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MCRL > SEC Filings for MCRL > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for MICREL INC

Form 10-K for MICREL INC


6-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report.

Overview

We design, develop, manufacture and market a range of high-performance analog power ICs, mixed-signal and digital ICs. These products address a wide range of end markets including cellular handsets, enterprise and portable computing, enterprise and home networking, wide area and metropolitan area networks and industrial equipment. We also manufacture custom analog and mixed-signal circuits and provide wafer foundry services for customers who produce electronic systems for communications, consumer and military applications.

To enhance the readers' understanding of our performance, the following reverse chronological overview of our results for the years 2011 through 2013 have been provided.

For the year ended December 31, 2013, net revenues decreased 5.2% to $237.1 million from $250.1 million for the year ended December 31, 2012. The decrease was primarily due to lower demand from the communications and computing end markets and lower average selling prices for the wireless handset end market, which were partially offset by revenues from the acquisitions of Phaselink and Discera and higher demand from the industrial market. The book-to-bill ratio was approximately one for the full year of 2013. Gross margin for 2013 decreased to 51.5% from 53.1% for 2012. The decrease was primarily due to lower factory utilization, higher inventory reserves and a shift in product mix to lower gross margin mobile handset products, compared to 2012. Operating margin for 2013 decreased to 8.0% from 11.1% for 2012 primarily due to lower sales and restructuring charges of $1.4 million recorded in the fourth quarter of 2013. Income tax provision was $1.6 million in 2013, compared to $16.0 million in 2012 due primarily to benefit from research and development credits in 2013 and recording a valuation allowance on state deferred tax assets in 2012. Net income was $17.6 million, or $0.30 per diluted share, in 2013, compared to $12.3 million, or $0.20 per diluted shares, in 2012. During 2013, cash, cash equivalents and short-term investments decreased by $15.0 million from $103.6 million primarily due to repurchases of our common stock totaling $23.3 million and dividends paid to shareholders of $8.2 million. Additionally, during 2013, we paid a total of $6.1 million for the acquisition of Discera.

For the year ended December 31, 2012, net revenues decreased 3.4% to $250.1 million from $259.0 million for the year ended December 31, 2011. The decrease was primarily due to the continued global downturn which impacted Europe to a greater degree resulting in less demand of our products, partially offset by an increase of revenues from Asia due to added revenues from the acquisition of PhaseLink since the second quarter of 2012. The book-to-bill ratio was approximately one for the full year of 2012. Gross margin for 2012 decreased to 53.1% from 55.3% for 2011. The decrease was primarily due to lower factory utilization and increased inventory reserve charges. Operating margin for 2012 decreased to 11.1% from 18.1% for 2011 principally due to lower sales and increased spending in research and development. Net income was $12.3 million, or $0.20 per diluted share, compared with $33.9 million, or $0.54 per diluted share, in 2011. During 2012, cash, cash equivalents and short term investments decreased by $34.2 million from $137.9 million primarily due to repurchases of our common stock totaling $34.6 million and dividends paid to shareholders of $12.1 million. Additionally, during 2012, we paid a total of $17.4 million, net of cash acquired, for the acquisition of PhaseLink.


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For the year ended December 31, 2011, net revenues decreased 12.9% to $259.0 million from $297.4 million for the year ended December 31, 2010. This decrease was due to lower customer demand across most of our geographies and end markets, which resulted from global macro-economic conditions. Gross margin for 2011 decreased to 55.3% from 56.8% for 2010. This decrease was primarily due to a shift in mix to lower margin consumer-oriented products and lower factory utilization. Operating margin for 2011 was 18.1% which decreased from the record level of 25.2% in 2010. Net income was $33.9 million, or $0.54 per diluted share, compared with $50.5 million, or $0.81 per diluted share, in 2010. At December 31, 2011, cash, cash equivalents and short term investments were $137.9 million, an increase of $28.6 million from $109.2 million in 2010. We generated $50.1 million in cash flows from operations in 2011. In addition, in 2011 we repurchased $20.3 million of our common stock and dividends paid to shareholders of $9.4 million.

Our 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 our products backlog is cancelable without significant penalty, we typically plan our production and inventory levels based on forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. In addition, we are limited in our ability to reduce costs quickly in response to any revenue shortfalls.

