UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003.
[ ] 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 (I.R.S. Employer
of 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
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 March 1, 2004, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $1,256,517,723 based upon
the closing sales price of the Common Stock as reported on the Nasdaq National
Market on such date. Shares of Common Stock held by officers, directors and
holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be
affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 1, 2004, the Registrant had outstanding 92,570,951 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on May 27, 2004 are incorporated by reference in Part
III of this Report.
This Report on Form 10-K includes 76 pages with the Index to Exhibits
located on page 70.
MICREL, INCORPORATED
INDEX TO
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2003
Page
----
PART I
Item 1. Business 3
Item 2. Properties 16
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II
Item 5. Market for the Registrant's Common Equity, Related Shareholder
Matters and Issuer Purchases of Equity Securities 19
Item 6. Selected Financial Data 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 39
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 39
Item 9a. Controls and Procedures 39
PART III
Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Shareholder Matters 40
Item 13. Certain Relationships and Related Transactions 40
Item 14. Principal Accountant Fees and Services 40
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 41
Signatures 69
Exhibit Index 70
Certifications 74
2
PART I
ITEM 1. BUSINESS
General
The Company was incorporated in California in July 1978. References to the
"Company" and "Micrel" refer to Micrel, Incorporated and subsidiaries, which
also does business as Micrel Semiconductor. The Company's principal executive
offices are located at 2180 Fortune Drive, San Jose, California 95131. The
Company's telephone number is (408) 944-0800. We maintain a corporate website
located at www.micrel.com, however none of the information contained on our
website is incorporated into this annual report. Our annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports are made available, free of charge, on the website
noted above as soon as reasonably practicable after filing with the Securities
and Exchange Commission.
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 2,000 standard products and has derived
the majority of its product revenue for the year ended December 31, 2003 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 and industrial equipment. For the years ended December 31, 2003,
2002, and 2001, the Company's standard products accounted for 90%, 88%, and
84%, respectively, of the Company's net revenues. 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.
Continuing trends to lower voltages and higher currents in the
communications, networking and computing markets have created demand for high
performance analog products to accurately control, regulate, convert and route
voltage and current in electronic systems. The demand for high performance
power management circuits has been further fueled by the growth of portable
communications and computing devices (e.g. cellular telephones, personal
digital assistants ("PDA"), MP3 players and notebook computers). The Company
sells a wide range of switching and linear regulators, power switches, voltage
supervisors, and thermal management products for these portable devices.
Micrel was one of the first companies to offer analog products for the PCMCIA
Card and universal serial bus ("USB") market. In additional to USB power
switches the Company now offers a family of transceiver products to support
USB connectivity from a PC to a USB equipped peripheral at data rates up to 12
Megabits per second.
The Company also has an extensive power management offering for the
networking and communications infrastructure markets including PC servers,
network switches and routers, storage area networks and wireless base
stations. This offering includes a new family of switching regulators for
point of load applications in distributed power schemes, and a new family of
hot swap power controllers. These hot swap controllers support 24 hours a day,
7 days per week operations by enabling customers to remove and insert printed
circuit boards during system operation. Future families of hot swap
controllers are being developed to address the higher voltage requirements of
the telecommunications market. The Company also offers standard analog
products that address other markets, including industrial, defense and
automotive electronics.
In addition to power and thermal management products, Micrel also offers
two families of highly integrated radio frequency ("RF") products. Micrel's
QwikRadio(R) devices enable customers to develop wireless control systems
significantly improving the consumer experience of their products.
Applications for the QwikRadio(R) products include remote keyless entry for
automobiles, garage door openers and remote controls. Micrel's RadioWire(R)
3
transceivers provide frequency hopping capability to extend the range and
improve the integrity of the data link. RadioWire(R) devices are often used to
replace wires in applications including remote metering, security systems and
factory automation. On March 3, 2004, Micrel completed the acquisition of
BlueChip Communications AS, a fabless semiconductor company that designs,
develops and markets high performance RF integrated circuits. This acquisition
further enhances Micrel's ability to address the needs of the low power RF
market through additional design, applications and technical marketing
resources.
The Company's high bandwidth communications circuits are used primarily for
enterprise switch networks, storage area networks, and metropolitan area
networks. With form factor and size reductions critical to the continued
growth of this technology, Micrel has utilized its own process technology and
innovative packaging to address these challenges. For example, Micrel provides
a complete chipset solution for fiber optic module transceivers supporting
data rates up to 10 Gigabits per second (OC-192). In 2002, Micrel introduced
the first integrated controller solution supporting the new digital diagnostic
standard for optical transceivers to improve system reliability and networking
support costs. The MIC3000 controller replaces 4-5 ICs in the current solution
with a 75% reduction in size.
In May 2001, Micrel completed its acquisition of Kendin Communications, Inc.
("Kendin"), a privately held fabless semiconductor company that designs,
develops and markets high performance ICs for the communications and
networking markets. This acquisition enabled Micrel to enter the Ethernet
market with a family of Ethernet switch products targeting the small office,
home office ("SOHO") and enterprise networking markets. This product portfolio
consists of transceiver and switch devices that support various Ethernet
protocols supporting communication transmission speeds from 10 Megabits per
second to 100 Megabits per second. Micrel's Ethernet operations are currently
developing products to serve the Gigabit Ethernet communication protocol.
In addition to standard analog and mixed signal products, Micrel offers
customers various combinations of design, process and foundry services.
Through interaction with customers in its custom and foundry business, we have
been able to enhance our design and process technology capabilities, which in
turn provide engineering and marketing benefits to the Company's standard
products business.
Industry Background
Analog Circuit, Mixed-Signal and Digital ICs Markets
ICs may be divided into three general categories - digital, analog (also
known as "linear") and mixed-signal. Digital circuits, such as memories and
microprocessors, process information in the form of on-off electronic signals
and are capable of implementing only two values, "1" or "0." Analog circuits,
such as regulators, converters and amplifiers, process information in the form
of continuously varying voltages and currents that have an infinite number of
values or states. Analog circuits condition, process, and measure or control
real world variables such as current, sound, temperature, pressure or speed.
Mixed-signal ICs combine analog and digital functions on one chip.
Analog circuits are used in virtually every electronic system, and the
largest markets for such circuits are computers, telecommunications and data
communications, industrial equipment, military, consumer and automotive
electronics. Because of their numerous applications, analog circuits have a
wide range of operating specifications and functions. For each application,
different users may have unique requirements for circuits with specific
resolution, linearity, speed, power and signal amplitude capability. Such
differentiation results in a high degree of market fragmentation, providing
smaller companies an opportunity to compete successfully against larger
suppliers in certain market segments.
4
Mixed-signal and digital ICs may be divided into six general categories,
LSI/MSI logic, data processing, signal processing, memory, FPGA and
application specific.
Mixed-signal and digital ICs are used in computer and communication systems
and in industrial products. The primary markets for such circuits are
consumer, communications, personal computer systems, and industrial. The
primary advantages of the Company's mixed-signal and digital ICs are high
speed and low noise.
As compared with the digital integrated circuit industry, the analog
integrated circuit industry has the following important characteristics:
* Dependence on Individual Design Teams. The design of analog circuits
involves the complex and critical placement of various circuits. Analog
circuit design has traditionally been highly dependent on the skills and
experience of individual design engineers.
* Interdependence of Design and Process. Analog designers, especially at
companies having their own wafer fabrication facility, are able to select
from several wafer fabrication processes in order to achieve higher
performance and greater functionality from their designs.
* Longer Product Cycles and More Stable Pricing. Analog circuits generally
have longer product cycles as compared to digital circuits.
Analog, mixed-signal and digital ICs are sold to customers as either
standard products or custom products. Standard analog products are available
to customers "off-the-shelf" and are often sold in large volumes to a wide
variety of customers in different industries. Custom products are designed to
an individual customer's specifications.
Recent Trends in Analog Power Management, Mixed-Signal and Digital ICs
Most electronic systems utilize analog circuits to perform power management
functions ("power analog circuits") such as the control, regulation,
conversion and routing of voltages and current. The computer and
communications markets have emerged as two of the largest markets for power
analog circuits. In particular, the recent growth and proliferation of
portable, battery-powered devices, such as cellular telephones, PDAs and
notebook computers, continue to increase demand and create new technological
challenges for power analog circuits.
Cellular telephones, which are composed of components and subsystems that
utilize several different voltage levels, require multiple power analog
circuits to precisely regulate and control voltage. Manufacturers continue to
pack more processing power and functionality into smaller form factors placing
severe demands on the battery. To maintain or extend talk times, high
performance power management products are required. With the introduction of
new color displays, "boost" voltage regulators are now required to step up the
battery voltage to the higher voltage required to backlight the display with
white or blue light emitting diodes ("LEDs"). In 2003 Micrel introduced the
MIC2287 and MIC2289 boost converters, designed specifically to address the
needs of white LEDs. These two new products from Micrel are smaller and
achieve much higher efficiency than competing "charge pump" solutions,
extending battery life. Several manufacturers are also adding USB connectivity
to their cellular phones to enable efficient downloads from their PCs or PDAs.
Micrel offers a family of USB transceivers to support this emerging trend.
Another emerging trend is the use of switching regulators to improve
efficiency in power hungry devices such as the baseband processor and power
amplifier. The resulting need for longer standby and talk times for the
cellular handset provides a significant opportunity for the Company's high
frequency switching regulators.
5
The rapid adoption of the Internet for information exchange, in business
and consumer markets, has led to a significant increase in the need for
broadband communications technology. In 2003 there was a significant expansion
in the number of broadband subscribers for both DSL and cable modem services.
