such as purchasing
hedging instruments. In addition, the Company sells to domestic customers that
do business worldwide and cannot predict how the businesses of these customers
may be affected by economic or political conditions elsewhere in the world.
Such factors could adversely affect the Company's future revenues, financial
condition, results of operations or cash flows.
The Company is reliant on certain key suppliers for wafer fabrication,
circuit assembly and testing services. Most of these suppliers are based
outside of the U.S. The Company's supply could be interrupted as a result of
any of the previously mentioned risk factors relating to international markets.
Market conditions may lead the Company to initiate additional cost reduction
plans, which may negatively affect near term operating results. Weak customer
demand, competitive pricing pressures, excess capacity, weak economic
conditions or other factors, may cause the Company to initiate additional
actions to reduce the Company's cost structure and improve the Company's future
operating results. The cost reduction actions may require incremental costs to
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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). 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. During 2004, some of the Company's stocking
representatives and distributors 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.
During a period when economic growth and customer demand have been less
certain, both the semiconductor industry and the Company have experienced
significant price erosion since the beginning of 2001. If price erosion
continues, it will have the effect of reducing revenue levels and gross margins
in future periods. Furthermore, the trend for the Company's customers to move
their electronics manufacturing to Asian countries has brought increased
pricing pressure for Micrel and the semiconductor industry. Asian based
manufacturers are typically more concerned about cost and less concerned about
the capability of the integrated circuits they purchase. The increased
concentration of electronics procurement and manufacturing in the Asia Pacific
region may lead to continued price pressure and additional product advertising
costs for the Company's products in the future.
An important part of the Company's strategy is to continue to focus on the
market for high-speed communications ICs. If the recovery in the
telecommunications infrastructure and wire line networking markets is not
sustainable, resulting in reduced demand for the Company's high bandwidth
products, the Company's future revenue growth and profitability could be
adversely affected.
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.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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.
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.
Compliance with corporate governance regulations such as the Sarbanes-Oxley
Act, which requires the Company's management to conduct an evaluation of the
effectiveness of its internal control over financial reporting, has increased
the Company's costs. Compliance with Section 404 of the Sarbanes-Oxley Act and
other recent corporate governance and internal control regulations resulted in
a tripling of audit and accounting fees in 2004 as well as increased costs for
internal auditing and third party consultants. The increased expense in 2004
associated with this compliance effort was approximately $1 million, reducing
net income per diluted share by approximately $0.01. Although the Company
expects the cost of compliance to decrease in 2005, the cost will remain
significantly above years prior to 2004 and new regulations, or changes to
existing regulations, could cause expenses to be higher than anticipated in the
future.
The success of companies in the semiconductor industry depends in part upon
intellectual property, including patents, trade secrets, know-how and
continuing technology innovation. There can be no assurance that the steps
taken by the Company to protect its intellectual property will be adequate to
prevent misappropriation or that others will not develop competitive
technologies or products. There can be no assurance that any patent owned by
the Company will not be invalidated, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages or that any of
its pending or future patent applications will be issued with the scope of the
claims sought, if at all. Furthermore, there can be no assurance that others
will not develop technologies that are similar or superior to the Company's
technology, duplicate technology or design around the patents owned by the
Company. Additionally, the semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property rights. There can
be no assurance that existing claims or any other assertions or claims for
indemnity resulting from infringement claims will not adversely affect the
Company's business, financial condition, results of operations, or cash flows.
The recently issued Statement of Accounting Standards ("SFAS") No. 123R,
"Share-Based Payment" will require the Company to recognize the cost of
employee services received in exchange for awards of equity instruments, based
on the grant date fair value of those awards, in the financial statements. As
discussed in Note 1 of Notes to Consolidated Financial Statements, the ultimate
impact from the adoption of this accounting standard is uncertain but it is
expected to significantly increase stock based compensation expense in future
periods after adoption. The pro forma effect to net income and earnings per
share had the Company applied the fair value method to stock-based awards has
been disclosed in the Company's previous Form 10-K filings and is contained in
Note 1 of the Notes to Condensed Consolidated Financial Statements of this Form
10-Q. However, a reduction in net income and earnings per share from the
expensing of stock option awards in the Company's future results of operation
may have an adverse affect on the value of the Company's common stock. If the
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Company reduces the number of stock option grants to employees to minimize the
cost associated with share based incentive awards, it will most likely make it
more difficult for the Company to hire and retain employees.
