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MICREL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including statements regarding our expectations, hopes, intentions or strategies regarding the future. Forward-looking statements include, but are not limited to statements regarding: future revenues and dependence on product sales; the levels of international sales; the effect of global market conditions on revenue levels, profitability and results of operations; future products or product development; statements regarding fluctuations in our results of operations; future returns and price adjustments and allowance; future uncollectible amounts and doubtful accounts allowance; future products or product development; future research and development spending and our product development strategy; our markets, product features and performance; product demand and inventory to service such demand; competitive threats and pricing pressure; the effect of dependence on third parties; our future use and protection of its intellectual property; future expansion or utilization of manufacturing capacity; future expenditures; current or future acquisitions; the ability to meet anticipated short term and long term cash requirements; effect of changes in market interest rates on investments; our need and ability to attract and retain certain personnel; the cost and outcome of litigation and its effect on us; the future realization of tax benefits; and share-based incentive awards and expectations regarding future share-based compensation expense. In some cases, forward-looking statements can be identified by the use of forward-looking terminology such as "believe," "estimate," "may," "can," "will," "could," "would," "intend," "objective," "plan," "expect," "likely," "potential," "possible" or "anticipate" or the negative of these terms or other comparable terminology and similar expressions. All forward-looking statements included in this document are based on information available to us on the date of this Report, and we assume no obligation to update any such forward-looking statements, including risks discussed under "Risk Factors" and elsewhere in this Report, except as required by applicable law. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those expressed or implied by such forward-looking statements. Additional factors that may affect operating results are contained within the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Overview We design, develop, manufacture and market a range of high-performance analog power ICs, mixed-signal and digital ICs. These products address a wide range of end markets including cellular handsets, enterprise and portable computing, enterprise and home networking, wide area and metropolitan area networks and industrial equipment. We also manufacture custom analog and mixed-signal circuits and provide wafer foundry services for customers who produce electronic systems for communications, consumer and military applications. Our high performance linear and power products are characterized by high power density and small form factors. Presently, the demand for high performance linear and power circuits has been fueled by the growth of portable communications and computing devices, including for example, cellular handsets and tablet devices. We also have an extensive linear and power management product portfolio for the networking and communications infrastructure markets including cloud and enterprise servers, network switches and routers, storage area networks, wireless base stations, and the Internet of Everything. In addition, we offer products that serve the solid state drive market and are seeing strength in the emergence of solid state drives. We also offer an extensive portfolio of load switches and MOSFET drivers for industrial applications such as DC brushless motors. These products are gaining traction for applications in the power tool and fan markets. Our timing and communications circuits are used primarily for enterprise networks, storage area networks, access networks and metropolitan area networks. This product portfolio consists of timing, clock management and high-speed Physical Media Device ("PMD") products. With form factor, size reductions and ease-of-use critical for system designs, we utilize innovative packaging and proprietary process technology to address these challenges. In 2012, we acquired PhaseLink, a private company based in Taiwan and in San Jose, California, in order to complement our high performance clock generation and distribution products for the communication market and to expand our product offerings into the consumer and industrial markets. PhaseLink provides high performance integrated timing solutions to system and oscillator manufacturers. In September 2013, we acquired specific net assets of Discera, which uses micro-electrical mechanical system ("MEMS") resonators to compete with standard quartz oscillators and quartz oscillator-based clock generators. We acquired Discera to complement our high performance clock and timing products, as well as expand our MEMS capabilities. With the acquisition of PhaseLink and Discera, coupled with our organic product development, we now offer a comprehensive portfolio of clock generation and clock distribution products. 