We may experience significant fluctuations in our results of operations. Factors that affect our 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 and customer acceptance of new products. These and other factors are described in further detail later in this discussion and in Part I, Item 1A. "Risk Factors" of this Report. As a result of the foregoing or other factors, including global economic conditions, there can be no assurance that we will not experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect our business, financial condition and results of operations or cash flows.

In the fourth quarter of 2013, we recorded restructuring charges of $1.4 million related to workforce reductions. We paid $0.5 million related to severance costs in the year ended December 31, 2013 and expect to pay the remaining amount accrued in 2014.

Critical Accounting Policies and Estimates

The consolidated financial statements included in this Form 10-K 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. For a detailed discussion of our significant accounting policies, see Note 1 of Notes to Consolidated Financial Statements. We consider certain accounting policies related to revenue recognition, inventory valuation, share-based accounting and income taxes to be critical to the fair presentation of our financial statements.

Revenue Recognition and Receivables

We generate revenue by selling products to original equipment manufacturers ("OEM"), sell-through distributors and sell-in distributors. Our 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.

We allow certain sell-through distributors to have price protection and pricing adjustments subsequent to the initial product shipment. As these price concessions have historically been significant, and price concessions are difficult to reliably estimate, we defer 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 sell-through distributors until they have resold our products to their customers. Although revenue and related cost of sales are not recognized, we record an accounts receivable and relieve inventory at the time of initial product shipment. As standard terms are EXW or FCA shipping point, payment terms are enforced from shipment date and legal title and risk of inventory loss passes to the sell-through distributor upon shipment.

In addition, we may offer to our sell-through distributors, where revenue is deferred upon shipment and recognized on a sell-through basis, price adjustments to allow our sell-through distributors to price our products competitively for specific resale


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opportunities. We estimate and record an adjustment for sell-through distributor price adjustments for which the specific resale transaction has been completed, but the price adjustment claim has not yet been received by us.

Sales to OEM customers and sell-in distributors are recognized based upon the shipment terms of the sale transaction when all other revenue recognition criteria have been met. We do not grant return rights, price protection or pricing adjustments to OEM customers. We offer limited contractual stock rotation rights to sell-in distributors. In addition, we are not contractually obligated to offer, but may infrequently grant, price adjustments or price protection to certain sell-in distributors on an exception basis. At the time of shipment to sell-in distributors, 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.

Our accounts receivable balances represent trade accounts receivable which have been recorded at invoiced amount and do not bear interest. We maintain an allowance for doubtful accounts for estimated uncollectible accounts receivable. This estimate is based on an analysis of specific customer creditworthiness and historical bad debt experience. At December 31, 2013 and 2012, the allowance for doubtful accounts was approximately $0.8 million and $0.8 million, respectively.

Inventory Valuation

Inventories are stated at the lower of cost (first-in, first-out method) or market. We record adjustments to write down the cost of obsolete and excess inventory to the estimated market value based on historical and forecasted demand for our products. If actual future demand for our 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.

Share-Based Compensation

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 for stock options, we use 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, we estimate expected forfeiture rates of stock grants and share-based compensation expense is 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. We must regularly assess the likelihood that future taxable income levels will be sufficient to ultimately realize the tax benefits of these deferred tax assets. Due to California tax law changes in 2012 which require mandatory single sales factor apportionment in California for most multi-state taxpayers for tax years beginning on or after January 1, 2013, it became more likely than not that all of our California deferred tax assets would not be recognized. As such, a valuation allowance was recorded on the California deferred tax assets as of December 31, 2012. We believe that future taxable income levels would be sufficient to realize the tax benefits and have not established a valuation on the remaining deferred tax assets. Should we determine that future realization of these tax benefits is not more likely than not, a valuation allowance would be established, which would increase our tax provision in the period of such determination.

We use a two-step approach to recognize and measure uncertain tax positions. 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. We consider 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.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired. Goodwill is measured and tested for impairment annually at the reporting unit level during the last quarter of our fiscal year, or more frequently if we believe indicators of impairment exist. Events that could trigger a more frequent impairment review may include adverse industry or economic trends, restructuring actions, lower projections of profitability, or a sustained decline in our market capitalization. We have allocated our goodwill to our timing and communications reporting unit.


