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| MCRL > SEC Filings for MCRL > Form 10-Q on 7-Aug-2009 | All Recent SEC Filings |
7-Aug-2009
Quarterly Report
Overview
The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding the Company's expectations, hopes, intentions or strategies regarding the future. Forward-looking statements include, but are not limited to statements regarding: future revenues and dependence on standard products sales and international sales; the levels of international sales; the effect of global market conditions on revenue levels, profitability and results of operations: future products or product development; statements regarding fluctuations in the Company's results of operations; future returns and price adjustments and allowance; future uncollectible amounts and doubtful accounts allowance; future products or product development; future research and development spending and the Company's product development strategy; the Company's markets, product features and performance; product demand and inventory to service such demand; competitive threats and pricing pressure; the effect of dependence on third parties; the Company's future use and protection of its intellectual property; future expansion or utilization of manufacturing capacity; future expenditures; current or future acquisitions; the ability to meet anticipated short term and long term cash requirements; effect of changes in market interest rates on investments; the Company's need and ability to attract and retain certain personnel; the cost and outcome of litigation and its effect on the Company; the future realization of tax benefits; and share based incentive awards and expectations regarding future stock based compensation expense and estimates made under SFAS No. 123R. In some cases, forward-looking statements can be identified by the use of forward-looking terminology such as "believe," "estimate," "may," "can," "will," "could," "would," "intend," "objective," "plan," "expect," "likely," "potential," "possible" or "anticipate" or the negative of these terms or other comparable terminology. All forward-looking statements included in this document are based on information available to the Company on the date of this report, and the Company assumes no obligation to update any such forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those expressed or implied by such forward-looking statements. Additional factors that may affect operating results are contained within the Company's Form 10-K for the year ended December 31, 2008.
Micrel designs, develops, manufactures and markets a range of high-performance analog power integrated circuits ("ICs"), mixed-signal and digital ICs. The Company currently ships over 3000 standard products and has derived the majority of its product revenue from sales of standard analog and high speed communications ICs. These products address a wide range of end markets including cellular handsets, portable computing, enterprise and home networking, wide area and metropolitan area networks, digital televisions and industrial equipment. The Company also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers who produce electronic systems for communications, consumer and military applications.
To enhance the readers' understanding of the Company's performance, the following chronological overview of the Company's results for the quarterly periods from January 1, 2008 through June 30, 2009 has been provided.
In the first quarter of 2008, bookings levels rebounded from the fourth quarter of 2007, resulting in the highest quarterly booking level since Q1 2006 and a book-to-bill ratio significantly above one. First quarter revenues of $66.1 million increased 2% sequentially compared to fourth quarter 2007 revenues of $64.6 million. The increase in revenues was primarily due to stronger demand from the wire line communications, digital television, industrial and voice-over-IP end markets, which offset seasonal declines in sales to the computing and wireless handset end markets. Revenues through Micrel's sell-through distributors increased in the first quarter of 2008 and the number of weeks of distribution channel inventory decreased slightly on a sequential basis. Gross margin improved to 56.3% in the first quarter of 2008 from 55.7% in the fourth quarter of 2007 while at the same time inventory levels were reduced. First quarter 2008 operating profit was $11.6 million, or 18% of revenues. Earnings per diluted share for the first quarter of 2008 increased to $0.12 per share from $0.11 per share reported in the fourth quarter of 2007.
During the first quarter of 2008, the Company became engaged in its first proxy contest since going public in 1994, with a small activist hedge fund, Obrem Capital Management LLC ("OCM"). This issue resulted in Micrel incurring incremental operating expenses on this matter of $331,000 in the first quarter, $2.4 million in the second quarter, $349,000 in the third quarter and $1.1 million in the fourth quarter of 2008. See "Management Discussions and Analysis of Financial Conditions and Results of Operations - Proxy Contest Expense" for additional information.