Our customers are requiring that the Company offer its products in lead-free
packages. Governmental regulations in certain countries and our customers'
intention to produce products that are less harmful to the environment has
resulted in a requirement from many of the Company's customers to purchase
integrated circuits that do not contain lead. The Company has responded by
offering its products in lead-free versions. While the lead-free versions of
the Company's products are expected to be more friendly to the environment, the
ultimate impact is uncertain. The transition to lead-free products may produce
sudden changes in demand depending on the packaging method used, which may
result in excess inventory of products packaged using traditional methods.
This may have an adverse affect on the Company's results of operations. In
addition, the quality, cost and manufacturing yields of the lead free products
may be less favorable compared to the products packaged using more traditional
materials which may result in higher costs to the Company.
Companies in the semiconductor industry are subject to a variety of federal,
state and local governmental regulations related to the use, storage, discharge
and disposal of toxic, volatile or otherwise hazardous chemicals used in its
manufacturing process. Any failure to comply with present or future
regulations could result in the imposition of fines, the suspension of
production, alteration of manufacturing processes or a cessation of operations.
In addition, these regulations could restrict the Company's ability to expand
its facilities at their present locations or construct or operate a new wafer
fabrication facility or could require the Company to acquire costly equipment
or incur other significant expenses to comply with environmental regulations or
clean up prior discharges. The Company's failure to appropriately control the
use of, disposal or storage of, or adequately restrict the discharge of,
hazardous substances could subject it to future liabilities and could have a
material adverse effect on its business.
Company-Specific Risks
- ----------------------
In addition to the risks that affect multinational semiconductor companies
listed above, there are additional risks which are more specific to the Company
such as:
The Company's gross margin, operating margin and net income are highly
dependent on the level of revenue and capacity utilization that the Company
experiences. Semiconductor manufacturing is a capital-intensive business
resulting in high fixed costs. If the Company is unable to utilize its
installed wafer fabrication or test capacity at a high level, the costs
associated with these facilities and equipment would not be fully absorbed,
resulting in higher average unit costs and lower profit margins.
The cellular telephone (wireless handset) market comprises a significant
portion of the Company's standard product revenues. The proportion of the
Company's annual revenues from customers serving the cellular telephone market
has been increasing over the last three years, growing from less than 20% of
worldwide sales in 2001 to approximately 25% in 2004 and the first quarter of
2005. Due to the highly competitive and fast changing environment in which the
Company's cellular telephone customers operate, demand for the product the
Company sells into this end market can change rapidly and unexpectedly. If the
Company's cellular telephone customers lose market share, or accumulate too
much inventory of completed handsets, the demand for the Company's products can
decline sharply which could adversely affect the Company's revenues and results
of operations.
The Company derives a significant portion of its revenues from customers
located in certain geographic regions or countries. A significant portion of
the Company's revenues come from customers located in South Korea. In the event
that political tensions surrounding North Korea evolve into military or social
conflict, or other factors disrupt the Korean economy, the Company's revenues,
results of operations, cash flow and financial condition could be adversely
affected. A significant portion of the Company's revenues come from customers
located in Taiwan and China. In the event that economic activity in these two
countries declines, or is disrupted by geopolitical events, the Company's
revenues and results of operations could be adversely affected.