18-------------------------------------------------------------------------------- Table of Contents Our family of local area network ("LAN") solutions products targets the digital home, unified communications, industrial, Internet of Everything, and automotive markets. This product portfolio consists of physical layer transceivers ("PHY"), Media Access Controllers ("MAC"), switches and high value Application Specific Standard Products ("ASSP") comprising analog, mixed signal and digital functions that support transmission speeds from 10 Megabits per second to one Gigabit per second. In order to increase value to our customers, we have continued to transition our LAN solutions portfolio to higher function switch and ASSP products including VoIP. This transition is intended to better align our products with the emergence of cloud based services and the rapidly expanding Internet of Things ("IoT"). Our foundry business offers foundry services to commercial, military, and MEMS IC designers and all manufacturers seeking a production solution compatible with their specific application and/or technology needs. We offer various combinations of design, process and wafer foundry services including MEMS manufacturing capability. MEMS are highly specialized devices used in a wide variety of devices, including pressure, temperature, chemical and vibration sensors, light reflectors and switches as well as accelerometers for airbags, vehicle controls and games. We fabricate wafers for customers using our standard processes, their existing processes or customized processes we develop for them. We currently operate in one segment: the design, manufacturing, marketing and sale of semiconductor products. The chief operating decision maker, the President and CEO, evaluates our financial performance and allocates resources on a company-wide basis. During the third quarter of 2014, we amended the terms of our agreements with certain sell-through distributors. These amendments included the removal of significant return rights, price protection and pricing adjustments subsequent to the initial product shipment. Therefore, upon amendment of the agreements, these distributors were changed from sell-through distributors to sell-in distributors and we recognized the revenue for sales to these distributors upon the initial product shipments to these distributors, net of estimated allowance for returns established based upon historical return rates. In addition, revenue was recognized for unsold inventory held by these distributors on the date of change. The effect of changing these sell-through distributors to sell-in distributors resulted in a one-time increase in revenue of approximately $5.1 million and related cost of goods sold of $1.6 million related to unsold inventory held by these distributors at June 30, 2014. We generate revenue from four product groups: Linear and Power, Timing and Communications, LAN, and Foundry. The following table sets forth the net revenues attributable to our four product groups as a percentage of total net revenues, for the periods presented. Three Months Ended Nine Months Ended Net Revenues by Product Group September 30, September 30, 2014 2013 2014 2013 Net Revenues: Linear and Power 52 % 57 % 53 % 57 % Timing and Communications 25 22 24 21 LAN 21 19 21 20 Foundry 2 2 2 2 Total net revenues 100 % 100 % 100 % 100 % 19-------------------------------------------------------------------------------- Table of Contents Our products address a wide range of end markets. Net revenues by end market categorization is based on the estimated predominant category of the OEM or distributor purchasing the parts. The eventual end market where our products are incorporated may differ, especially for parts sold through distribution channels. The following table presents our revenues by end market as a percentage of total net revenues. Three Months Ended Nine Months Ended Net Revenues by End Market September 30, September 30, 2014 2013 2014 2013 As a Percentage of Total Net Revenues: Industrial 49 % 50 % 50 % 53 % Wireline Communications 21 17 19 16 Mobility 10 14 10 13 Enterprise / Cloud Infrastructure 17 15 17 14 Other 3 4 4 4 Total net revenues 100 % 100 % 100 % 100 % Critical Accounting Policies and Estimates There have been no significant changes in our critical accounting policies and estimates for the three months and nine months ended September 30, 2014, compared with our critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013. Results of Operations The following table sets forth certain operating data as a percentage of total net revenues for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Net revenues 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenues 49.0 49.3 48.1 48.3 Gross profit 51.0 50.7 51.9 51.7 Operating expenses: Research and development 23.7 24.2 24.7 23.3 Selling, general and administrative 18.1 19.2 19.3 19.5 Restructuring charges 0.8 - 0.3 - Total operating expenses 42.6 43.4 44.3 42.8 Income from operations 8.4 7.3 7.6 8.9 Interest and other (expense) income: Interest income 0.1 0.2 0.1 0.2 Other expense, net (0.1 ) (0.1 ) (0.1 ) (0.1 ) Total interest and other (expense) income, net - 0.1 - 0.1 Income before income taxes 8.4 7.4 7.6 9.0 Provision for income taxes 1.5 0.5 2.1 1.0 Net income 6.9 % 6.9 % 5.5 % 8.0 % 20-------------------------------------------------------------------------------- Table of Contents Net Revenues. For the three months ended September 30, 2014, net revenues increased 16.0% to $67.5 million from $58.2 million for the same period in the prior year. For the nine months ended September 30, 2014, net revenues increased 7.1% to $189.7 million from $177.1 million for the same period in the prior year. During the third quarter of 2014, we amended the terms of our agreements with certain sell-through distributors. These amendments included the removal of significant return rights, price protection and pricing adjustments subsequent to the initial product shipment. Therefore, upon amendment of the agreements, these distributors were changed from sell-through distributors to sell-in distributors