In the second quarter of 2008, total bookings remained firm, resulting in a book-to-bill ratio above one. Second quarter 2008 bookings were paced by demand from customers serving the communications, industrial, and wireless handset end markets. Customers remained very cautious, which continued to keep order lead times in the 4 to 5 week range. In the second quarter of 2008, Micrel posted its highest sequential revenue growth rate in four years. Second quarter 2008 revenues of $70.6 million came in at the high end of the Company's guidance, increasing by $4.5 million, or 7%, from the first quarter of 2008. The growth in revenues was led by stronger demand from customers serving the wireline communications, wireless handset, and wi-fi voice-over-IP end markets, combined with record sales through the Company's global sell-through distributors. The turns fill percentage for the second quarter of 2008 was slightly above 50%. Gross margin was 56.4%, which was similar to gross margin in the first quarter of 2008. Second quarter 2008 operating profit was $11.1 million, or 16% of sales. A total of $2.4 million of proxy contest expenses reduced Micrel's operating income by approximately 18% in the second quarter of 2008, and also had the effect of reducing operating margin by approximately 3% in the second quarter of 2008. Second quarter 2008 net income was $7.4 million, or $0.10 per diluted share. Expenses related to the Company's proxy contest reduced net income by $0.02 per share in the second quarter of 2008.
Financial markets in the United States, Europe and Asia experienced extreme disruption in the second half 2008, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, ratings downgrades of certain investments and declining valuations of others. In the third quarter of 2008, concerns related to the deterioration in the global financial and credit markets, including with respect to the availability and cost of credit, contributed to instability in worldwide capital and credit markets and diminished expectations for the U.S. and global economy. These conditions worsened in the fourth quarter of 2008, and combined with uncertainty about the global economy in general, contributed to volatility of unprecedented levels and a further economic slowdown. Although governments have taken unprecedented actions in an attempt to alleviate the credit crisis, customers and consumers began to cut back on spending in order to conserve cash in the third quarter of 2008. This resulted in the slowing of orders from Micrel's distributors and direct OEM customers, which continued into the fourth quarter of 2008.
During the third quarter of 2008, total bookings were less than revenues, resulting in a book-to-bill ratio of less than one. Third quarter 2008 bookings decreased abruptly in the last two weeks of the quarter. Notwithstanding the order decrease, resales of the Company's products from global sell-through distributors remained strong throughout the quarter and were at the highest levels ever experienced by the Company. In the third quarter of 2008, Micrel posted $67.5 million in revenue, a decrease of 4% from the second quarter of 2008. The sequential quarter decrease in sales primarily resulted from reduced demand from customers serving the wireline communications, Wi-FI voice-over IP and foundry sales to a major solar end customer. This was offset by slight increases in the computer and consumer markets. The OEM turns fill percentage for the third quarter of 2008 was approximately 50%. Third quarter gross margin was 55.3%, down 1.1% from 56.4% in the second quarter of 2008. Research and development spending was $13.8 million, or 20% of revenues in the third quarter of 2008 compared to $14.8 million or 21% of revenues in the second quarter of 2008. Selling, general and administrative expenses were $11.3 million, or 17% of sales, down from $11.6 million in the second quarter of 2008. Operating income was $11.9 million, or 18% of sales. This compares to operating income of $11.1 million in the second quarter of 2008. Other income, net was unchanged quarter to quarter at $700,000. The effective tax rate was 38.9% for the third quarter. Third quarter 2008 net income was $7.7 million, or $0.11 per diluted share.
Fourth quarter 2008 revenue of $55.2 million decreased by $12.4 million, or 18%, from $67.5 million in the third quarter of 2008. The decrease in revenues was due to tight year-end inventory control in most geographies, channels and end markets as a result of the worldwide financial crisis. The worldwide macroeconomic recession in the fourth quarter caused the Company's customers to focus on maintaining lean inventories. The Company's global distributors and a number of major OEM customers took action to minimize inventories at year-end. As a consequence, customer orders and purchases declined in November and December after strong activity in October. For the fourth quarter 2008, Micrel's overall book-to-bill ratio was below one. Order lead times from the Company's customers remained relatively short at from three to six weeks during the quarter.
Fourth quarter 2008 gross margin was 52.0%, compared to 55.3% in the third quarter of 2008. The decrease in gross margin was the result of factory underutilization and additional inventory reserves due to a lower sales forecast. Fourth quarter 2008 net income was $4.9 million, or $0.07 per diluted share.