The increased bandwidth demand of these users will continue to consume the
installed capacity in the metropolitan and wide area networks. The additional
demand of new wireless services utilizing the transmission of video will
further consume this installed capacity. It is anticipated these trends will
continue in 2004. Micrel has maintained a significant investment in its
communications products ensuring the Company is positioned with new products
to capitalize on future growth in the communications equipment market. The
Company has significantly expanded its high-speed interface portfolio of
clocking, clock distribution, level translation, and physical media products
with the introduction of 31 new products in 2003.
In the networking market, Ethernet has been widely adopted as a
communication standard. Ethernet ports are now being provided on equipment
ranging from PCs and PC peripherals such as printers, media converters, set-
top boxes, internet protocol ("IP") phones and game consoles. This is driving
rapid growth in the SOHO market to connect multiple PCs and peripherals. With
its acquisition of Kendin Communications, Micrel entered this market with
leadership products and technology. Micrel's networking products transmit,
receive and switch data in local area networks utilizing Ethernet data
transmission protocols. Micrel offers a broad range of physical layer ("PHY"),
media access controllers ("MACs") and switch products for the 10/100 Megabit
Ethernet standard.
With the continued development of the standard to Gigabit and now 10-
Gigabit data rates, Ethernet is now starting to challenge the SONET standard in
the metropolitan area network. As applications such as Voice Over Internet
Protocol ("VOIP"), video conferencing and video multicasting continue to grow
in the corporate enterprise, video streaming of movies and online gaming
continue to increase over the Internet, and broadband DSL connections continue
to grow worldwide, there is an ever increasing demand for more bandwidth.
Micrel is positioned with the capabilities to provide the Gigabit and 10-
Gigabit Ethernet components that enable these applications. These products are
currently in design. There can be no assurance that the Company will
successfully bring these products to market.
Micrel's Strategy
Micrel seeks to capitalize on the growth opportunities within the high-
performance analog, mixed-signal and digital semiconductor markets. The
Company's core competencies are its analog design and process technology, its
large, in-house wafer fabrication capability and manufacturing expertise. The
Company also seeks to capitalize on growth opportunities within the
communications and networking markets and has successfully acquired companies
serving these market segments. The Company intends to build a leadership
position in its targeted markets by pursuing the following strategies:
* Focus on Standard Products for High Growth Markets. Currently, Micrel ships
over 2,000 standard products, with net revenues from standard products
generating 90% of the Company's net revenues for the year ended December
31, 2003. Micrel believes that its long-term growth will depend
substantially on its ability to increase standard product sales in its
existing markets and to penetrate new standard product markets. The
Company, however, will pursue additional custom and foundry business as
opportunities arise.
* Target Power Analog, High-Speed Mixed-signal and Digital Markets. Micrel
has leveraged its expertise in power analog circuits by addressing market
opportunities in cellular telephones, battery-powered computers and desktop
personal computers. A majority of the Company's standard products net
revenues for the year ended December 31, 2003 were derived from products
relating to power management. Through the acquisitions of Synergy
Semiconductor, Altos Semiconductor, Electronic Technology and Kendin, the
Company has gained expertise in high-speed, mixed-signal and system-level
6
digital ICs, required to address the wide area, metropolitan area and local
area network communication markets as well as increase its penetration of
the power and thermal management markets.
* Maintain Technological Leadership. The Company seeks to utilize its design
strengths and its process expertise to enhance what the Company believes
are its competitive advantages in linear and switching regulators, USB
power switches, hot-swap-power controllers, high-speed interface, and
communications devices. The Company's broad portfolio of process technology
is a key value proposition to the customer and enables the Company to
differentiate its products from the competition. The Company now has its
sub-micron CMOS and bipolar processes in production and is currently
developing an in-house silicon germanium process. The combination of design
expertise and breadth of process technology will enable development of
future products with increased functionality.
* Develop/Acquire New Complementary Businesses. The Company seeks to identify
complementary business opportunities building on its core strengths in the
analog and mixed signal area. The Company has significantly expanded its
product scope through the acquisition of Kendin's high performance
transceiver and switch products that address local area network
communication applications. The Company has also expanded its product
portfolio to include hot swap power controllers, thermal management
products and voltage supervisors. On March 3, 2004, Micrel completed the
acquisition of BlueChip Communications AS, a fabless semiconductor company
that designs, develops and markets high performance RF integrated circuits.
These additions enable Micrel to provide a more complete solution to its
customers and facilitates the Company's growth.
* Capitalize on In-house Wafer Fabrication Facility. The Company believes
that its in-house six-inch wafer fabrication facility provides a
significant competitive advantage because it facilitates close
collaboration between design and process engineers in the development of
the Company's products.
* Maintain a Strategic Level of Custom and Foundry Products Revenue. Micrel
believes that its custom and foundry products business complements its
standard products business by generating a broader revenue base and
lowering overall per unit manufacturing costs through greater utilization
of its manufacturing facilities. Through interaction with customers, Micrel
has been able to enhance its design and process technology capabilities.
Products and Markets
Overview
The following table sets forth the net revenues attributable to the
Company's two segments, standard products and custom and foundry products
expressed in dollars and as a percentage of total net revenues.
Net Revenues by Segment
(Dollars in thousands)
Years Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Net Revenues:
Standard Products $ 191,134 $ 180,407 $ 183,103
Custom and Foundry Products 20,592 24,297 34,705
--------- --------- ---------
Total net revenues $ 211,726 $ 204,704 $ 217,808
========= ========= =========
As a Percentage of Total Net Revenues:
Standard Products 90% 88% 84%
Custom and Foundry Products 10 12 16
--------- --------- ---------
Total net revenues 100% 100% 100%
========= ========= =========
7
The Company's products address a wide range of end markets. The following
table presents the Company's revenues by end market as a percentage of total
net revenues.
Years Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
As a Percentage of Total Net Revenues:
High-Speed Communications 24% 27% 32%
Wireless Handsets 21 17 15
Computer 29 34 30
Industrial 24 19 20
Military & Consumer 2 3 3
--------- --------- ---------
Total net revenues 100% 100% 100%
========= ========= =========
For a discussion of the changes in net revenues from period to period, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Standard Products
In recent years, the Company has directed a majority of its development,
sales and marketing efforts towards standard products in an effort to address
the larger markets for these products and to expand its customer base. The
Company offers a broad range of high performance analog, mixed signal, and
digital ICs that address high growth markets including cellular telephones,
portable computers, desktop personal computers, networking and communications.
The majority of the Company's revenue is derived from power management
standard products that, in addition to the above markets, are also used in the
industrial, defense, and automotive electronics markets.
Portable Battery-Powered Computer Market. The Company makes power analog
circuits for notebook computers, pocket PCs, and PDAs. Products in this
growing segment are differentiated on the basis of power efficiency, weight,
small size and battery life.
Cellular Telephone Market. Micrel offers a range of power control and
regulating analog circuits to address the demand for cellular telephones with
longer battery lives. Micrel supplies high performance low dropout ("LDO")
regulators and higher efficiency switching regulators that convert, regulate,
switch and control the DC voltages used in cellular telephones. Micrel's
SuperBeta PNP(TM) LDO and CMOS regulators enable cellular telephones to
continue to operate effectively until the battery is almost completely
exhausted. Micrel products are designed to reduce board space and decrease
system cost. The introduction of new, large display technologies to the
cellular handset has created a demand for new "boost" converters which provide
higher voltages from single cell lithium batteries. This includes products for
both electro-luminescent and color LCD displays. In addition, Micrel offers
switch mode power supply ("SMPS") regulators that convert AC to useable DC
power in battery chargers and cellular base stations.
Universal Serial Bus Market. USB has become the standard way of connecting
computers with computer peripherals. In addition to implementing data
communications between the connected devices, USB also provides a power source
capable of powering the peripheral. Micrel believes that it is the leader in
the design and manufacture of circuits that safely control the delivery of
this power source. Micrel also pioneered switch products utilizing the new
Advanced Control and Power Interface ("ACPI") standard for lower power
consumption. Micrel has also added to its USB product portfolio recently with
the introduction of a family of USB transceivers to support connectivity from
the PC host to a USB peripheral at data rates up to 12 Megabits per second and
is actively developing products to address the new "On the Go" USB standard
8
for peer-to-peer communications.
PCMCIA Card and Socket Markets. The Personal Computer Memory Card
International Association, of which Micrel is a member, has established
standards for personal computer cards that are the size of credit cards and
for sockets that allow insertion of such cards into personal computers. Micrel
believes that it is a leader in the design and manufacture of ICs that enable
PC Card sockets to have such compatibility. Micrel is involved in the creation
of next generation PC card standards, including Express Card.
Power Supply Market. Most electronic equipment includes a power supply that
converts and regulates the electrical power source into usable current for the
equipment. Micrel has several families of high voltage switching controllers
for the networking, telecommunications and computing markets. These devices
offer high efficiency to minimize power loss through heat and high switching
frequencies in a minimal solution size. Applications for these products
include DC-DC converter modules, VOIP phones, network switches and routers,
wireless base-stations, wireless-access points and PC servers. In addition to
SMPS controllers and single chip SMPS regulators, Micrel offers a full line of
MOSFET drivers, smart switches, voltage supervisors and LDOs.
General Purpose Analog. Micrel sells a variety of general purpose analog
products including high-speed, low-power operational amplifiers, comparators,
fan controllers and intelligent protected power switches. Most of these
general purpose devices focus on low-voltage and low-current applications.
Thermal Management. Micrel's thermal management products address the need
to accurately measure temperature in several system locations and control
cooling fans. The ability to measure temperature accurately allows customers
to optimize system performance and is critical to both the reliability and
operating life of today's electronic systems. Micrel's thermal management
technology enables high accuracy at low system cost by sensing the temperature
at each location using only one pin connection. Applications for these
products include notebook computers, enterprise storage, printers, copiers and
set-top boxes.