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Qualitative factors are assessed to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the qualitative assessment indicates that the carrying amount is more likely than not higher than the fair value, goodwill is tested for impairment based on a two-step test. The first step requires comparing the fair value of our reporting unit to its net book value, including goodwill. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and forecasted operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and determination of appropriate market comparables. We base our fair value estimates on assumptions we believe to be reasonable. Actual future results may differ from those estimates. Future competitive, market and economic conditions could negatively impact key assumptions including our market capitalization or the carrying value of our net assets which could require us to realize an impairment of our goodwill.

A potential impairment exists if the fair value of the reporting unit is less than its net book value. The second step of the process is only performed if a potential impairment exists, and it involves determining the difference between the fair value of the reporting unit's net assets other than goodwill to the fair value of the reporting unit and if the difference is less than the net book value of goodwill, an impairment exists and is recorded. No goodwill impairment was recognized in 2013, 2012 and 2011.

Impairment of Long-Lived Assets

We review purchased intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability of these intangible assets is assessed based on the estimated undiscounted future cash flows expected to result from the use of the asset. If the undiscounted future cash flows are less than the carrying amount, the purchased intangible assets with finite lives are considered to be impaired. The amount of the impairment is measured as the difference between the carrying amount of these assets and the fair value.

Our business combinations have included the purchase of in-process research and development assets that are not amortizable until the underlying project is complete. We assess that our in-process research and development project is complete when all material research and development costs have been incurred and no significant risks remain. We review the carrying value of indefinite-lived intangible assets for impairment at least annually during the last quarter of our fiscal year, or more frequently if we believe indicators of impairment exist. In 2012, we recorded an impairment of $1.0 million as a component of research and development expense for a developed technology which was replaced by more advanced technologies. In 2013 and 2011, no impairment was noted.

Litigation

An estimated liability is accrued for legal matters and other contingencies 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. We regularly evaluate current information available to determine whether such accruals should be made.

Restructuring Charges

Our restructuring accruals include primarily payments to employees for severance. Accruals are recorded when management has approved a plan to restructure operations and a liability is probable and estimable. The restructuring accruals are based upon management estimates at the time they are recorded. These estimates can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded.


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Results of Operations
The following table sets forth certain operating data as a percentage of total net revenues for the periods indicated.

                                                         Years Ended December 31,
                                                     2013           2012         2011
Net revenues                                         100.0 %        100.0 %      100.0 %
Cost of revenues                                      48.5           46.9         44.7
Gross profit                                          51.5           53.1         55.3
Operating expenses:
Research and development                              23.6           22.8         19.3
Selling, general and administrative                   19.3           19.2         17.9
Restructuring charges                                  0.6              -            -
Total operating expenses                              43.5           42.0         37.2
Income from operations                                 8.0           11.1         18.1
Interest and other income (expense), net               0.1            0.2          0.3
Income before income taxes and noncontrolling
interest                                               8.1           11.3         18.4
Provision for income taxes                             0.7            6.4          5.3
Net income                                             7.4            4.9         13.1
Less: Net income attributable to noncontrolling
interest                                                 -              -            -
Net income attributable to Micrel, Incorporated
shareholders                                           7.4 %          4.9 %       13.1 %

Net Revenues. Net revenues decreased 5.2% to $237.1 million for the year ended December 31, 2013 compared to $250.1 million in 2012. The decrease was primarily due to lower demand from the communications and computing end market and lower average selling prices from the wireless handset end market partially offset by revenues from the acquisitions of PhaseLink and Discera and higher demand from the industrial end market.

Net revenues decreased 3% to $250.1 million for the year ended December 31, 2012 compared to $259.0 million in 2011. This decrease was primarily due to lower customer demand across our end markets and geographies which resulted primarily from continued global macroeconomic conditions partially offset by revenues from the acquisition of PhaseLink.

Customer demand for semiconductors can change quickly and unexpectedly. Historically, our revenue levels have been highly dependent on the amount of new orders for products to be delivered to the customer within the same quarter. Within the semiconductor industry, orders that are booked and shipped within the same quarter are called "turns fill" orders. When the turns fill level exceeds approximately 35% of quarterly revenues, it can be very difficult to predict near term revenues and income. The resulting lack of visibility into demand also makes it difficult to match product build with future demand as our lead times to build our products may be substantially longer than order lead times.