For the year ended December 31, 2008, Micrel's financial performance continued to be strong, especially in light of the current economic conditions. 2008 revenues of $259.4 million were up slightly, compared with $258.0 million in 2007. Net income for 2008 was $28.3 million, or $0.40 per diluted share, compared with net income of $44.1 million, or $0.57 per diluted share in 2007. 2007 net income included a $15.5 million pre-tax gain associated with a first quarter legal settlement, which after income taxes, is equivalent to $0.12 per diluted share. Gross margins for 2008 were 55.1% compared to 56.9% in 2007. The Company's design efforts resulted in a record number of new product releases in 2008. Solid cash flows from operations of $53.3 million during the year enabled the repurchase of 7.1 million shares of common stock, or approximately 9.6% of the shares outstanding at the beginning of 2008. In addition, during the year ended December 31, 2008, the Company paid cash dividends of $9.5 million.
The worldwide macroeconomic recession continued to impact demand in the first quarter of 2009 and the Company's customers continued to maintain lean inventory levels. Despite the difficult environment, first quarter bookings increased significantly over fourth quarter levels and resulted in a book to bill ratio above one for both the OEM and distribution sales channels. Micrel's financial performance for the first quarter of 2009 was solid and results were within the expected guidance ranges for the key metrics of revenues and net income. The Company's first quarter revenues were $47.0 million, compared to $55.2 million in the fourth quarter of 2008. First quarter gross margin was 50.3%, compared to 52% in the prior quarter. The decrease in gross margin was primarily the result of factory capacity under-utilization as Micrel continued to control its inventory levels. First quarter 2009 net income was $1.5 million, or $0.02 per diluted share as compared to fourth quarter 2008 net income of $4.9 million, or $0.07 per diluted share. In addition to solid first quarter 2009 financial results, the Company continued to enhance shareholder value by maintaining its quarterly three and one-half cent per share dividend and repurchasing 1.9 million shares under its stock repurchase plan.
Despite the continuing weak economic environment, the second quarter of 2009 was an exceptional quarter for Micrel. The Company experienced strong growth of both revenues and net income. Bookings were solid which resulted in a book-to-bill ratio above one. Second quarter revenues exceeded management's expectations and grew on a sequential quarter basis for the first time in four quarters. The Company saw strength in all major segments of its business with primary growth coming from markets in China. In particular, the build out of China's 3G infrastructure was an important driver for the Company's revenue growth in the second quarter of 2009. However, the Company's management believes that the general worldwide economic slowdown is continuing to have an impact on the overall market for semiconductors, and believes that restocking due to the lower inventories coming out of the first quarter of 2009 represented about one third of the sequential growth for the quarter. Management is pleased with the Company's operating performance during the second quarter of 2009. Revenues increased to $51.8 million in the second quarter of 2009, compared to $47.0 million in the first quarter of 2009. Second quarter 2009 operating expenses were down by 4% sequentially. Second quarter 2009 net income of $3.9 million was more than double the net income of $1.5 million reported for the first quarter of 2009. In addition to the good financial performance, the Company continued to enhance shareholder value with its stock buy-back program. Average shares outstanding in the second quarter of 2009 decreased by 4% compared to the first quarter of 2009. In addition, the Company also maintained its quarterly three and one-half cent per share dividend payment.
The Company derives a substantial portion of its net revenues from standard products. For each of the three and six month periods ended June 30, 2009 the Company's standard products sales accounted for 97% of the Company's net revenues as compared to 95% and 94%, respectively, of net revenues for the comparable periods in 2008. 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 and in Item 1A. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect the Company's business, financial condition, results of operations or cash flows.