Hot Swap Controllers. Micrel's hot swap power controllers support the
requirement for 24/7 operation in servers and communications equipment. These
products allow customers to upgrade or replace system boards without having to
power down the system. This family offers the industry's most integrated hot
swap solution for CompactPCI(TM) applications. These devices build on Micrel's
expertise in power control and distribution and target the PC server and
industrial computing market segments. Micrel's dual channel hot swap
controller to support Intel's Itanium(TM) 64-bit microprocessor for the latest
generation of PC servers and the next generation product to support the latest
PCI-Express standard is in development. The Company also offers high voltage
(+/- 48V) controllers for the telecommunications and networking equipment
markets.
Radio Frequency Data Communications. Micrel's QwikRadio(R) family of RF
receivers and transmitters are designed for use in any system requiring a
cost-effective, low-data-rate wireless link. Typical examples include garage
door openers, lighting and fan controls, automotive keyless entry and remote
controls. Micrel's RadioWire(R) transceivers provide a higher level of
performance for more demanding applications such as remote metering, security
systems and factory automation. On March 3, 2004, Micrel completed the
acquisition of BlueChip Communications AS, a fabless semiconductor company
that designs, develops and markets high performance RF integrated circuits.
This acquisition further enhances Micrel's ability to address the needs of the
low power RF market through additional design, applications and technical
marketing resources.
9
Networking and High-Speed Communications Circuits Market. The Company's
High Bandwidth division has directed a majority of its development, sales and
marketing efforts towards the enterprise networking, storage area networking,
and metropolitan area network markets. The group develops and produces
communications products targeted at fiber optic modules as well as clock
recovery, clock distribution and level translation circuits. During 2003, the
Division expanded its high-speed portfolio with the introduction of 31 new
products. These products offer the highest signal integrity in the industry to
ensure minimal data loss at transmission speeds up to 10 Gigabits per second.
Micrel continues to innovate through the addition of novel level translation
techniques and the introduction of new data transmission functions.
Micrel entered the Ethernet networking market with its acquisition of
Kendin Communications in May 2001. Micrel's networking products transmit,
receive and switch data in local area networks utilizing Ethernet data
transmission protocols. Micrel offers a broad range of PHYs, MACs and switch
products for the 10/100 Megabit Ethernet standard. The primary applications
for the switch products are SOHO computer networks, VOIP phones and media
converters, used to convert signals transmitted optically over fiber to
standard cable (copper) and vice versa. In 2002 Micrel introduced the KS8695,
the world's first integrated SOHO router solution using the ARM 9 processor
core. The device is capable of utilizing a broadband connection (cable modem
or DSL) to connect up to four PCs with 10/100 Ethernet to realize a home or
small business network. Single 10/100 Megabit PHYs are also used in set-top
boxes, cable modems, game consoles, printers, copiers and a host of other PC
peripherals. This success was followed up in 2003 with the introduction of the
KS8695P for use in multimedia 'triple-play' voice, video and data applications
and the KS8695PX for use in wireless LAN 802.11g applications.
The Company's future success will depend in part upon the timely
completion, introduction, and market acceptance of new standard products. The
standard products business is characterized by generally shorter product
lifecycles, greater pricing pressure, larger competitors and more rapid
technological change as compared to the Company's custom and foundry products
business. Generally, the standard products market is a rapidly changing market
where the Company faces the risk that its product offerings can quickly become
obsolete. The success of new standard products depends on a variety of
factors, including product selection, successful and timely completion of
product development, achievement of acceptable manufacturing yields by the
Company's foundry and the Company's ability to offer products at competitive
prices.
Micrel's new products are generally incorporated into a customer's products
or systems at the design stage. The value of any design win largely depends
upon the commercial success of the customer's product and the extent to which
the design of the customer's electronic system accommodates incorporation of
components manufactured by the Company's competitors. In addition, products or
systems may be subsequently redesigned so that they no longer require the
Company's products. No assurance can be given that the Company will achieve
design wins or that any design win will result in future revenues. The failure
of the Company to achieve design wins would materially and adversely affect
the Company's financial condition, results of operations and cash flows.
Custom and Foundry Products
Micrel offers various combinations of design, process and foundry services
in order to provide customers with the following alternatives:
Full Service Custom. Based on a customer's specification, Micrel designs
and then manufactures ICs.
10
Custom and Semicustom. Based on a customer's high level or partial circuit
design, Micrel uses varying combinations of its design and process
technologies to complete the design and then manufactures ICs for the
customer.
R&D Foundry. Micrel modifies a process or develops a new process for a
customer. Using that process and mask sets provided by the customer, Micrel
manufactures fabricated wafers for the customer.
Foundry. Micrel duplicates a customer's process to manufacture fabricated
wafers designed by the customer.
Micrel's full service custom, custom and semicustom products primarily
address high bandwidth communications, consumer, automotive and military
applications and use both analog and digital technologies. Military
applications include communications and transport aircraft.
Sales, Distribution and Marketing
The Company sells its products through a worldwide network of independent
sales representative and distributor firms and through a direct sales staff.
The Company sells its products in Europe through a direct sales staff in
England and France as well as independent sales representative firms,
independent distributors and independent stocking representative firms. Asian
sales are handled through Micrel sales offices in Korea, Japan, Taiwan and
China and independent stocking representative firms. The 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.
Sales to customers in North America, Asia and Europe accounted for 30%, 60%
and 10% respectively, of the Company's net revenues for the year ended
December 31, 2003 compared to 31%, 60% and 9%, respectively, of the Company's
net revenues for the year ended December 31, 2002 and 39%, 50% and 11%,
respectively, of the Company's net revenues for 2001. The Company's standard
products are sold throughout the world, while its custom and foundry products
are primarily sold to North American customers. The Company's net revenues by
country, including the United States, are included in Note 12 of Notes to
Consolidated Financial Statements.
The Company's international sales are primarily denominated in U.S.
currency. Consequently, changes in exchange rates that strengthen the U.S.
dollar could increase the price in local currencies of the Company's products
in foreign markets and make the Company's products relatively more expensive
than 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 with respect to such fluctuations.
Customers
For the year ended December 31, 2003, two customers, a worldwide
distributor and an Asian based stocking representative, each accounted for 13%
of the Company's net revenues. For the years ended December 31, 2002 and 2001
the same Asian based stocking representative, accounted for 13% and 11% of the
Company's net revenues, respectively.
11
Design and Process Technology
Micrel's analog proprietary design technology depends on the skills of its
analog design team. The Company has experienced analog design engineers who
utilize an extensive macro library of analog and mixed-signal circuits and
computer simulation models.
Micrel can produce ICs using a variety of manufacturing processes, some of
which are proprietary and provide enhanced product features. Designers at
companies that do not have in-house fabs or have a limited selection of
available processes often have to compromise design methodology in order to
match process parameters.
Micrel produces high-speed communication transceivers, clock
generation/distribution circuits and clock recovery circuits as well as high-
speed logic using the Company's proprietary All Spacer Separated Element
Transistor ("ASSET") process.
The Company utilizes the following process technologies:
* Bipolar - Bipolar technology is one of the oldest technologies. It is
utilized where precision analog elements are required.
* High Speed Bipolar - This is a variation of bipolar technology that is
specially optimized for very fast transistors and is used where high-speed
switching or signal conditioning is required.
* SuperBeta PNP(TM) - The Company's proprietary SuperBeta PNP(TM) process
technology allows power transistors to be driven with much lower current as
compared to conventional PNP bipolar technology, which gives such
transistors a competitive advantage.
* CMOS - CMOS is the technology most widely used in digital applications. It
has the advantages of low power consumption and high packing density.
* BiCMOS - Bipolar/CMOS ("BiCMOS") merges the Bipolar and CMOS technologies
and offers the benefits of both technologies. This process, however, adds
more expense to a product.
* BCD - Bipolar/CMOS/DMOS ("BCD") merges three technologies, Bipolar, CMOS
and DMOS. DMOS is best suited for handling high current and is used in the
output section of the circuit. BCD combines the high speed, ruggedness and
power of DMOS and the benefits of BiCMOS.
* ASSET - ASSET technology is the Company's proprietary high-speed bipolar
process developed by the Company's High Bandwidth division. This technology
allows high speed with low jitter and is ideally suited for high-speed
mixed-signal designs.
* Silicon Germanium - Silicon Germanium ("SiGe") allows even higher speed
with lower power than Micrel's high-speed Bipolar process, and it is ideal for
10Gbps communications.
The Company continues to develop each of these technologies to improve both
the performance and cost of its new products. Micrel is also developing new
process technologies to support its own product development and the needs of
its foundry customers.
The Company utilizes third-party wafer fabrication foundries for advanced
CMOS fabrication processes and other advanced processes that are not available
in-house. For the year ended December 31, 2003, 9% of Micrel's wafer
12
requirements were fabricated at third-party foundry suppliers, which includes
all of Micrel's Ethernet networking products.
Research and Development
The ability of the Company to compete will substantially depend on its
ability to define, design, develop and introduce on a timely basis new
products offering design or technology innovations. Research and development
in the analog and mixed-signal integrated circuit industry is characterized
primarily by circuit design and product engineering that enables new
functionality or improved performance. Research and development in the high-
speed communications circuit industry is characterized primarily by innovative
process technologies, novel design techniques and high-speed test methodology.
The Company's research and development efforts are also directed at its
process technologies and focus on cost reductions to existing manufacturing
processes and the development of new process capabilities to manufacture new
products and add new features to existing products. With respect to more
established products, the Company's research and development efforts also
include product redesign, shrinkage of device size and the reduction of mask
steps in order to improve die yields per wafer and reduce per device costs.