and we recognized the revenue for sales to these distributors upon the initial product shipments to these distributors, net of estimated allowance for returns established based upon historical return rates. In addition, revenue was recognized for unsold inventory held by these distributors on the date of change. The effect of changing these sell-through distributors to sell-in distributors resulted in a one-time increase in revenue of approximately $5.1 million and related cost of goods sold of $1.6 million related to unsold inventory held by these distributors at June 30, 2014. The remainder of the increase resulted primarily from the increased demand for our products serving the enterprise/cloud infrastructure and industrial end markets, which was partially offset by the decreased demand for our products serving the mobility end market. Customer demand for semiconductors can change quickly and unexpectedly. Historically, our revenue levels have been highly dependent on the amount of new orders for products to be delivered to the customer within the same quarter. Within the semiconductor industry, orders that are booked and shipped within the same quarter are called "turns fill" orders. When the turns fill level exceeds approximately 35% of quarterly revenues, it can be very difficult to predict near term revenues and income. The resulting lack of visibility into demand also makes it difficult to match product build with future demand as our lead times to build our products may be substantially longer than order lead times. International sales represented 81% and 78% of net revenues for the three and nine months ended September 30, 2014, respectively, compared to 74% and 71% of net revenues for the three and nine months ended September 30, 2013. Sales to customers in Asia represented 67% and 64% of net revenues for the three and nine months ended September 30, 2014, compared to 60% and 58% of net revenues for the three and nine months ended September 30, 2013. The trend for our customers to move their electronics manufacturing to Asian countries has resulted in increased pricing pressure for us and other semiconductor manufacturers. The increased concentration of electronics procurement and manufacturing in the Asia Pacific region has led, and may continue to lead, to continued price pressure for our products in the future. Gross Profit. Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing capacity utilization, inventory write-downs and recoveries, product yields and average selling prices. Our gross profit margin was 51.0% and 51.9% for the three and nine months ended September 30, 2014, compared to 50.7% and 51.7% for the three and nine months ended September 30, 2013. Our gross profit continues to be negatively impacted by average selling price erosion, product mix and capacity utilization. Our gross profit was 49.5% without the one-time revenue of $5.1 million and related cost of goods sold of $1.6 million in connection with the changes from sell-through distributors to sell-in distributors as described above. Research and Development Expenses. Research and development ("R&D") expenses as a percentage of net revenues represented 23.7% for the three months ended September 30, 2014, compared to 24.2% for the three months ended September 30, 2013. On a dollar basis, R&D expenses increased $1.9 million, or 13.9%, to $16.0 million for the three months ended September 30, 2014 from $14.1 million for the three months ended September 30, 2013. This increase was primarily due to increased spending on product development, higher share-based compensation expense of $0.2 million and increased expenses related to the acquisition of Discera completed in the third quarter of 2013. For the nine months ended September 30, 2014 and 2013, R&D expenses as a percentage of net revenues represented 24.7% and 23.3%, respectively. On a dollar basis, R&D expenses increased $5.6 million, or 13.6%, to $46.9 million for the nine months ended September 30, 2014 from $41.3 million for the nine months ended September 30, 2013. The increase was primarily due to increased spending on product development, higher share-based compensation expense of $0.4 million and increased expenses related to the acquisition of Discera completed in the third quarter of 2013. We believe that the development and introduction of new products is critical to our future success and expect to continue our investment in research and development activities in the future. Selling, General and Administrative Expenses. As a percentage of net revenues, selling, general and administrative ("SG&A") expenses represented 18.1% for the three months ended September 30, 2014, compared to 19.2% for the three months ended September 30, 2013. On a dollar basis, SG&A expenses increased $1.0 million, or 9.2%, to $12.2 million for the three months ended September 30, 2014 from $11.2 million for the three months ended September 30, 2013. This increase was primarily due to increased spending on outside services of $0.2 million, higher share-based compensation expense of $0.1 million and increased expenses related to the acquisition of Discera completed in the third quarter of 2013. 