Revision of Prior Period Financial Statements
During the fourth quarter of 2008, the Company identified an error related to its calculation of deferred income on shipments to distributors ("deferred income"). Upon review of its calculations, management determined that the estimated shipping margin percentage used to calculate the deferred income balance was incorrect and this resulted in an understatement of deferred income and related cost of sales. The Company assessed the materiality of this error on prior periods financial statements in accordance with the SEC's Staff Accounting Bulletin No. 99 ("SAB 99"), and concluded that the error was not material to any prior annual or interim periods but would be material to the three and twelve months periods ended December 31, 2008 if the entire correction was recorded in those periods. In accordance with the SEC's Staff Accounting Bulletin No. 108 ("SAB 108"), the 2006, and 2007 and first three quarters of 2008 financial statements have been revised to correct for the immaterial error. In addition, in the financial statements included in the Company's Annual Report on Form 10-K an adjustment was also recorded to reduce the beginning retained earnings at January 1, 2006 for the cumulative impact of this error on prior periods. The revision had no net impact on the Company's Consolidated Statement of Cash Flows. See Note 2 of Notes to Condensed Consolidated Financial Statements for discussion of the impact of the revisions on the 2008 interim results included in this Form 10-Q.
Critical Accounting Policies and Estimates
The financial statements included in this Quarterly Report on 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 and valuation of receivables, inventory valuation, share-based compensation, income taxes, and litigation to be critical to the fair presentation of its financial statements. For a detailed discussion of the Company's significant accounting policies, see Note 1 of Notes to Consolidated Financial Statements in Item 8 of the Company's Annual Report on Form 10-K for the year ended December 31, 2008.
Revenue Recognition and Receivables. Micrel generates revenue by selling products to 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 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 and related cost of sales are not recognized, the Company records an accounts receivable and relieves inventory at the time of initial product shipment. As standard terms are FOB shipping point, payment terms are enforced from shipment date and legal title and risk of inventory loss passes to the distributor upon shipment. In addition, where revenue is deferred upon shipment and recognized on a sell-through basis, the Company may offer price adjustments to its distributors to allow the distributor to price the Company's products competitively for specific resale opportunities. The Company estimates and records an allowance for distributor price adjustments for which the specific resale transaction has been completed, but the price adjustment claim has not yet been received and recorded by the Company.
Sales to OEM customers and stocking representatives are recognized based upon the shipment terms of the sale transaction when all other revenue recognition criteria have been met. The Company does not grant return rights, price protection or pricing adjustments to OEM customers. The Company offers limited contractual stock rotation rights to stocking representatives. In addition, the Company is not contractually obligated to offer, but may infrequently grant, price adjustments or price protection to certain stocking representatives on an exception basis. At the time of shipment to OEMs and stocking representatives, an allowance for returns is established based upon historical return rates, and an allowance for price adjustments is established based on an estimate of price adjustments to be granted. Actual future returns and price adjustments could be different than the allowance established.
The Company also maintains an allowance for doubtful accounts for estimated uncollectible accounts receivable. This estimate is based on an analysis of specific customer creditworthiness and historical bad debts experience. Actual future uncollectible amounts could exceed the doubtful accounts allowance established.
Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company records adjustments to write down the cost of obsolete and excess inventory to the estimated market value based on historical and forecasted demand for its products. If actual future demand for the Company's products is less than currently forecasted, additional inventory adjustments may be required. Once an inventory write-down provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of. This treatment is in accordance with Accounting Research Bulletin 43 and SEC Staff Accounting Bulletin 100 "Restructuring and Impairment Charges."
Share-Based Compensation. Effective January 1, 2006, Micrel adopted the provisions of SFAS No. 123R using the modified-prospective transition method. Under SFAS No. 123R share-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense in the statement of operations. To determine fair value, the Company uses the Black-Scholes valuation model which requires input factors such as expected term, stock price volatility, dividend yield and risk free interest rate. In addition, SFAS No. 123R requires an estimate of expected forfeiture rates of stock grants and share-based compensation expense is to be only recognized for those shares expected to vest. Determining the input factors, such as expected term, expected volatility and estimated forfeiture rates, requires significant judgment based on subjective future expectations.
Income Taxes. Deferred tax assets and liabilities result primarily from temporary timing differences between book and tax valuation of assets and liabilities, and state research and development 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 June 30, 2009, 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 more likely than not, a valuation allowance would be established, which would increase the Company's tax provision in the period of such determination.
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109. FIN No. 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.
Litigation. The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. During the past three years, the Company has resolved litigation involving intellectual property claims. An estimated liability is accrued when it is determined to be probable that a liability has been incurred and the amount of loss can be reasonably estimated. The liability accrual is charged to income in the period such determination is made. The Company regularly evaluates current information available to determine whether such accruals should be made.
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