The Company's analog design engineers principally focus on developing next
generation standard products. The Company's new product development strategy
emphasizes a broad line of standard products that are based on customer input
and requests. The Company often develops new standard analog products with the
cooperation of customers in order to better ensure market acceptance. The
Company is currently developing products to expand its line of USB switches,
SMPS regulators, LDOs, hot swap controllers, voltage supervisors, MOSFET
drivers and RF transmitters, receivers and transceivers.
The Company's mixed-signal design engineers principally focus in two areas.
The first is high-speed, low-noise media driving and clock/data recovery
devices used in communication and advanced computer systems. New product
development in this area includes high-speed Current Mode Logic ("CML") for
optical networking, high-speed, precision timing devices for next generation
servers and enterprise networking, fiber optic module components for 1.25, 2.5
and 10Gbps optical networking, and communications transceivers for OC-12, OC-
48 and 10-Gigabit Ethernet applications. The second area of focus is Ethernet
based local area network devices. New product development in this area
includes three and five port switches for the SOHO market, switch products for
IP telephony, and switch products for business enterprises. The Company has
also developed a media access controller for the Gigabit Ethernet market and
has transceiver and switch products for Gigabit Ethernet applications in
development.
In 2003, 2002, and 2001 the Company spent $47.0 million $53.3 million, and
$51.3 million, respectively, on research and development. The Company expects
that it will continue to spend substantial funds on research and development
activities. The Company is currently developing, and may in the future
develop, certain types of standard products with which the Company has only
limited experience. Certain of these new standard products will be targeted at
emerging market segments in which the Company has not previously participated.
Additionally, there can be no assurance that the Company will be able to
identify new standard product opportunities successfully and develop and bring
to market such new products or that the Company will be able to respond
effectively to new technological changes or new product announcements by
others.
13
Patents and Intellectual Property Protection
The Company seeks patent protection for those inventions and technologies
for which such protection is suitable and is likely to provide competitive
advantage to the Company. The Company currently holds 93 United States patents
on semiconductor devices and methods, with various expiration dates through
2020. The Company has applications for 80 United States patents pending. The
Company holds 50 issued foreign patents and has applications for 9 foreign
patents pending. 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 to the Company or that
any of the Company's pending or future patent applications will issue or will
be issued with the scope of the claims sought by the Company.
The semiconductor industry is characterized by frequent litigation
regarding patent and other intellectual property rights. To the extent that
the Company becomes involved in such intellectual property litigation, it
could result in substantial costs and diversion of resources to the Company
and could have a material adverse effect on the Company's financial condition,
results of operations, or cash flows. See Note 11 of Notes to Consolidated
Financial Statements.
Supply of Materials and Purchased Components
Micrel currently purchases certain components from a limited group of
vendors. The packaging of the Company's products is performed by, and certain
of the raw materials included in such products are obtained from, a limited
group of suppliers. The wafer supply for the Company's Ethernet products is
currently dependent upon a single large third-party wafer foundry supplier.
Although the Company seeks to reduce its dependence on its sole and limited
source suppliers, disruption or termination of any of these sources could
occur and such disruptions could have an adverse effect on the Company's
financial condition, results of operations, or cash flows. The Company has
rarely experienced delays in obtaining raw materials which have adversely
affected production.
Manufacturing
The Company produces the majority of its wafers at the Company's wafer
fabrication facility located in San Jose, California while a small percentage
of wafer fabrication is subcontracted to outside foundries, including 100% of
Micrel's Ethernet product wafer requirements. The San Jose facility includes a
57,000 square foot office and manufacturing facility containing a 28,000
square foot clean room facility, which provides production processes. The San
Jose facility is classified as a Class 10 facility, which means that the
facility achieves a clean room level of fewer than 10 foreign particles larger
than 0.5 microns in size in each cubic foot of space. The facility uses six-
inch wafer technology. The Company also owns approximately 63,000 square feet
of additional adjacent space in San Jose that is used as a testing facility.
The fabrication of ICs is a highly complex and precise process. Minute
impurities, contaminants in the manufacturing environment, difficulties in the
fabrication process, defects in the masks used to print circuits on a wafer,
manufacturing equipment failure, wafer breakage or other factors can cause a
substantial percentage of wafers to be rejected or numerous die on each wafer
to be nonfunctional. There can be no assurance that the Company in general
will be able to maintain acceptable manufacturing yields in the future.
Generally, each die on the Company's wafers is electrically tested for
performance, and most of the wafers are subsequently sent to independent
assembly and final test contract facilities in Malaysia and certain other
Asian countries. At such facilities, the wafers are separated into individual
14
circuits and packaged. The Company's reliance on independent assemblers may
subject the Company to longer manufacturing cycle times. The Company from time
to time has experienced competition with respect to these contractors from
other manufacturers seeking assembly of circuits by independent contractors.
Although the Company currently believes that alternate foreign assembly
sources are readily available, there can be no assurance that such alternate
sources could be obtained without significant interruptions.
The Company manufactures the majority of its products at one wafer
fabrication facility. Given the nature of the Company's products, it would be
difficult to arrange for independent manufacturing facilities to supply such
products. Any prolonged inability to utilize the Company's manufacturing
facilities as a result of fire, utility interruptions, natural disaster or
otherwise, would have a material adverse effect on the Company's financial
condition, results of operations and cash flows.
Competition
The semiconductor industry is highly competitive and subject to rapid
technological change. Significant competitive factors in the market for
standard products include product features, performance, price, the timing of
product introductions, the emergence of new technological standards, quality
and customer support. The Company believes that it competes favorably in all
of these areas.
Because the standard products market for analog ICs is diverse and highly
fragmented, the Company encounters different competitors in its various market
areas. The Company's principal analog circuit competitors include Linear
Technology Corporation, Maxim Integrated Products, Inc., and National
Semiconductor Corp. in one or more of its product areas. Other competitors
include Texas Instruments, Motorola, Fairchild Semiconductor, Semtech and On
Semiconductor. Each of these companies has substantially greater technical,
financial and marketing resources and greater name recognition than the
Company. The Company's principal competitors for products targeted at the high
bandwidth communications market are On Semiconductor, Applied Micro Circuits
Corp., Maxim Integrated Products, Inc., Vitesse Semiconductor Corp.,
Integrated Circuit Systems, and Mindspeed. The primary competitors for
Micrel's Ethernet products are Broadcom Corp., Marvell Technology Group Ltd.
and a number of Taiwanese companies.
With respect to the custom and foundry products business, significant
competitive factors include product quality and reliability, established
relationships between customers and suppliers, timely delivery of products and
price. The Company believes that it competes favorably in all these areas.
Backlog
At December 31, 2003, the Company's backlog was approximately $40 million,
all of which was scheduled to be shipped during the first six months of 2004.
At December 31, 2002, the Company's backlog was approximately $27 million.
Orders in backlog are subject to cancellation or rescheduling by the customer,
generally with a cancellation charge in the case of custom and foundry
products. The Company's backlog consists of distributor and customer released
orders requesting shipment within the next six months. Shipments to United
States, Canadian and certain other international distributors who receive
significant return rights and price adjustments from the Company are not
recognized as revenue by the Company until the product is sold from the
distributor stock and through to the end-users. Because of possible changes in
product delivery schedules and cancellation of product orders and because an
increasing percentage of the Company's sales are shipped in the same quarter
that the orders are received, the Company's backlog at any particular date is
not necessarily indicative of actual sales for any succeeding period.
15
Environmental Matters
Federal, state and local regulations impose various environmental controls
on the storage, handling, discharge and disposal of chemicals and gases used
in the Company's manufacturing process. The Company believes that its
activities conform to present environmental regulations. Increasing public
attention has, however, been focused on the environmental impact of
semiconductor operations. While the Company has not experienced any materially
adverse effects on its operations from environmental regulations, there can be
no assurance that changes in such regulations will not impose the need for
additional capital equipment or other requirements or restrict the Company's
ability to expand its operations. Any failure by the Company to restrict the
discharge of hazardous substances adequately could subject the Company to
future liabilities or could cause its manufacturing operations to be
suspended.
Employees
As of December 31, 2003, the Company had 779 full-time employees. The
Company's employees are not represented by any collective bargaining
agreements, and the Company has never experienced a work stoppage. The Company
believes that its employee relations are good.
ITEM 2. PROPERTIES
The majority of the Company's manufacturing operations are located in San
Jose, California in a 57,000 square foot facility and an adjacent 63,000
square foot facility which are owned by the Company. The Company fabricates
the majority of its wafers at this location in a 28,000 square foot clean room
facility, which provides all production processes. In addition to wafer
fabrication, the Company also uses this location as a testing facility. The
Company's main executive, administrative, and technical offices are located in
another 57,000 square foot facility in San Jose, California under a lease
agreement that expires in April 2011.
Associated with the acquisition of ETC, the company owns a 12,175 square
foot design facility in Huxley, Iowa.
The Company also leases small sales and technical facilities located in
Medford, NJ; Coppell, TX; Seattle, WA; Irvine, CA; Raleigh, NC; Seoul, Korea;
Taipei, Taiwan; Shenzhen, P.R. China; Tokyo, Japan; Newbury, U.K.; Livingston,
Scotland; Frankfurt, Germany and Courtaboeuf Cedex, France.
The Company believes that its existing and planned facilities are adequate
for its current manufacturing needs. The Company believes that if it should
need additional space, such space would be available at commercially
reasonable terms.
16
ITEM 3. LEGAL PROCEEDINGS
On February 26, 1999, the Lemelson Medical, Education & Research Foundation
(the "Lemelson Partnership") filed a complaint which was served on the Company
on June 15, 1999, entitled Lemelson Medical, Education & Research Foundation,
Limited Partnership v. Lucent Technologies Inc., et al. in the United States
District Court in Phoenix, Arizona, against eighty-eight defendants, including
the Company, alleging infringement of Lemelson Foundation patents. The
complaint in the lawsuit seeks unspecified compensatory damages, treble
damages and attorneys' fees, as well as injunctive relief against further
infringement of the Lemelson patents at issue. The case is currently in the
motion and hearing phase. The Company intends to continue to defend itself
against these claims.