21-------------------------------------------------------------------------------- Table of Contents For the nine months ended September 30, 2014 and 2013, SG&A expenses as a percentage of net revenues represented 19.3% and 19.5%, respectively. On a dollar basis, SG&A expenses increased $2.1 million, or 6.2%, to $36.6 million for the nine months ended September 30, 2014 from $34.5 million for the nine months ended September 30, 2013. The increase was primarily due to increased spending on outside services of $0.4 million, higher share-based compensation expense of $0.3 million and increased expenses related to the acquisition of Discera completed in the third quarter of 2013. Restructuring Charges. In the third quarter of 2014, we continued our efforts to reduce operating expenses. Therefore, the Company recorded restructuring charges of $0.5 million related to workforce reductions and facility closure. See Note 16 of Notes to Condensed Consolidated Financial Statements for the summary of activity related to the accrual for restructuring charges detailed by event. Share-Based Compensation. Our results of operations for the three months ended September 30, 2014 and 2013 included $2.0 million and $1.8 million, respectively, of non-cash expense related to the fair value of share-based compensation awards. For the nine months ended September 30, 2014 and 2013, our results of operations included $5.7 million and $5.1 million, respectively, of share-based compensation expense. Share-based compensation expense is included in the statements of income in cost of revenues, R&D expenses and SG&A expenses (see Note 3 of Notes to Condensed Consolidated Financial Statements). Interest and Other (Expense) Income, net. Interest and other (expense) income, net was a net expense of less than $0.1 million for the three months ended September 30, 2014 primarily due to interest expense related to unclaimed property. Interest and other (expense) income, net was an income of $0.1 million for the nine months ended September 30, 2014. The Company had a net interest and other income of less than $0.1 million and $0.1 million for the three and nine months ended September 30, 2013, respectively. Interest income reflects income from short-term and long-term investments and money market funds. Provision for Income Taxes. For the three months ended September 30, 2014, the provision for income taxes was $1.0 million, or 17.3% of income before taxes, compared to $0.3 million, or 6.1% of income before taxes for the three months ended September 30, 2013. For the nine months ended September 30, 2014, the provision for income taxes was $4.0 million, or 27.4% of income before taxes, compared to $1.7 million, or 10.6% of income before taxes for the nine months ended September 30, 2013. The increase in the provision for income taxes for both the three months and nine months ended September 30, 2014, compared to the three months and nine months ended September 30, 2013 was primarily due to the expiration of the federal R&D credit as of December 31, 2013 and additional research and development credits for various periods recorded as a discrete benefit for the three months ended March 31, 2013. The income tax provision for the three months ended September 30, 2014 and 2013 included previously unrecognized tax benefits of $0.9 million and $0.8 million, respectively, due to a lapse of the statute of limitations. The income tax provision for these interim periods differs from taxes computed at the federal statutory rate primarily due to the tax effects of share-based compensation, federal and state research and development credits, federal qualified production activity deductions and previously unrecognized tax benefits. Liquidity and Capital Resources Since inception, our principal sources of funding have been our cash from operations, bank borrowings and sales of common stock. Principal sources of liquidity at September 30, 2014 consisted of cash, cash equivalents and short-term investments of $100.7 million and a $5.0 million unsecured credit facility from a commercial bank. We generated $24.5 million in cash from operating activities during the nine months ended September 30, 2014. Significant cash flows included cash provided by net income of $10.5 million plus additions for non-cash activities of $13.7 million (consisting primarily of $10.3 million in depreciation and amortization and $5.7 million in share-based compensation expense, partially offset by a $2.3 million increase in deferred income taxes), combined with a $1.6 million increase in accrued liabilities and other long-term liabilities, $1.3 million decrease in inventories, $0.8 million increase in accounts payable which were offset in part by a $1.3 million decrease in prepaid taxes and a $0.7 million decrease in deferred income on shipments to distributors. We generated $22.2 million in cash from operating activities during the nine months ended September 30, 2013. Significant cash flows included cash provided by net income of $14.3 million plus additions for non-cash activities of $11.8 million (consisting primarily of $9.8 million in depreciation and amortization, $5.1 million in share-based compensation expense, partially offset by a $3.1 million increase in deferred income taxes) combined with a $6.7 million increase in deferred income on shipments to distributors, and a $2.1 million increase in accrued liabilities and other long-term liabilities which were offset in part by a $3.5 million increase in accounts receivable, a $1.7 million increase in inventories and a $6.4 million decrease in accounts payable. 