As noted in Item 1A "Risk Factors" and above in the overview section of this "Management Discussion and Analysis of Financial Condition and Results of Operations," a trend has developed over the last several years whereby customers in the semiconductor supply chain have worked to minimize the amount of inventory of semiconductors they hold. As a consequence, customers are generally providing less order backlog to us and other semiconductor suppliers, and relying on short lead times to buffer their build schedules. Shorter lead times reduce visibility into end demand and increase the reliance on turns fill orders. The reluctance of customers to provide order backlog together with short lead times and the uncertain growth rate of the world economy, make it difficult to precisely predict future levels of sales and profitability.

International sales represented 74%, 73%, and 72% of net revenues for the years ended December 31, 2013, 2012 and 2011, respectively. Sales to customers in Asia represented 61% of net revenues for the year ended December 31, 2013, compared to 61% for the year ended December 31, 2012 and 58% for the year ended December 31, 2011. The trend for our customers to move their electronics manufacturing to Asian countries has resulted in increased pricing pressure for us and other semiconductor manufacturers. 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 our products in the future.


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Gross Profit. Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing capacity utilization, product yields and average selling prices. Our gross margin decreased to 51% for the year ended December 31, 2013 from 53% for 2012. This decrease was primarily due to lower factory utilization, higher inventory reserves, and a shift in product mix to lower gross margin mobile handset products. For the year ended December 31, 2012, our gross margin decreased to 53% from 55% for 2011. This decrease was primarily due to a shift in mix to lower margin consumer-oriented products and lower factory utilization.

Research and Development Expenses. Research and development ("R&D") expenses as a percentage of net revenues represented 24% for the year ended December 31, 2013, compared to 23% for 2012. R&D expenses decreased $1.3 million or 2.3% to $55.9 million for the year ended December 31, 2013, compared to $57.2 million for 2012. The decrease was primarily due to reduced spending on mask sets of $0.6 million, lowered share-based compensation of $0.3 million, partially offset by increased headcount from our acquisitions of Phaselink and Discera.

For the year ended December 31, 2012, R&D expenses increased $7.2 million or 14.5% to $57.2 million compared to $50.0 million for 2011. The increase was primarily due to increased mask expenses for R&D activities, consulting services, added headcount from the acquisition of PhaseLink and an impairment of $1.0 million for purchased technology which was replaced by more advanced technologies.

We believe that the development and introduction of new products is critical to our future success and expect to continue its investment in R&D activities in the future.

Selling, General and Administrative Expenses. Selling, General and Administrative ("SG&A") expenses as a percentage of net revenues represented 19% for the year ended December 31, 2013, compared to 19% for 2012. SG&A expenses decreased $2.2 million, or 4.6%, to $45.8 million from $48.0 million for 2012. The decrease was primarily due to spending reductions on product and corporate marketing activities of $1.1 million, personnel of $0.9 million and travel of $0.6 million.

For the year ended December 31, 2012, SG&A expenses increased $1.6 million, or 3.0%, to $48.0 million for the year ended December 31, 2012 from $46.4 million for 2011. The increase primarily resulted from increased spending on product marketing activities, added headcount expenses from the acquisition of PhaseLink and related amortization expenses of acquired intangible assets, increased share-based compensation expense and a payment for a legal settlement, which were partially offset by decreased profit sharing accruals and a reduction of selling expenses.

Share-Based Compensation. Our results of operations for the years ended December 31, 2013, 2012 and 2011 were impacted by the recognition of non-cash expense related to the fair value of share-based compensation awards. During 2013, we recorded $7.1 million in pre-tax share-based compensation expense, of which $1.1 million was included in cost of revenues, $2.9 million was included in R&D expense and $3.2 million was included in SG&A expense. During 2012, we recorded $7.6 million in pre-tax share-based compensation expense, of which $1.2 million was included in cost of revenues, $3.1 million was included in R&D expense and $3.3 million was included in SG&A expense. During 2011, we recorded $5.9 million in pre-tax share-based compensation expense, of which $1.0 million was included in cost of revenues, $2.4 million was included in R&D expense and $2.4 million was included in SG&A expense.

Restructuring Charges. In the fourth quarter of 2013, we recorded restructuring charges of $1.4 million related to workforce reductions. We paid $0.5 million related to severance costs in the year ended December 31, 2013 and expect to pay the remaining amount accrued in 2014.

Interest and Other Income (Expense), Net. Interest and other income (expense), net were $0.2 million, $0.6 million and $0.8 million for the years ended December 31, 2013, 2012 and 2011, respectively. They reflect interest income from short-term and long-term investments and money market funds.

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