On May 9, 1994, Linear Technology Corporation ("Linear" or "LTC"), a
competitor of the Company, filed a complaint against the Company, entitled
Linear Technology Corporation v. Micrel, Incorporated, in the United States
District Court in San Jose, California, alleging patent and copyright
infringement and unfair competition. All claims, except the patent
infringement claim, have been settled or dismissed. The complaint in the
lawsuit seeks unspecified compensatory damages, treble damages and attorneys'
fees as well as preliminary and permanent injunctive relief against
infringement of the Linear patent at issue. On August 20, 1999, the United
States District Court in San Jose adjudicated in favor of the Company on a
motion, finding the patent to be invalid under the "on sale bar" defense as
the plaintiff had placed ICs containing the alleged invention on sale more
than a year before filing its patent application. The United States District
Court in San Jose dismissed the plaintiff's complaint on the merits of the
case and awarded the Company its legal costs. Linear appealed the trial
Court's decision to the United States Court of Appeal for the Federal Circuit
("CAFC") on September 17, 1999. On December 28, 2001, the CAFC reversed the
District Court's judgment of invalidity and remanded the case to the District
Court. After the Company's Petition for Rehearing En Banc by the Court of
Appeal was denied, the Company filed a Petition for Writ of Certiorari with
the Supreme Court of the United States, which Linear opposed. On May 19, 2003,
the Supreme Court denied the Petition for Writ of Certiorari. The District
Court subsequently determined a schedule for further discovery and hearing
matters before the Court. A claim construction hearing (also called a
"Markman" hearing) was held before the District Court on December 16, 2003.
The Court issued its ruling on January 24, 2004, interpreting the claims at
issue in the litigation. Furthermore, the parties have attended two settlement
conferences before the District Court. The Company intends to continue to
defend itself against the claims alleged in this litigation.
On December 27, 2002, the Company filed a complaint against TRW, Inc.
("TRW") entitled Micrel, Incorporated v. TRW, Inc., dba TRW Automotive
Electronics Group, in the United States District Court, Northern District of
Ohio, Eastern Division, alleging various causes of action relating to breach
of a relationship surrounding the development of certain custom products by
Micrel for TRW. In this lawsuit, Micrel is alleging that TRW breached various
agreements to assist in Micrel's development of, and to purchase, certain
Application Specific Integrated Circuits. The complaint seeks compensatory
damages, attorneys' fees and costs of suit. On February 24, 2003, TRW filed an
answer to the Company's complaint and a counterclaim alleging various causes
of action relating to breach of the above-mentioned relationship concerning
ASIC development. The Company intends to vigorously defend itself against
these counterclaims. The case is currently in the motion and discovery phase.
On April 21, 2003, the Company filed a complaint against its former
principal accountants Deloitte & Touche LLP ("Deloitte") entitled Micrel,
Incorporated v. Deloitte & Touche LLP in the Superior Court of the State of
California, County of Santa Clara, alleging various causes of action relating
to certain professional advice received by Micrel from Deloitte. In this
lawsuit, Micrel is alleging that Deloitte negligently rendered services as
accountants to Micrel, breached certain agreements with Micrel by failing to
perform services using ordinary skill and competence and in conformance with
generally accepted principles for such work and made certain false
representations upon which Micrel justifiably relied. As a direct result of
17
Deloitte's actions, Micrel alleges damages including: expenses incurred in the
form of payments to various professionals to address the impact on Micrel's
financial statements and other effects of the wrongful conduct; loss of cash
as well as equity from stock options; additional charges to earnings that
Micrel would not incur but for the wrongful advice; additional potential
liability for taxes; potential liability for tax penalties; and the harm to
Micrel in both financial and semiconductor markets resulting in loss of
overall value of the company as a whole. Deloitte has denied all allegations
in the complaint. The complaint seeks compensatory damages, costs of suit and
such other relief that the court may deem just and proper. The case is
currently in the discovery phase.
The Company believes that the ultimate outcome of the legal actions
discussed above will not result in a material adverse effect on the Company's
financial condition, results of operation or cash flows. However, litigation
is subject to inherent uncertainties, and no assurance can be given that the
Company will prevail in these lawsuits. Accordingly, the pending lawsuits, as
well as potential future litigation with other companies, could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
The semiconductor industry is characterized by frequent litigation
regarding patent and other intellectual property rights. To the extent that
the Company becomes involved in such intellectual property litigation, it
could result in substantial costs and diversion of resources to the Company
and could have a material adverse effect on the Company's financial condition,
results of operation or cash flows.
In the event of an adverse ruling in any intellectual property litigation
that now exists or might arise in the future, the Company might be required to
discontinue the use of certain processes, cease the manufacture, use and sale
of infringing products, expend significant resources to develop non-infringing
technology or obtain licenses to the infringing technology. There can be no
assurance, however, that under such circumstances, a license would be
available under reasonable terms or at all. In the event of a successful claim
against the Company and the Company's failure to develop or license substitute
technology on commercially reasonable terms, the Company's financial
condition, results of operations, or cash flows could be adversely affected.
Certain additional claims and lawsuits have been filed by or have arisen
against the Company in its normal course of business. The Company believes
that these claims and lawsuits will not have a material adverse effect on the
Company's financial condition, results of operation or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In the fourth quarter of 2003, no matters were submitted to a vote of
security holders.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's Common Stock is listed on the Nasdaq National Market under
the Symbol "MCRL." The range of daily closing sales prices per share for the
Company's Common Stock from January 1, 2002 to December 31, 2003 was:
Year Ended December 31, 2003: High Low
------- -------
Fourth quarter $ 18.02 $ 12.75
Third quarter $ 14.44 $ 9.54
Second quarter $ 12.55 $ 8.06
First quarter $ 11.12 $ 8.02
Year Ended December 31, 2002: High Low
------- -------
Fourth quarter $ 12.60 $ 4.57
Third quarter $ 15.19 $ 5.38
Second quarter $ 25.65 $ 13.83
First quarter $ 29.52 $ 18.95
The reported last sale price of the Company's Common Stock on the Nasdaq
National Market on December 31, 2003 was $15.56. The approximate number of
holders of record of the shares of the Company's Common Stock was 560 as of
March 1, 2004. This number does not include shareholders whose shares are held
in trust by other entities. The actual number of shareholders is greater than
this number of holders of record. The Company estimates that the number of
beneficial shareholders of the shares of the Company's Common Stock as of
March 1, 2004 was approximately 7,000.
The Company has authorized Common Stock, no par value and Preferred Stock,
no par value. The Company has not issued any Preferred Stock.
Dividend Policy
The Company has not paid any cash dividends on its capital stock. The
Company currently intends to retain its earnings to fund the development and
growth of its business and, therefore, does not anticipate paying any cash
dividends in the foreseeable future. In addition, the Company's existing
credit facilities prohibit the payment of cash or stock dividends on the
Company's capital stock without the lender's prior written consent. See Item 7
- - "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" and Note 6 of Notes to
Consolidated Financial Statements contained in Item 8.
19
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and
related notes thereto.
Years Ended December 31,
------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands, except per share amounts)
Income Statement Data:
Net revenues $211,726 $204,704 $217,808 $346,335 $200,016
Cost of revenues* 128,007 139,554 126,242 149,083 89,572
-------- -------- -------- -------- --------
Gross profit 83,719 65,150 91,566 197,252 110,444
-------- -------- -------- -------- --------
Operating expenses:
Research and development 46,953 53,308 51,306 42,201 29,563
Selling, general and
administrative 28,987 32,160 32,862 45,319 29,399
Amortization of deferred
stock compensation* 3,034 22,535 9,572 6,060 2,109
Manufacturing facility
impairment (624) 23,357 - - -
Restructuring expense 286 5,536 - - -
Acquisition expenses* - - 8,894 - -
Purchased in-process
technology - - - - 603
-------- -------- -------- -------- --------
Total operating expenses 78,636 136,896 102,634 93,580 61,674
-------- -------- -------- -------- --------
Income (loss) from operations 5,083 (71,746) (11,068) 103,672 48,770
Other income, net 619 1,056 6,086 4,739 692
-------- -------- -------- -------- --------
Income (loss) before
income taxes 5,702 (70,690) (4,982) 108,411 49,462
Provision (benefit) for
income taxes 855 (29,690) (5,534) 35,104 16,019
-------- -------- -------- -------- --------
Net income (loss) $ 4,847 $(41,000) $ 552 $ 73,307 $ 33,443
======== ======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.05 $ (0.44) $ 0.01 $ 0.82 $ 0.39
======== ======== ======== ======== ========
Diluted $ 0.05 $ (0.44) $ 0.01 $ 0.75 $ 0.36
======== ======== ======== ======== ========
Shares used in computing per
share amounts:
Basic 92,215 92,600 91,888 89,242 85,762
======== ======== ======== ======== ========
Diluted 93,786 92,600 98,092 98,186 92,906
======== ======== ======== ======== ========
*Amortization of deferred
stock compensation related to:
Cost of revenues $ 1,104 $ 7,354 $ 3,141 $ 2,202 $ 926
======== ======== ======== ======== ========
Operating expenses:
Research and development $ 1,604 $ 11,430 $ 5,047 $ 3,347 $ 1,444
Selling, general and
administrative 1,430 11,105 4,525 2,713 665
-------- -------- -------- -------- --------
Amortization of deferred
stock compensation 3,034 22,535 9,572 6,060 2,109
Acquisition expenses - - 2,007 - -
-------- -------- -------- -------- --------
Total operating expenses $ 3,034 $ 22,535 $ 11,579 $ 6,060 $ 2,109
======== ======== ======== ======== ========
December 31,
------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands)
Balance Sheet Data:
Working capital $195,026 $182,155 $196,940 $172,768 $ 91,629
Total assets 337,439 330,675 354,813 359,748 214,171
Long-term debt and other
obligations 8,179 19,237 5,200 9,211 10,648
Total shareholders' equity 283,609 273,619 313,330 281,835 157,258
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Rapid growth in dollar shipments of semiconductors of 38% in 2000 was
followed by the most severe downturn in the history of the semiconductor
industry in 2001. Customer demand for the Company's products declined sharply
in 2001 as customers reacted to the economic recession in the United States
and high inventory levels of semiconductor components by reducing order rates.