The Company manufactures most of its semiconductors at its San Jose,
California fabrication facilities. The Company's existing wafer fabrication
facility, located in Northern California, may be subject to natural disasters
such as earthquakes. A significant natural disaster, such as an earthquake or
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
prolonged drought, could have a material adverse impact on the Company's
business, financial condition and operating results. Furthermore,
manufacturing semiconductors requires manufacturing tools that are unique to
each product being produced. If one of these unique manufacturing tools was
damaged or destroyed, the Company's ability to manufacture the related product
would be impaired and its business would suffer until the tool was repaired or
replaced. Additionally, the fabrication of ICs is a highly complex and precise
process. Small impurities, contaminants in the manufacturing environment,
difficulties in the fabrication process, defects in the masks used to print
circuits on a wafer, manufacturing equipment failures, wafer breakage or other
factors can cause a substantial percentage of wafers to be rejected or numerous
die on each wafer to be nonfunctional. The Company maintains approximately two
to three months of inventory that has completed the wafer fabrication
manufacturing process. This inventory is generally located offshore at third
party subcontractors and can act to buffer some of the adverse impact from a
disruption to the Company's San Jose wafer fabrication activity arising from a
natural disaster such as an earthquake.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At March 31, 2005, the Company held $29.5 million in short-term investments
and $2.0 million in long-term investments. Short-term and long-term investments
consist primarily of liquid debt instruments and are classified as available-
for-sale securities. Investments purchased with remaining maturity dates of
greater than three months and less than 12 months are classified as short-term.
Investments purchased with remaining maturity dates of 12 months or greater are
classified as either as short-term or long-term based on maturities and the
Company's intent with regards to those securities (expectations of sales and
redemptions). These available-for-sale securities are subject to interest rate
risk and will fall in value if market interest rates increase. If market
interest rates were to increase immediately and uniformly by 10 percent from
levels at March 31, 2005, the fair value of the short-term investments would
decline by an immaterial amount. The Company generally expects to have the
ability to hold its fixed income investments until maturity and therefore
would not expect operating results or cash flows to be affected to any
significant degree by the effect of a sudden change in market interest rates on
short-term investments.
At March 31, 2005, the Company held no fixed-rate long-term debt subject to
interest rate risk.
ITEM 4: CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's reports
under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission, and that such information is accumulated
and communicated to the Company's management, including its chief executive
officer and chief financial officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As required by Securities and Exchange Commission Rule 13a-15(b), the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
the end of the period covered by this report. Based on the foregoing, the
Company's chief executive officer and chief financial officer have concluded
that the Company's disclosure controls and procedures are effective at the
reasonable assurance level at March 31, 2005.
There has been no change in the Company's internal control over financial
reporting during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information included in Note 9 of Notes to Condensed Consolidated Financial
Statements under the caption "Litigation and Other Contingencies" in Item 1 of
Part I is incorporated herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Dividend Payment Restrictions
The Company has entered into borrowing agreements that contain restrictions on
the declaration and payment of dividends without the lender's consent. In
addition, the Company currently intends to retain future earnings to fund
operations, and does not anticipate paying dividends on its common stock in the
foreseeable future.
Issuer Purchases of Equity Securities
Maximum Dollar
Total Number of Value of Shares
Total Shares Purchased that May Yet be
Number Average as Part of Repurchased Under
of Shares Price Paid Publicly Announced the Plans or
Period Purchased Per Share Plans or Programs Programs ($000)
- ----------------- --------- ---------- ------------------ -----------------
January 2005 478,500 $ 9.19 478,500 $ 31,216
February 2005 415,800 $ 8.85 415,800 $ 27,535
March 2005 943,900 $ 9.61 943,900 $ 57,852
--------- ---------
Total 1,838,200 $ 9.33 1,838,200
In February 2002, the Company's Board of Directors approved a plan to
repurchase shares of the Company's common stock in the open market. Shares of
common stock purchased pursuant to the repurchase program are cancelled upon
repurchase, and are intended to offset dilution from the Company's stock option
plans, employee stock purchase plans and 401(k) plan. In August 2004, the
Board of Directors amended the repurchase program and authorized the repurchase
of common stock up to a maximum value of $75 million during the period from
January 1, 2004 through June 30, 2005. In March 2005, the Board of Directors
approved a $75 million share repurchase program for calendar year 2005. This
action supercedes the Company's previously approved authorization to repurchase
Micrel common stock announced in August, 2004.
ITEM 6. EXHIBITS
Exhibit No. Description
----------- -----------
31 Certifications of the Company's Chief Executive Officer
and Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certifications of the Company's Chief Executive Officer
and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICREL, INCORPORATED
--------------------
(Registrant)
Date: May 9, 2005 By /s/ Richard D. Crowley, Jr.
------------------------------
Richard D. Crowley, Jr.
Vice President, Finance and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
27