22-------------------------------------------------------------------------------- Table of Contents We used $2.7 million of cash for investing activities during the nine months ended September 30, 2014, primarily comprised of $36.5 million in purchases of investments and $5.6 million of purchases of property, plant and equipment, offset by $38.4 million in proceeds from the sales and maturities of investments. We used $5.8 million of cash for investing activities during the nine months ended September 30, 2013, primarily comprised of $50.1 million in purchases of investments, $6.1 million of acquisition of Discera and $5.8 million of purchases of property, plant and equipment, partially offset by $57.0 million in proceeds from the sales and maturities of investments. We used $10.6 million of cash for financing activities during the nine months ended September 30, 2014 primarily for the repurchases of $13.0 million of our common stock and $8.5 million for the payment of cash dividends, which were partially offset by $10.4 million in proceeds from employee stock transactions. We used $15.1 million of cash for financing activities during the nine months ended September 30, 2013 primarily for the repurchases of $13.2 million of our common stock and $5.4 million for the payment of cash dividends, which were partially offset by $3.7 million in proceeds from employee stock transactions. We currently intend to spend approximately $4.0 million to $8.0 million to purchase capital equipment and make facility improvements during the next twelve months primarily for manufacturing equipment and additional research and development related software and equipment. On October, 23, 2014, our Board of Directors declared a cash dividend of $0.05 per outstanding share of common stock payable on November 20, 2014 to shareholders of record at the close of business on November 6, 2014. This dividend will be recorded in the fourth quarter of 2014 and is expected to be approximately $2.8 million. On August 20, 2014, we announced that our Board of Directors authorized the repurchase of $25.0 million of our common stock, which increased the total approval for repurchase since February 2010 to $145.0 million. Under our stock repurchase program, as of September 30, 2014, we have remaining authorization to repurchase $37.4 million of our common stock. During the three and nine months ended September 30, 2014, we repurchased 0.6 million and 1.2 million shares, respectively, of our common stock for an aggregate price of $7.5 million and $13.4 million, respectively, which included $0.5 million of share repurchases pending cash settlement as of September 30, 2014. We believe that our cash from operations, existing cash balances, short-term investments and our credit facility will be sufficient to meet our cash requirements for at least the next twelve months. In the longer term, we believe future cash requirements will continue to be met by our cash from operations, credit arrangements and future debt or equity financings as required. During the three and nine months ended September 30, 2014, we sold $0.1 million and $3.0 million of auction-rate notes at par value, respectively. At September 30, 2014, we held remaining $1.8 million in principal of senior auction-rate notes secured by student loans. Auctions for these remaining auction-rate notes have failed as of September 30, 2014. The fair value of these notes, $1.7 million, has been classified as long-term investments as of September 30, 2014. The funds associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuers redeem the securities or the underlying securities have matured. For additional information regarding our investments, see Note 4 of Notes to the Condensed Consolidated Financial Statements. At September 30, 2014, we had cash, cash equivalents and short-term investments of $100.7 million, of which $13.2 million was held by our foreign subsidiaries. Some of these available cash, cash equivalents and short-term investments are held in accounts managed by third-party financial institutions and consist of invested cash and cash in our operating accounts. The invested cash is invested in interest bearing funds managed by third-party financial institutions. To date, we have not experienced loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. Recently Issued Accounting Standards Please refer to Note 2 of Notes to Condensed Consolidated Financial Statements for a discussion of the expected impact of recently issued accounting standards. 23-------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments As of September 30, 2014, we had the following contractual obligations and commitments (in thousands): Payments Due By Period Less than 1 Total Year 1-3 Years 4-5 Years After 5 Years Operating leases $ 2,424 $ 1,148 $ 1,064 $ 212 $ - Open purchase orders 23,297 23,297 - - - Software licenses purchase obligations 1,682 938 589 155 - Total $ 27,403 $ 25,383 $ 1,653 $ 367 $ - 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. Borrowing agreements consisted of a $5.0 million unsecured credit facility for general working capital needs, which includes a $5.0 million letter of credit sub-facility including a $2.0 million foreign exchange sub-facility. As of September 30, 2014, we had no borrowings under the credit facility. Our borrowing arrangements include a provision for the issuance of commercial or standby letters of credit by the bank on our behalf, which are issued to guarantee payments for our workers compensation program. As of September 30, 2014, there was $0.3 million in letters of credit outstanding. As of September 30, 2014, we had $9.1 million of net unrecognized tax benefits consisting of $3.0 million included in long-term income taxes payable and $6.0 million recorded as a reduction to deferred tax assets. We do not anticipate a significant change to the $3.0 million long-term uncertain income tax positions within the next twelve months. Due to the high degree of uncertainty regarding the settlement of these liabilities, we are unable to estimate the year in which the future cash flows may occur and therefore have not included them in the above table. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements and have not entered into any transactions involving unconsolidated, limited purpose entities or commodity contracts. |