The resulting environment, which continued from the beginning of 2001 through
the second quarter of 2003, was characterized by reduced demand for the
Company's products, especially from customers serving the high speed
communications market, and by poor visibility into future customer demand. The
Company's gross profit and net income declined in 2001 and 2002 due to lower
unit volume, declining selling prices for the Company's products and an
increased level of unabsorbed fixed costs due to lower utilization levels of
the Company's wafer fabrication lines. In response to this environment, the
Company focused on reducing costs in 2001, 2002 and 2003.
The Company's objective was to align its cost structure with the reduced
revenue levels while retaining sufficient manufacturing capacity, and
sustaining a level of research and development investment that should
facilitate future growth. In addition to reducing discretionary spending and
payroll costs, the Company sought to significantly reduce its manufacturing
costs. One of the Company's most significant cost reduction actions was the
consolidation of its Santa Clara, California wafer fabrication operation into
its San Jose, California wafer fabrication facility. This action commenced in
2002 and was completed in 2003. By the end of 2003, the Company's
manufacturing cost reduction efforts had offset a substantial portion of the
erosion in gross profit resulting from the decline in average selling prices
(see the discussion regarding gross margin). The Company continued to invest
in research and development at a rate in excess of 20% of revenues while
selling, general and administrative spending was reduced to a level in 2003
which approached 1999 spending. Throughout the 2001 to 2003 period the Company
continued to generate positive cash flows from operations.
As a result of its cost reduction actions, the Company returned to
profitability in 2003 after recording a loss on an annual basis for the first
time in its history in 2002 primarily due to the effect of charges related to
the manufacturing consolidation and from the one time acceleration of stock
compensation expense due to the Company's stock option exchange offer. The
first half of 2003 was characterized by the continuation of limited visibility
into, and uncertainty of, customer demand. The uncertainty of demand was
compounded in the first half of 2003 by events such as the war in Iraq and the
outbreak of severe acute respiratory syndrome in Asia ("SARS"). The Company's
quarterly revenues remained relatively flat, averaging $50 million per quarter
for the first half of 2003. The Company recorded a small net loss for this
period. In the second half of 2003, customer demand increased as the United
States' and Asian economies began to grow more rapidly. The Company's new
order rates, or bookings, grew faster than revenue in the third and fourth
quarter of 2003, resulting in sequential growth in both revenues and order
backlog. The growth in new orders and revenues in the second half of 2003 was
driven by demand for the Company's standard products from customers serving
the communications, computing, industrial and wireless handset end markets.
Gross margins and net income increased in the second half of 2003.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company derives a substantial portion of its net revenues from standard
products. For 2003, 2002 and 2001 the Company's standard products sales
accounted for 90%, 88%, and 84%, respectively, of the Company's net revenues.
The Company believes that a substantial portion of its net revenues in the
future will depend upon standard products sales, although such sales as a
proportion of net revenues may vary as the Company adjusts product output
levels to correspond with varying economic conditions and demand levels in the
markets which it serves. The standard products business is characterized by
short-term orders and shipment schedules, and customer orders typically can be
canceled or rescheduled without significant penalty to the customer. Since
most standard products backlog is cancelable without significant penalty, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand, which is highly unpredictable and can fluctuate
substantially. In addition, the Company is limited in its ability to reduce
costs quickly in response to any revenue shortfalls.
Critical Accounting Policies and Estimates
The 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 the Company's significant accounting policies, see Note 1 of Notes to
Consolidated Financial Statements. 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.
Revenue Recognition and Receivables. Micrel generates revenue by selling
products to original equipment manufacturers ("OEM"s), distributors and
stocking representatives. Stocking representative firms may buy and stock the
Company's products for resale or may act as the Company's sales representative
in arranging for direct sales from the Company to an OEM customer. The
Company's policy is to recognize revenue from sales to customers when the
rights and risks of ownership have passed to the customer, when persuasive
evidence of an arrangement exists, the product has been delivered, the price
is fixed or determinable and collection of the resulting receivable is
reasonably assured.
Micrel allows certain distributors, primarily located in North America and
Europe, significant return rights, price protection and pricing adjustments
subsequent to the initial product shipment. Micrel defers recognition of
revenue and related cost of sales (in the balance sheet line item "deferred
income on shipments to distributors") derived from sales to these distributors
until they have resold the Company's products to their customers. Sales to OEM
customers and stocking representatives, primarily located in Asia, which have
limited return rights and pricing adjustments, are recognized upon shipment
and a related returns allowance is established based upon historical return
rates. The Company's total allowance for returns was $2.7 million and $2.9
million as of December 31, 2003 and 2002, respectively. Actual future returns
could be different than the returns allowance established.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company also maintains an allowance for doubtful accounts for estimated
uncollectible accounts receivables. This estimate is based on an analysis of
specific customer creditworthiness and historical bad debts experience. The
Company's total allowance for doubtful accounts was $180,000 and $421,000 as
of December 31, 2003 and 2002, respectively. Actual future uncollectible
amounts could exceed the doubtful accounts allowance established.
Inventory Valuation. Inventories are stated at the lower of cost (first-in,
first-out method) or market. The Company records adjustments to write down the
cost of obsolete and excess inventory to the estimated market value based on
historical and forecasted demand for its products. If actual future demand for
the Company's products is less than currently forecasted, additional inventory
adjustments may be required. Once a reserve is established, it is maintained
until the product to which it relates is sold or otherwise disposed of. This
treatment is in accordance with Accounting Research Bulletin 43 and SEC Staff
Accounting Bulletin 100 "Restructuring and Impairment Charges."
Income Taxes. Deferred tax assets and liabilities result primarily from
temporary timing differences between book and tax valuation of assets and
liabilities, state and federal research and development credit carryforwards
and state manufacturers credit carryforwards. The Company had net deferred tax
assets of $36.8 million as of December 31, 2003, as compared to $40.4 million
as of December 31, 2002. The reduction in deferred assets resulted primarily
from the reversal of temporary timing differences associated with the closure
of the Company's Santa Clara, CA wafer fabrication facility during 2003.
The Company must assess the likelihood that future taxable income levels
will be sufficient to ultimately realize the tax benefits of these deferred tax
assets. As of December 31, 2003, 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 11 of Notes to 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.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Results of Operations
The following table sets forth certain operating data as a percentage of
total net revenues for the periods indicated.
Years Ended
December 31,
----------------------------
2003 2002 2001
-------- -------- --------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 60.5 68.2 58.0
-------- -------- --------
Gross profit 39.5 31.8 42.0
-------- -------- --------
Operating expenses:
Research and development 22.2 26.0 23.6
Selling, general and administrative 13.7 15.7 15.1
Amortization of deferred stock compensation 1.4 11.0 4.4
Manufacturing facility impairment (0.3) 11.4 -
Restructuring expense 0.1 2.7 -
Acquisition expenses - - 4.0
-------- -------- --------
Total operating expenses 37.1 66.8 47.1
-------- -------- --------
Income (loss) from operations 2.4 (35.0) (5.1)
Other income, net 0.3 0.5 2.8
-------- -------- --------
Income (loss) before income taxes 2.7 (34.5) (2.3)
Provision (benefit) for income taxes 0.4 (14.5) (2.6)
-------- -------- --------
Net income 2.3% (20.0)% 0.3%
======== ======== ========
Net Revenues. Net revenues increased 3% to $211.7 million for the year
ended December 31, 2003 from $204.7 million in 2002 primarily due to increased
standard product revenues, which were partially offset by decreased custom and
foundry revenues.
Standard product revenues increased 6% to $191.1 million, which represented
90% of net revenues for the year ended December 31, 2003, compared to $180.4
million and 88% of net revenues for 2002. This increase resulted primarily
from increased unit shipments of industrial, telecommunications, computer and
communications products, which was partially offset by decreased average
selling prices across all significant standard product lines.
Custom and foundry revenues decreased 15% to $20.6 million, which
represented 10% of net revenues for the year ended December 31, 2003, compared
to $24.3 million and 12% of net revenues for 2002. Such decreases were due
primarily to decreased unit shipments of foundry products. Demand from the
Company's largest foundry customer declined during 2003 and the Company
expects that foundry revenues will decrease in 2004.
Customer demand for semiconductors can change quickly and unexpectedly. As
a result of the slowing global economy, a rapid build-up of semiconductor
inventories in global sales channels occurred during 2001, causing lead times
for components to fall precipitously. Although it is generally believed that
industry wide channel inventories have decreased substantially since 2001, the
short lead time environment has continued from the middle of 2001 through the
end of 2003 as a result of underutilization of manufacturing capacity and
relatively high levels of work-in-process inventories within the semiconductor
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
industry. For over two years, customers have perceived that semiconductor
components have been readily available and have ordered only for their short-
term needs, resulting in historically low order backlog levels. The Company's
revenue levels have been highly dependent on the amount of new orders that are
received for which product is requested to be delivered to the customer within
the same quarter. Within the semiconductor industry these orders that are
booked and shipped within the quarter are called "turns fill" orders. When the
turns fill level exceeds approximately 35% of quarterly revenue, it makes it
very difficult to predict near term revenues and income. Because of the long
cycle time to build its products, the Company's lack of visibility into
demand when turns fill is high makes it difficult to predict what product
to build to match future demand. The Company averaged approximately 55% turns
fill during 2003. The Company believes the current high turns fill
requirements and pricing pressure will continue until lead times substantially
increase and order backlogs grow. The Company experienced an increase in order
rates and backlog in the second half of 2003, indicating that demand for
semiconductors may be increasing and that customers may be becoming more
concerned about product availability. When lead times, order backlog and
industry-wide capacity utilization increase, as they did at the end of 2003,
the semiconductor industry historically has experienced four to six quarters
of growth. However, the sustainability of improved customer demand is
uncertain and highly dependent on economic conditions. The high turns fill
requirement together with the uncertainty of product mix and pricing, make it
difficult to predict future levels of sales and profitability and may require
the Company to continue to carry higher levels of inventory.
For the year ended December 31, 2002, net revenues decreased 6% to $204.7
from $217.8 million in 2001 primarily due to lower custom and foundry revenues
and, to a lesser extent, lower standard product revenues. Standard product
revenues decreased 1% to $180.4 million, which represented 88% of net revenues
for the year ended December 31, 2002, compared to $183.1 million and 84% of
net revenues for 2001. This decrease resulted primarily from decreased average
selling prices across all product lines combined with decreased unit shipments
of high bandwidth communications products, which were partially offset by
increased unit shipments of telecommunications, computer and industrial and
Ethernet communications products. Custom and foundry revenues decreased 30% to
$24.3 million, which represented 12% of net revenues for the year ended
December 31, 2002, compared to $34.7 million and 16% of net revenues for 2001.
Such decreases were due primarily to decreased unit shipments of foundry
products.
International sales represented 70%, 69%, and 61% of net revenues for the
years ended December 31, 2003, 2002 and 2001, respectively. On a dollar basis,
international sales increased 4% to $147.8 million for the year ended
December 31, 2003 from $142.0 million for the comparable period in 2002. The
dollar increase in international sales resulted primarily from increased
shipments of telecommunications, personal computer and Ethernet communications
products, primarily in Asia, which were partially offset by decreased average
selling prices.
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.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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. The Company's gross margin increased
to 40% for the year ended December 31, 2003 from 32% for the year ended
December 31, 2002. The increase in gross margin primarily reflected decreased
wafer fabrication costs resulting from the Company's wafer fabrication
consolidation plan (see Note 13 of Notes to Consolidated Financial Statements),
lower costs for external assembly and test manufacturing services and lower
amortization of deferred stock compensation costs (see discussion of
"Amortization of Deferred Stock Compensation" below), which were partially
offset by a reduction in average selling prices as compared to the same periods
in 2002.
For the year ended December 31, 2002, the Company's gross margin decreased
to 32% from 42% for the year ended December 31, 2001. The decrease in gross
margin primarily reflected decreased average selling prices, a greater sales
mix of lower margin products and decreased capacity utilization as compared to
the same periods in 2001.
After recording a gross margin of 57% in 2000, the Company has experienced
lower gross margins over the past three years. As the Company grew rapidly in
1999 and 2000, its capital expenditures increased to keep pace with customer
demand. When demand for the Company's products fell sharply beginning in 2001,
the increased depreciation from the fixed asset expansion caused depreciation
and other fixed manufacturing costs to increase as a percent of revenues
causing gross margins to decline. Gross margins were also unfavorably affected
by the sizeable decline in sales of the Company's high bandwidth products
concurrent with the downturn in the semiconductor industry. These products
typically have higher average product margins than the rest of the Company's
product portfolio. The excess channel inventory and reduced demand environment
in 2001 and 2002 resulted in pricing pressure on virtually all products sold by
semiconductor manufacturers. The Company experienced price declines for its
products during this period and has reduced its manufacturing costs in response
to lower market prices. The average selling price for the Company's standard
products declined by approximately 53% from 2000 to 2003, while the gross
profit margin declined by 17% from 57% to 40%, highlighting the magnitude of
the overall cost reductions that have been achieved over the past three years.
While the company was able to significantly reduce its costs over the past
three years, the reductions were not sufficient to fully offset the decline in
average selling prices.
If the global economy continues to expand, resulting in continued increases
in demand for the Company's products, the Company believes that gross margin
should increase in future periods. The Company currently has the ability to
increase manufacturing output in response to higher customer demand. Should
this occur, the Company's fixed cost will be spread over a larger sales volume
which should result in a higher gross margin.
Research and Development Expenses. Research and development expenses
include costs associated with the development of new processes and the
definition, design and development of new products. The Company also expenses
prototype wafers and new production mask sets related to new products as
research and development costs until products based on new designs are fully
characterized by the Company and are demonstrated to support published data
sheets and satisfy reliability tests.
As a percentage of net revenues, research and development expenses
represented 22% and 26% for the years ended December 31, 2003 and 2002,
respectively. On a dollar basis, research and development expenses decreased
$6.4 million or 12% to $47.0 million for the year ended December 31, 2003 from
$53.3 million in 2002. The decrease was primarily due to decreased prototype
fabrication costs combined with reduced staffing costs and reduced mask costs.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
For the years ended December 31, 2002 and 2001, research and development
expenses represented 26% and 24% of net revenues, respectively. On a dollar
basis, research and development expenses increased $2.0 million or 4% to $53.3
million for the year ended December 31, 2002 from $51.3 million in 2001. The
increase was primarily due to increased prototype fabrication and new process
development costs.
Selling, General and Administrative Expenses. As a percentage of net
revenues, selling, general and administrative expenses represented 14% and 16%
for the years ended December 31, 2003 and 2002, respectively. On a dollar
basis, selling, general and administrative expenses decreased $3.2 million or
10% to $29.0 million for the year ended December 31, 2003 from $32.2 million
for the comparable period in 2002. The decrease was principally attributable
to decreased outside legal costs combined with decreased advertising expenses.
For the years ended December 31, 2002 and 2001, selling, general and
administrative expenses represented 16% and 15% of net revenues, respectively.
On a dollar basis, selling, general and administrative expenses decreased
$700,000 or 2% to $32.2 million for the year ended December 31, 2002 from
$32.9 million for the comparable period in 2001. The decrease was principally
attributable to decreased sales commissions and decreased staffing expenses,
which were partially offset by increased legal costs.
Amortization of Deferred Stock Compensation. For the year ended December
31, 2003, total amortization of deferred stock compensation was $4.1 million
compared to $29.9 million in 2002. This decrease resulted primarily from $17.1
million in accelerated amortization in 2002 which resulted from options
cancelled pursuant to an employee option exchange program (see Note 7 of Notes
to Consolidated Financial Statements).
Manufacturing Facility Impairment and Restructuring Expense. In September
2002, the Company approved a plan to close its Santa Clara, CA wafer
fabrication facility to reduce costs and improve operating efficiencies.
Associated with the facility closure, the Company accrued $5.5 million in
estimated restructuring expenses primarily for equipment disposal costs of
$1.0 million and $4.5 million for contractual building lease costs, less
estimated sublease income, that will provide no future benefit.
During 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 2003, the Company paid $1.3 million in
restructuring costs that reduced the previous restructuring accrual and
recorded an additional $286,000 in net restructuring accrual adjustments which
were charged to restructuring expense in 2003. As of December 31, 2003, the
remaining restructuring accrual was $4.5 million (see Note 13 of Notes to
Consolidated Financial Statements). Actual future costs or sublease income may
be different than these estimates and would require an adjustment to
restructuring expense in the period such determination is made.
Also related to the facility closure, in September 2002, the Company
recorded a $23.4 million impairment of long-lived assets to reduce the net
book value of the facility's leasehold improvements and equipment to fair
value. The fair value was based on a third-party estimate of the current net
sales value. During 2003, the Company sold previously impaired equipment
resulting in a $624,000 gain which has been recorded as a credit to the
manufacturing facility impairment expense.
Acquisition Expenses. Acquisition expenses for the year ended December 31,
2001, reflect $6.9 million in direct transaction costs and $2.0 million in
stock compensation costs related to the acquisition of Kendin.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Other Income, Net. Other income, net reflects interest income from
investments in short-term investment grade securities and money market funds
and other non-operating income, offset by interest expense incurred on term
notes. Other income, net decreased by $437,000 to $619,000 in 2003 from $1.1
million in 2002. The decrease was primarily due to decreased rates of return
on cash, cash equivalents and short-term investments as compared to the prior
year. In addition, the 2002 results included a $947,000 expense for the
settlement of a patent dispute and a credit of $490,000 in other income.
For the year ended December 31, 2002, other income, net decreased by $5.0
million to $1.1 million in 2002 from $6.1 million in 2001. The decrease was
primarily due to decreased rates of return on cash, cash equivalents and
short-term investments combined with an expense in 2002 of $947,000 for the
settlement of a patent dispute, partially offset by $490,000 in other income.
Provision (benefit) for Income Taxes. For the year ended December 31, 2003,
the provision for income taxes was $855,000 or 15% of income before taxes. The
2003 provision for income taxes differs from taxes computed at the federal
statutory rate primarily due to the effect of state income taxes, state
research and development credits, and state manufacturing credits. For the
years ended December 31, 2002 and 2001, the provision for taxes on income was
42% and 111% of loss before taxes, respectively. The 2002 and 2001 income tax
provisions differ from taxes computed at the federal statutory rate due to the
effect of state taxes offset by the benefits federal and state research and
development credits, and state manufacturing credits.
Liquidity and Capital Resources
Since inception, the Company's principal sources of funding have been its
cash from operations, bank borrowings and sales of common stock. Principal
sources of liquidity at December 31, 2003, consisted of cash and short-term
investments of $140 million and a $5 million revolving line of credit from a
commercial bank. The revolving line of credit agreement includes a provision
for the issuance of commercial or standby letters of credit by the bank on
behalf of the Company. The value of all letters of credit outstanding reduces
the total line of credit available. There were no borrowings under the
revolving line of credit at December 31, 2003 and there were $550,000 in
standby letters of credit outstanding. The revolving line of credit agreement
expires on June 30, 2005. Borrowings under the revolving line of credit bear
interest rates of, at the Company's election, the prime rate (4.0% at
December 31, 2003), or the bank's revolving offshore rate, which approximates
LIBOR (1.15% at December 31, 2003) 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 December 31, 2003.
In September 2002, the Company borrowed $10.7 million through a commercial
mortgage financing agreement which was associated with the purchase of its
previously leased manufacturing facilities in San Jose, CA. Borrowings under
this agreement bear interest, at the Company's election, at the daily floating
prime rate (4.0% at December 31, 2003), or adjustable monthly LIBOR (1.15% at
December 31, 2003) plus 1.5%. The principal balance of the loan shall be paid
in 59 consecutive monthly installments of $16,890 and one final installment in
the amount necessary to pay in full the remaining outstanding principal
balance, with no early payment penalty. In December 2003, the company repaid
$7.0 million of the loan, resulting in a remaining loan balance of $3.5
million at December 31, 2003. The mortgage agreement contains certain
restrictive covenants with which the Company was in compliance at December 31,
2003.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company generated $50.7 million in cash flows from operating activities
for the year ended December 31, 2003 compared to $28.7 million for the year
ended December 31, 2002. The $22.0 million increase in cash flows provided by
operating activities in 2003 compared with 2002 was primarily due to a $11.0
million increase to net income adjusted for non-cash activities ($4.8 million
net income plus $35.9 million in non-cash activities in 2003 compared to a
$41.0 million net loss plus $70.8 million in non-cash activities in 2002)
combined with $12.5 million cash flow increase due to reduced inventory levels
in 2003 as compared to 2002 (2003 inventory decrease provided $8.4 million in
cash flow as compared to a use of cash in 2002 by an inventory increase of
$4.1 million.)
For the year ended December 31, 2003, cash flows provided by operating
activities of $50.7 million were primarily attributable to net income after
adding back non-cash activities of $40.7 million combined with a $8.4 million
decrease in inventory, a $2.4 million increase in deferred income, a $4.2
million increase in income taxes payable, which were partially offset by a
$3.5 million increase in accounts receivable and $2.0 million decrease in all
other accrued liabilities.
For the year ended December 31, 2002, cash flows provided by operating
activities of $ 28.7 million were primarily attributable to net income after
adding back non-cash activities. Net income after adding back non-cash
activities consisted of a $41.0 million net loss offset by non-cash activities
of $70.8 million. Non-cash activities for 2002 included additions of $33.9
million for depreciation and amortization, $29.9 million for stock
compensation and $23.4 million for manufacturing facility impairment which
were partially offset by a $15.9 increase in net deferred income tax assets.
The Company's investing activities during the year ended December 31, 2003,
used cash of $21.1 million, $7.4 million less than in 2002. This decrease in
cash used for investing activities was primarily due to an $18.0 million
facility purchase included in 2002, which was partially offset by increased
capital expenditures in 2003. Cash used for investing activities during the
year ended December 31, 2003 of $21.1 million resulted from net purchases of
property, plant and equipment.
Cash used for investing activities during the year ended December 31, 2002
of $28.5 million resulted primarily from $29.5 in net purchases of property,
plant and equipment, which includes $18.0 million for the purchase of the
Company's previously leased manufacturing facilities located in San Jose,
California, combined with the purchase of $2.1 million in intangible assets,
which was partially offset by $3.1 million in sales of short-term investments.
The Company's financing activities during the year ended December 31, 2003,
used cash of $6.9 million as compared to cash used of $13.2 million during the
year ended December 31, 2002. This decrease in cash flow used primarily
resulted from a decrease in cash used to repurchase shares of the Company's
common stock which was partially offset by reduced borrowing.
Cash used by financing activities during the year ended December 31, 2003
of $6.9 million was the result of $7.9 million in repayments of long-term debt
combined with $6.5 million to repurchase 492,450 shares of common stock, which
was partially offset by proceeds from the issuance of common stock through
employee stock transactions of $7.5 million.
Cash used by financing activities during the year ended December 31, 2002
of $13.2 million was the result of $29.1 million to repurchase 2,274,300
shares of common stock and $3.8 million in repayments of long-term debt, which
was partially offset by proceeds from long-term debt borrowings of $10.7
million related to the purchase of the company's previously leased
manufacturing facilities and proceeds from the issuance of common stock
through employee stock transactions of $8.9 million.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Company currently intends to purchase approximately $20 million to $30
million in capital equipment and 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. The Company is currently authorized by its Board of Directors to
repurchase $25.0 million of its common stock through December 31, 2004. The
Company expects that its cash requirements through 2004 will be met by its cash
from operations, existing cash balances and short-term investments, and its
credit facility. Since inception, the Company's principal sources of funding
have been its cash from operations, bank borrowings and sales of common stock.
In the longer term, the Company believes future cash requirements will continue
to be met by its cash from operations, and future debt or equity financings as
required.
Contractual Obligations and Commitments
As of December 31, 2003, the Company had the following contractual
obligations and commitments (in thousands):
Payments Due By Period
------------------------------------------------
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
-------- -------- -------- -------- --------
Long-term debt (see Note 6
of Notes to Consolidated
Financial Statements) $ 3,983 $ 703 $ 405 $ 2,875 $ -
Operating leases (see Note 9
of Notes to Consolidated
Financial Statements) 12,218 2,557 5,029 2,066 2,566
Other long-term liabilities
(see Note 14 of Notes to
Consolidated Financial
Statements) 4,000 2,000 2,000 - -
Open purchase orders 24,845 24,845 - - -
-------- -------- -------- -------- --------
Total $ 45,046 $ 30,105 $ 7,434 $ 4,941 $ 2,566
======== ======== ======== ======== ========
Open purchase orders are defined as agreements to purchase goods or
services that are enforceable and legally binding and that specify all
significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum or variable pricing provisions; and the approximate timing of
the transactions. These obligations primarily relate to future purchases of
wafer fabrication raw materials, foundry wafers, assembly and testing services
and manufacturing equipment. The amounts are based on our contractual
commitments.
Borrowing agreements consisted of a $5 million revolving line of credit
from a commercial bank. The revolving line of credit agreement includes a
provision for the issuance of commercial or standby letters of credit by the
bank on behalf of the Company. The value of all letters of credit outstanding
reduces the total line of credit available. There were no borrowings under the
revolving line of credit at December 31, 2003 and there were $550,000 in
standby letters of credit outstanding. The letters of credit are issued to
guarantee payments for the Company's workers compensation program.
The Company has no other off-balance sheet arrangements and has not entered
into any transactions involving unconsolidated, limited purpose entities or
commodity contracts.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Factors That May Affect Operating Results
The statements contained in this Report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. Forward-looking statements
include: statements regarding future products or product development;
statements regarding future research and development spending and the
Company's product development strategy; statements regarding the levels of
international sales; statements regarding future expansion or utilization of
manufacturing capacity; statements regarding future expenditures; and
statements regarding current or future acquisitions. All forward-looking
statements included in this document are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update
any such forward-looking statements. It is important to note that our actual
results could differ materially from those in such forward-looking statements.
Some of the factors that could cause actual results to differ materially are
set forth in Item 1 ("Business"), Item 3 ("Legal Proceedings"), Item 7
("Management's Discussion and Analysis of Financial Condition and Results of
Operations") and in the additional factors set forth below.
The Company's operating results may fluctuate because of a number of factors,
many of which are beyond its control.
If the Company's operating results are below the expectations of public
market analysts or investors, then the market price of its Common Stock could
decline. Some of the factors that affect or may affect the Company's quarterly
and annual results, but which are difficult for the Company to control or
predict are:
- - the volume and timing of orders received
- - changes in the mix of products sold
- - market acceptance of the Company's products and its customers' products
- - competitive pricing pressures
- - cyclical semiconductor industry conditions
- - dependence on third-party suppliers
- - the ability to introduce new products on a timely basis
- - the timing of new product announcements and introductions by the Company or
its competitors
- - the timing and extent of research and development expenses
- - fluctuations in manufacturing yields
- - the ability to hire and retain key technical and management personnel
- - access to advanced process technologies
- - the timing and extent of new process development costs
Customer demand for the Company's products is volatile and difficult to
predict.
The Company's customers continuously adjust their inventories in response
to changes in end market demand for their products and the availability of
semiconductor components. This results in frequent changes in demand for the
Company's products. The volatility of customer demand limits the Company's
ability to predict future levels of sales and profitability. The supply of
semiconductors can quickly and unexpectedly match or exceed demand because end
customer demand can change very quickly. Also, semiconductor suppliers can
rapidly increase production output. This can lead to a sudden oversupply
situation and a subsequent reduction in order rates and revenues as customers
adjust their inventories to true demand rates. A rapid and sudden decline in
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
customer demand for the Company's products can result in excess quantities of
certain of the Company's products relative to demand. Should this occur the
Company's operating results may be adversely affected as a result of charges
to reduce the carrying value of the Company's inventory to the estimated
demand level or market price.
The weakness in the global economy in 2001, 2002, and 2003 has caused the
end markets that the Company's customers serve to grow less rapidly, or in
some cases, contract. The resulting uncertainty of demand has caused most of
the Company's customers to err on the side of caution until they see signs of
order strength for their end products. In this environment, customers are not
making large purchase commitments, instead, or